Forfaiting and factoring

Factoring and forfaiting

International financial settlements

2

Lecture outline
Factoring as trade finance method
Forfaiting as trade finance method


3

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

4

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


5

The mechanism of factoring
 The factoring transaction involves three parties:
 The seller-the exporter
 The debtor-the importer
 The factor


6

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

7

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


8

Advantages
 Factoring enables risk-free export sales
 The exporter can offer more attractive
transaction terms
 Exporters are relieved from administration
duties


9

When to use factoring?
 Factoring is more expensive than a bank
loan
 In fact it is not a loan
 It 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

10

Would factors always buy the
receivables?
The credit history of the debtor is a crucial
condition
The current creditworthiness of the debtor
Usually even average credit rating of the
debtor is refused by factors

120881-1165

11

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

12

Forfaiting (1)
 A transaction where a forfaiting institution buys withoutrecourse the debt resulting from a trade contract which is
due in the future
Forfaiting is usually aimed at medium-term capital goods
financing
The subject of forfaiting transactions are usually fixed
assets
As this type of goods are usually expensive the financing
period may account for several years


13

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


14

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


15

The forfaiting process

Source: E. Bishop, op. Cit.
16

Does the bank always agree to
forfaiting?
 The bank needs a guarantee that the debt will
be paid off
 The debt should be freely transferable
 The 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


17

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


18

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 papers
 They are liquid assets with comparatively high
yields


19

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



20

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

21

Advantages of forfaiting for the
exporter
 Conversion of a credit transaction into a
cash transaction
Increase of liquidity
 Risk elimination (market, transaction and
political risks)
 Relieve of administration duties

22

Advantages of forfaiting for the
importer
The flexibility to pay for his goods
Deferred payment
Fixed interest cost


23

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


24

Discussion
Factoring and forfaiting are withoutrecourse methods of trade finance. Is this
always beneficial? Name examples when
recourse financing would be more
beneficial.

25

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


26

Forfaiting and factoring

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