Forfaiting and factoring

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Factoring and forfaiting

International financial settlements 120881-1165

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Lecture outline

Factoring as trade finance methodForfaiting as trade finance method


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Factoring

Factoring is a transaction where the exporter

sells its receivables to an institution

The factoring institution buys the receivables

without recourse

Due to increased risk factors demand

discount on the receivables


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Types of factoring

Maturity factoring- the factor pays the exporter at maturity of the accounts receivable

Advance factoring- the factor pays the exporter in advance a specified share of the receivables


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The mechanism of factoring

The factoring transaction involves three parties: The seller-the exporter The debtor-the importer The factor


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The mechanism of factoring

The receivables sold are usually invoices for the delivered products

Factoring can take place with or without notification of the debtor

In the case of notification the factor carries out the collection, in the case of lack of notification the exporter carries out the collection


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Advantages

Factoring is advantageous for exporters because this way they can obtain cash

This can especially beneficial if companies struggle with liquidity problems

In some industries factoring is the historic method of finance e.g. in textiles or apparel branches


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Advantages

Factoring enables risk-free export sales The exporter can offer more attractive

transaction termsExporters are relieved from administration

duties


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When to use factoring?

Factoring is more expensive than a bank loan

In fact it is not a loanIt can happen that banks would refuse a loan

to an exporter to provide him with cash but a factor would buy his receivables

The factor checks the creditworthiness of the debtor and not of the seller

Especially beneficial for small exporters


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Would factors always buy the receivables?

The credit history of the debtor is a crucial condition

The current creditworthiness of the debtorUsually even average credit rating of the

debtor is refused by factors


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Is the debtor affected by factoring?

Some types of debtors- usually large firms or governments have specified procedures when it comes to transferring the payment from the seller to debtor

This matters especially due to the obligation of the factor to perform the collection

The distinction between assignment of the responsibility to perform the work and the assignment of funds to the factor influences largely the debtor’s processes

Sometimes the debtor wants the seller to perform the collection


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Forfaiting (1)

A transaction where a forfaiting institution buys without-recourse the debt resulting from a trade contract which is due in the futureForfaiting is usually aimed at medium-term capital goods financingThe subject of forfaiting transactions are usually fixed assetsAs this type of goods are usually expensive the financing period may account for several years


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Forfaiting (2)

Exporters are not willing to finance importers over such a long period

This is why the debt of the importer is sold to forfaiters (usually banks)

Forfaiting financing usually refers to transactions exceeding 500000 USD

For larger transaction more than one forfaiting institutions can be involved


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Forfaiting (3)

The forfaiting institution takes over the risk of the sales transaction.

The exporter is liable for the quality and reliability of the project

The forfaiter has an unconditional payment obligation


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Source: E. Bishop, op. Cit.

The forfaiting process

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Does the bank always agree to forfaiting?

The bank needs a guarantee that the debt will be paid off

The debt should be freely transferableThe forfaiting bank requires the debt purchased

to be secured by a credible bank guarantee or the importer to be a prime buyer, e.g. government agency or a multinational company


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Required documents

The guarantee can take the form of: promissory notes bills of exchange, book receivables deferred payments under a letter of

credit


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Forfaiting paper

All documents guarantying the transaction e.g. bills of exchange and promissory notes become the property of the forfaiter

The documents are called forfaiting papersThey are liquid assets with comparatively high

yields


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What are the costs of forfaiting?(1)

The forfaiting institution demands cash for buying the debt

The value of the debt is discounted at a specified rate,

The forfaiting institution demands also a risk premium on the transaction


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What are the costs of forfaiting? (2)

The discount margin is the one of the principal costs of forfaiting

Besides the discount margin the bank charges a commitment fee

The discount can be computed as straight discount or discount to yield basis


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Advantages of forfaiting for the exporter

Conversion of a credit transaction into a cash transactionIncrease of liquidity Risk elimination (market, transaction and political risks) Relieve of administration duties


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Advantages of forfaiting for the importer

The flexibility to pay for his goods Deferred paymentFixed interest cost


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Summing up

Factoring and forfaiting can be beneficial methods of

trade finance

Both allow to transfer credit transactions into cash

transactions

Factoring serves financing short term transactions while

forfaiting medium term transactions


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Discussion

Factoring and forfaiting are without-

recourse methods of trade finance. Is this

always beneficial? Name examples when

recourse financing would be more

beneficial.


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Literature

E. Bishop, Finance of international trade, Chapter 10. Publication available via Science Direct Database


Forfaiting and factoring

Economy & Finance

factoring factoring

factoring transaction

forfaiting bank

factoring institution

costs of forfaiting

forfaiting institutions

forfaiting papers

future forfaiting