Forfaiting and Factoring are often used synonymously by a layman, but there are differences between the two. Forfaiting is an international finance mechanism where an exporter sells its accounts receivables to a third party, whereas in factoring a business sells the receivables of accounts to a third party and in exchange receives an immediate advance on the amount.
What is Forfaiting?
Forfaiting is defined as a method where the exporter of the products or services sells its accounts receivables to a third party at a discount in order to immediately receive the cash payment. Here the third party is known as the forfeiter. The third party can be any financial institution, trading firm, bank, or any single individual who is purchasing foreign products or services from the exporters. To collect the due amount from the importer within the credit time period is the responsibility of the third party. Therefore the risk of non-payments is towards the third party. Further, the exporter is not responsible for further payment dues and other deals.
Features of Forfaiting
- Forfaiting is an international finance mechanism.
- Any convertible currency can be used to receive the payments.
- In the Forfaiting mechanism, only long-term and medium-term bills receivables can be financed.
- The minimum value of the transaction must be greater than $100,000
- The third party has the right to hold treasury bills and promissory notes till the maturity period ends.
- Exporters have an advantage in forfaiting that they are not responsible for credit and money transfer-related risks.
- Forfaiting is extended to export capital goods.
- In forfaiting the credit period can range from three months to seven years.
What is Factoring?
In finance, factoring is defined as a mechanism where businesses sell the receivables of their accounts to a third party and in exchange receive an immediate advance on the amount. The third party in factoring is known as a factor. The business receives an advance of 80% of its total invoice amount. In the process of factoring the responsibility of collecting the payments from the customers is transferred to the third party. The seller does not have any responsibility for collecting the dues or payments from customers. The service fees charged by the factors range from 2% to 6%. This service fee depends upon various factors, such as size of deal, market trends, type of factoring, quality of portfolio, competitors in the market, etc.
Features of Factoring
- Factoring is used for international as well as domestic trade.
- Factoring is used for short-term account receivables.
- In factoring the credit period for account receivables is 90 days to 150 days.
- Collecting the payments from customers is the responsibility of factors.
- In order to recover the due payment from customers, factors have the right to take legal action.
- Factoring can be done with or without recourse.
- If factoring is recourse, the loss that occurred due to payment defaults by customers or buyers needs to be bear by the seller.
Difference between Forfaiting and Factoring
|
Basis |
Forfaiting |
Factoring |
|---|---|---|
| Definition | Forfaiting is defined as a term where the exporter of the products or services sells its accounts receivables to a third party at a discount in order to immediately receive the cash payment. | Factoring is defined as a mechanism where businesses sell the receivables of their accounts to a third party and in exchange receive an immediate advance on the amount. |
| Goods | Goods involved in forfaiting are majorly capital goods such as machinery and other equipment. | Goods involved in factoring are mostly consumer goods and services. |
| Type of Trade | Forfaiting mainly includes international trade. | Factoring mainly includes domestic trade. |
| Risk | In forfaiting, the third party has to deal with all the risk. | In factoring, the seller has to deal with risk. |
| Recourse | Forfaiting is always without recourse. | Factoring can be done with or without recourse |
| Time period | Forfaiting is used for long-term and medium-term account receivables therefore credit period is of 3 months to 7 years. | Factoring is used for short-term account receivables therefore credit period is of 90 to 150 days. |
| Cost | In forfaiting, the third party has to bear the cost. | In factoring, the seller has to bear the cost. |
| Secondary Market | In the forfaiting process, the receivables can be sold in the secondary market. | In the factoring process, there is no involvement with the secondary market. |
| Negotiable instrument | In Forfaiting, the third party has the right to hold negotiable instruments such as treasury bills and promissory notes till the maturity period ends. | In the process of factoring, no negotiable instruments are held by any of the involved parties. |
| Financing | 100% finance can be provided in forfaiting. | 80% to 90% of finance can be provided in factoring. |