Forfaiting and factoring are two types of financing for international trade that involve the sale of an exporter’s accounts receivable. Factoring deals with ordinary goods with immediate payment, while forfaiting deals with high-value exports with longer payment terms. Both provide cash flow and reduce risk for exporters.
Forfaiting and factoring are two ways of financing exports of international goods through the collection of accounts receivable, distinguishable from each other by the type of export goods involved and the time that the importer has to pay. Factoring deals with the sale of an exporter’s receivables in ordinary goods with the balance of payment terms due at or shortly after delivery. Forfaiting also deals with the sale of an exporter’s accounts receivable, but only in connection with capital goods, products, or other high-value export transactions and when the importer’s period to complete payment is at least six months. .
Commercial banks and specialized financial firms have developed credit products that reduce the risks inherent in international trade and provide cash flow so that exporters can be competitive in the global marketplace. Forfaiting and factoring are two types of international trade financing mechanisms that play an essential role in the viability of exports. Typically, once an exporter ships product to an importer, they have to wait until the products are received before payment is processed. Payment is generally guaranteed by the importer’s bank, but receipt of payment does not occur until after proof of delivery is presented.
Consequently, a shipment of goods appears on the exporter’s books as an account receivable, or money that is scheduled to be collected at some point in the future. This can have a negative impact on the exporter’s cash flow, tying up money that cannot be reinvested in the production of additional goods for sale. Forfaiting and factoring provide solutions to this cash flow problem and, as a result, allow exporters to sell more products and be more competitive internationally. The difference between the two types of financing lies in the types of assets each deals with and the length of time accounts receivable can remain on the books before payment.
Both forfaiting and factoring are carried out by banks or by specialized financial companies. The financial institution buys the accounts receivable from the exporter at a discount. This provides the exporter with their sales revenue immediately, without having to wait for the importer to confirm delivery, and provides the finance company with the discount percentage as interest on the extension of credit. This transaction is often non-recourse, but there is a small risk in the transaction for the financing company because the importer’s payment is usually guaranteed by a letter of credit from the importer’s bank.
Although they involve the same basic process, forfaiting and factoring differ in subject matter. Factoring is the term used for ordinary commercial goods with payment expected immediately upon delivery. Forfaiting is the term used for financing accounts receivable for capital goods, products, or other high-value bulk merchandise. These types of transactions have longer payment terms, so abandonment may imply the extension of credit for payment terms from six months to seven years.
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