Factoring
Factoring is a financial transaction where a business sells its accounts receivable (invoices) to a
third party, known as a factor, at a discount. This enables the business to receive immediate
cash, improving its liquidity and allowing it to focus on its operations without waiting for
customer payments.
Key Components of Factoring
1. Accounts Receivable: The money owed to a company by its customers for goods or
services delivered but not yet paid for.
2. Factor: A financial intermediary or institution that purchases the receivables from the
business at a discount and assumes responsibility for collecting the payment from the customer.
3. Discount Rate: The fee the factor charges the business for providing upfront cash. This
typically ranges from 1% to 5% of the invoice value, depending on factors like the customer's
creditworthiness, industry, and payment terms.
How Factoring Works
1. Sale of Receivables: A business generates sales and invoices its customers. Instead of
waiting for the payment terms (e.g., 30, 60, or 90 days), the business sells the invoice to the
factor.
2. Advance Payment: The factor pays the business an advance, typically around 70% to 90%
of the invoice value, upfront.
3. Collection: The factor collects the full payment from the customer on the due date of the
invoice.
4. Settlement: After collecting the payment, the factor remits the remaining balance to the
business, minus the factoring fee (the discount).
Types of Factoring
1. Recourse Factoring:
The business retains the credit risk.
If the customer fails to pay, the business must reimburse the factor for the uncollected invoice.
Lower cost since the factor bears less risk.
2. Non-Recourse Factoring:
The factor assumes the credit risk.
If the customer defaults, the factor absorbs the loss.
Higher cost due to the increased risk for the factor.
3. Disclosed vs. Undisclosed Factoring:
Disclosed Factoring: The customer is informed that the invoice has been sold to a factor and will
make payments directly to the factor.
Undisclosed Factoring: The customer is not aware of the factoring arrangement and continues
making payments to the business, which then passes them on to the factor.
4. Domestic vs. International Factoring:
Domestic Factoring: The sale of invoices within the same country.
International Factoring: Involves export or import transactions, often with a two-factor system
(one factor in the seller's country, another in the buyer's).
Advantages of Factoring
1. Improved Cash Flow: Immediate cash inflows help the business manage its working capital
efficiently without waiting for customer payments.
2. Risk Reduction: In non-recourse factoring, the factor assumes the credit risk, protecting the
business from customer defaults.
3. No Debt Incurred: Factoring is not a loan, so the business does not incur debt or affect its
balance sheet leverage.
4. Outsourced Collections: The factor handles the collection process, reducing administrative
burdens on the business.
5. Better Terms for Customers: Factoring allows the business to offer longer payment terms to
customers without hurting its cash flow.
Disadvantages of Factoring
1. Costly: Factoring fees (the discount) can be high, particularly for businesses with risky
customers or those seeking non-recourse factoring.
2. Customer Relationship: Customers may react negatively to being contacted by a third party
(the factor) for payment.
3. Loss of Control: The business may lose some control over the collection process, especially
in non-recourse factoring.
4. Qualification Criteria: Not all businesses qualify for factoring. Factors typically look at the
creditworthiness of the customers, not just the business.
Who Uses Factoring?
Factoring is commonly used by businesses in industries where credit sales are prevalent, and
long payment terms are standard, such as:
Manufacturing: Companies selling goods on credit need cash to finance production and
operations.
Transportation/Logistics: Trucking companies and logistics providers often use factoring to
manage cash flow while waiting for customer payments.
Textiles and Apparel: These industries often operate on long payment cycles, making factoring a
useful tool to manage cash.
Construction: Contractors and subcontractors may face delayed payments, so factoring helps
maintain liquidity.
Recent Trends in Factoring
1. Technology-Driven Factoring: The rise of fintech platforms has made factoring more
accessible, particularly for small and medium-sized enterprises (SMEs). Digital factoring
platforms enable businesses to quickly sell invoices online, often with lower fees.
2. Supply Chain Finance: Some companies have integrated factoring as part of supply chain
finance programs, where large buyers help their suppliers access factoring at more favorable
terms.
3. Green Factoring: Emerging as part of sustainable finance, some factors offer special terms
for businesses engaged in environmentally responsible activities.
