What is the difference between forfaiting and factoring?
Forfaiting and factoring are two ways of financing exports of international goods through the collection of accounts receivable, distinguished from each other by the type of export goods involved and the time the importer has to pay. Factoring deals with the sale of an exporter's receivables on common goods with the balance of payment terms due on delivery or shortly thereafter. Forfaiting also deals with the sale of accounts receivable from an exporter, but only in relation to capital goods, commodities or other high-value export transactions and when the importer's deadline to complete payment is at least six months.
Specialized commercial and financial banks 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 market. Forfaiting and factoring are two types of international trade financing mechanisms that play an indispensable role in the viability of exports. Normally, once an exporter ships the product to an importer, he has to wait until the products are received before processing the payment. Payment is usually guaranteed by the importer's bank, but payment is not received until proof of delivery is presented.
Consequently, a shipment of goods appears on the exporter's books as an account receivable, or cash 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 cash that cannot be reinvested in producing 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 handles and how long the account receivable can remain on the books before payment.
Both forfaiting and factoring are carried out by banks or specialized financial companies. The financial institution purchases the accounts receivable from the exporter at a discount. This provides the exporter with the proceeds of their sales immediately, without having to wait for the importer to confirm delivery, and provides the finance company with the discount percentage as interest on the credit extension. This operation is often without recourse, but there is a small risk in the operation for the financing company because the importer's payment is usually guaranteed by a letter of credit from the importer's bank.
Although it involves the same basic process, forfaiting and factoring differ in subject matter. Factoring is the term used for common 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 goods. These types of operations have longer payment terms, therefore, abandonment may imply extending the credit to payment terms from six months to seven years.