Forfaiting and factoring are two ways of financing exports of international goods through accounts receivables collection, distinguishable from each other by the type of export goods involved and the length of time the importer has to pay. Factoring deals with the sale of an exporter's accounts receivable on ordinary goods with the balance of payment terms due upon delivery or shortly thereafter. Forfaiting also deals with the sale of an exporter's accounts receivable but only in regard to capital goods, commodities or other high-value export transactions and when the importer's period to complete payment is at least six months.
Commercial banks and specialized financing firms have developed credit products that reduce the risks inherent in international trade and provide cash flow so exporters can be competitive in the global marketplace. Forfaiting and factoring are two types of international trade financing mechanisms that play an indispensable role in the viability of exporting. Ordinarily, once an exporter ships product to an importer, he has to wait until the goods are received before payment is processed. The payment is typically guaranteed by the importer's bank, but receipt of payment does not happen until after proof of delivery is presented.
Consequently, a shipment of goods appears on the exporter's books as a receivable, or money he is scheduled to collect at some point in the future. This can negatively impact the exporter's cash flow, tying up money that cannot be re-invested in producing additional goods for sale. Forfaiting and factoring provide solutions to this cash flow problem and, as a result, enable exporters to sell more goods and be more competitive in the international arena. The difference between the two types of financing lies in the types of goods each deals with and the length of time the receivable can sit on the books before payment.
Both forfaiting and factoring are performed by banks or by specialty financing firms. The financing entity purchases the exporter's accounts receivable at a discount. This provides the exporter with his sales revenue immediately, without having to wait for the importer to confirm delivery, and provides the financing firm with the discount percentage as interest on the credit extension. This transaction is often non-recourse, but there is little risk in the transaction for the financing firm because the importer's payment is typically guaranteed by a letter of credit from the importer's bank.
Although involving the same basic process, forfaiting and factoring differ in subject matter. Factoring is the term used for ordinary trade goods with payment expected immediately upon delivery. Forfaiting is the term used for the financing of accounts receivable for capital goods, commodities, or other high-value bulk merchandise. These types of transactions have longer payment windows, so forfaiting can involve the extension of credit for payment terms anywhere from six months to seven years.