Factoring remains a powerful tool for businesses to manage cash flow and mitigate credit risk,
particularly in industries where delayed payments are the norm. By selling receivables,
businesses can unlock liquidity and continue their operations smoothly.
Forfaiting
Forfaiting is a financing technique used primarily in international trade, where an exporter sells
its medium- to long-term receivables (promissory notes or bills of exchange) to a forfaiter
(usually a financial institution) in exchange for immediate cash. This transaction is non-recourse,
meaning the forfaiter assumes the risk of non-payment from the importer (the buyer).
Key Components of Forfaiting
1. Receivables: Forfaiting deals with long-term receivables, usually promissory notes or bills of
exchange, related to international trade transactions.
2. Forfaiter: The financial institution or intermediary that buys the receivables from the exporter
and provides upfront cash.
3. Non-Recourse: Forfaiting is always non-recourse, meaning the forfaiter bears all the risk
associated with non-payment by the buyer. If the buyer defaults, the exporter has no obligation
to repay the forfaiter.
4. Discounting: The forfaiter purchases the receivables at a discount, which reflects the time
value of money, the credit risk, and other associated costs.
How Forfaiting Works
1. Export and Sale Agreement: An exporter sells goods or services to a foreign buyer (importer).
Instead of receiving payment immediately, the buyer agrees to pay at a future date (deferred
payment).
2. Issuance of Receivables: The buyer issues a promissory note or bill of exchange for the
amount owed, which is often guaranteed by a bank in the buyer's country (via a letter of credit or
bank guarantee).
3. Forfaiting Agreement: The exporter sells the receivables to a forfaiter, usually at a discount.
The forfaiter provides the exporter with cash upfront (typically 100% of the receivables minus
the discount fee).
4. Collection of Payment: On the due date, the forfaiter collects the full payment from the buyer
or the buyer’s bank. Since the transaction is non-recourse, the forfaiter assumes all the risks
associated with non-payment.
Key Characteristics of Forfaiting
1. Non-Recourse: One of the defining features of forfaiting is that it is always non-recourse. This
means the forfaiter bears the risk of non-payment and the exporter is not liable if the buyer
defaults.
2. Medium to Long-Term Financing: Forfaiting is typically used for financing periods ranging
from 180 days to 7 years. It is often used for capital goods, large infrastructure projects, and
machinery.
3. International Trade Focus: Forfaiting is primarily used in international trade, particularly for
high-value export transactions. It helps exporters manage risks associated with cross-border
trade, such as political or economic instability.
4. Guaranteed Receivables: In many cases, the receivables are backed by bank guarantees or
letters of credit, providing an additional layer of security to the forfaiter.
Advantages of Forfaiting
1. Eliminates Risk for Exporter: Since forfaiting is non-recourse, the exporter is protected from
the risk of non-payment by the buyer or any political, economic, or currency risks in the buyer’s
country.
2. Improved Cash Flow: The exporter receives immediate cash instead of waiting for the buyer’s
deferred payment, improving liquidity and working capital.
3. No Debt on Balance Sheet: Forfaiting is not considered a loan, so the exporter does not take
on additional debt or affect its balance sheet leverage.
4. Simplifies Exporting: By outsourcing the credit risk and collections process, the exporter can
focus on its core operations without worrying about payment recovery or political risks.
5. Flexible: Forfaiting can be used for a wide variety of international transactions, especially for
projects requiring longer payment terms, such as capital goods exports or infrastructure
development.
Disadvantages of Forfaiting
1. Costly: The forfaiter charges a discount fee, which includes the cost of assuming the credit
risk, the time value of money, and administrative fees. This can make forfaiting more expensive
compared to other financing options.
2. Limited Use: Forfaiting is generally only applicable to large, high-value transactions (such as
exports of capital goods, machinery, or large construction projects) with medium- to long-term
payment terms.
3. Not Suitable for Short-Term Receivables: Forfaiting is generally used for longer payment
terms (180 days to several years) and may not be practical for short-term trade financing.
4. Dependence on Buyer’s Creditworthiness: The ability to forfait receivables often depends on
the creditworthiness of the buyer or the strength of the guarantees provided by their bank.
Forfaiting Process Flow
1. Negotiation: The exporter and the buyer agree on the sale of goods with deferred payment
terms, and the buyer issues a promissory note or bill of exchange.
2. Forfaiter Involvement: The exporter approaches a forfaiter, who evaluates the receivables
and offers a discount rate.
3. Sale of Receivables: The exporter sells the receivables to the forfaiter and receives cash
upfront, minus the forfaiting discount fee.
4. Collection by Forfaiter: The forfaiter collects the full payment from the buyer on the maturity
date.
Key Players in Forfaiting
1. Exporter: The seller of goods or services who wishes to transfer the risk of non-payment to a
third party (forfaiter) and receive immediate cash.
2. Importer (Buyer): The buyer who purchases goods or services on deferred payment terms
and provides a promissory note or bill of exchange.
3. Forfaiter: The financial institution or intermediary that purchases the receivables at a discount
and assumes the risk of collecting payment.
4. Bank (Guarantor): Often, a bank in the buyer’s country guarantees the payment via a letter of
credit or bank guarantee, providing additional security to the forfaiter.
Industries and Applications of Forfaiting
Forfaiting is most commonly used in industries that deal with large capital investments or
long-term projects, such as:
1. Capital Goods: Export of machinery, equipment, and heavy-duty vehicles often involves long
payment terms, making forfaiting an ideal solution.
2. Infrastructure Projects: Large-scale construction or development projects (e.g., roads,
bridges, power plants) often have extended payment periods that require forfaiting for risk
mitigation.
3. Aerospace and Defense: High-value, complex international transactions in aerospace and
defense can be de-risked using forfaiting, where payment might be deferred for several years.
4. Shipping and Transport: Long-term contracts for ships, cargo containers, or transport
equipment may involve forfaiting for financing.
Recent Trends in Forfaiting
1. Digital Platforms: Just like other trade finance solutions, forfaiting is being increasingly
facilitated by digital platforms. These platforms streamline the negotiation and execution
process, making it more accessible to exporters globally.
2. Sustainability: Some forfaiting transactions are now tied to green finance, focusing on
projects with positive environmental impacts, such as renewable energy exports or eco-friendly
infrastructure development.
3. Emerging Markets: Forfaiting is gaining prominence in emerging markets, particularly in Asia
and Africa, where exporters are looking to mitigate the higher political and economic risks
involved in cross-border trade.
Forfaiting is a valuable financial tool for exporters dealing with large, high-value transactions
and deferred payment terms. By selling receivables to a forfaiter, exporters can eliminate the
risks associated with buyer defaults, improve their cash flow, and focus on business growth.
However, forfaiting comes at a cost, and its use is best suited for medium- to long-term
international transactions, particularly in industries like capital goods, infrastructure, and
defense.
Comparison
1. Definition
Factoring: Factoring is a financial arrangement where a business sells its short-term receivables
(invoices) to a factor at a discount, in exchange for immediate cash. It is commonly used in
domestic and international trade where short payment terms are the norm.
Forfaiting: Forfaiting is a financial arrangement used primarily in international trade where an
exporter sells its medium- to long-term receivables (promissory notes, bills of exchange) to a
forfaiter at a discount, in exchange for immediate cash. It is typically used for larger transactions
with longer payment terms.
2. Receivables Type
Factoring:
Deals with short-term receivables (usually 30 to 90 days).
Invoices for goods or services that have already been delivered, and payment is expected within
a short period.
Forfaiting:
Deals with medium- to long-term receivables (180 days to 7 years).
Promissory notes or bills of exchange, usually for large capital goods or infrastructure projects
where payment terms are extended over a longer period.
3. Type of Transactions
Factoring:
Used for ongoing, repetitive transactions.
Suitable for businesses that generate regular sales and invoices.
Commonly used by manufacturers, wholesalers, retailers, and service providers that deal with
frequent orders and payments.
Forfaiting:
Typically used for one-off, high-value export transactions.
Ideal for companies that export capital goods, machinery, or are involved in large infrastructure
projects.
Often used in international transactions for projects with deferred payments over several years.
4. Recourse vs. Non-Recourse
Factoring:
Can be either recourse or non-recourse.
Recourse Factoring: The business remains liable if the customer (debtor) fails to pay. The factor
can claim the uncollected amount from the business.
Non-Recourse Factoring: The factor assumes the risk of non-payment, protecting the business
from customer defaults.
Forfaiting:
Always non-recourse. The forfaiter assumes the full risk of non-payment by the importer or
buyer, meaning the exporter is not liable if the buyer defaults. This is a critical feature of
forfaiting and is especially important in international trade, where political and economic risks
can be significant.
5. Nature of Risk
Factoring:
The factor assesses the creditworthiness of the buyer (debtor) before purchasing the invoices.
In recourse factoring, the business still retains some credit risk.
Factoring is often affected by the financial health of the business’s customers and their payment
habits.
Forfaiting:
The forfaiter assesses the creditworthiness of the buyer (importer) and typically requires bank
guarantees or letters of credit to further mitigate risk.
The risk borne by the forfaiter includes credit risk, political risk, currency risk, and economic risk
related to the buyer’s country.
Forfaiting provides complete protection to the exporter from both commercial and political risks.
6. Parties Involved
Factoring:
Involves three parties: the business (seller), the customer (debtor), and the factor.
The customer is typically notified that the invoice has been sold to the factor and payments are
made directly to the factor.
Forfaiting:
Involves four parties: the exporter, the importer (buyer), the forfaiter, and often a guarantor bank
(which provides a letter of credit or guarantee in favor of the forfaiter).
The importer’s bank plays a key role in enhancing the security of the transaction for the forfaiter.
7. Payment Terms
Factoring:
Payment terms are usually short-term (30 to 90 days).
The factor pays an advance of around 70% to 90% of the invoice value upfront, with the
remaining amount settled (minus fees) once the factor collects payment from the customer.
Forfaiting:
Payment terms are medium- to long-term, often ranging from 180 days to 7 years.
The forfaiter typically pays 100% of the face value of the promissory note upfront (minus the
discount) since they bear all the risk.
8. Use Case / Industries
Factoring:
Used in industries with short sales cycles and frequent sales transactions, such as:
Manufacturing
Retail
Textiles and Apparel
Transportation and Logistics
Services (e.g., staffing agencies)
Forfaiting:
Used in industries involved in capital-intensive and high-value projects with long-term payment
cycles, such as:
Capital goods (machinery, equipment)
Infrastructure (roads, bridges, power plants)
Aerospace and Defense
Shipping and Transport
9. Costs
Factoring:
The discount rate typically ranges from 1% to 5% of the invoice value, depending on the
creditworthiness of the customers, the industry, and the duration of the receivables.
Recourse factoring is generally cheaper than non-recourse factoring because the factor
assumes less risk.
Forfaiting:
The discount rate is typically higher, given the longer payment periods and the increased risk,
including commercial, political, and currency risks.
Forfaiting is generally more expensive than factoring because it involves more complex,
high-value, and long-term transactions.
10. Customer Relationship
Factoring:
The factor usually contacts the customer (debtor) directly for payment, which can sometimes
affect the business’s relationship with its customers.
In undisclosed factoring, the customer may not be aware that their invoice has been factored, so
the business retains control over customer communication.
Forfaiting:
The forfaiter does not typically interact directly with the importer (buyer) beyond collecting the
receivable when it matures.
Since forfaiting involves international trade, the buyer is often aware of the forfaiting agreement
as it typically requires a bank guarantee.
11. Collateral and Guarantees
Factoring:
The receivables themselves act as collateral.
In some cases, factoring may not require additional security beyond the receivables.
Forfaiting:
Forfaiting often requires additional security, such as bank guarantees or letters of credit from a
reputable bank in the buyer's country.
These guarantees provide additional protection for the forfaiter, especially in cross-border
transactions involving higher risk.
12. Common Geographical Focus
Factoring:
Used for both domestic and international trade, but more commonly for domestic transactions.
Growing use in small- and medium-sized enterprises (SMEs) looking for short-term financing
solutions.
Forfaiting:
Primarily used in international trade, especially for transactions between developed countries
and emerging markets.
Often used in large, cross-border trade deals that require longer-term financing.
