FACTORING AND FORFAITING

The main problem nowadays when trading with foreign countries is to obtain payments
from importers. Financing companies offer financial support to traders in exchange for
fees, and guarantees. There are two types of financing forms: factoring and forfaiting.
They are widely used as alternative financing tools to banks.

FACTORING
Factoring is the process of purchasing invoices from a business at a certain discount.
Factors provide financing service to small an medium-sized companies who need cash.
For this the factor charges a fee equal to a percentage of the invoices purchased generally
5%. Factoring is a low value short term financing forms. It involves the purchase of
invoices, for an amount less than $10,000 an 90-120 days payment terms. After shipping
your goods or services, the factor purchases the invoices, and advances cash to you
company. Factoring provide liquid assets to small business. In fact banks have strict
criteria when lending money so it is difficult for these companies to obtain loans.

FORFAITING
Forfaiting is the purchase of a series of credit instruments such as drafts, bills of
exchange, other freely negotiable instruments on a nonrecourse basis. Nonrecourse means
that if the importer does not pay, the forfeiter cannot recover payment from the exporter.

The exporter gets immediate cash on presentation of relevant documents and the importer
is the liable for the cost of the contract and receives credit for “x” years and at certain per
cent interest.

The forfaiter deducts interest at an agreed rate for credit period. The debt instruments are
drawn by the exporter, accepted by the importer, and will bear an aval or unconditional
guarantee, issue by the importer’s bank. The forfeiter takes over responsibility for
claiming the debt from the importer. The forfeiter holds the notes until maturity, or sells
them to another investor. The holder of the notes presents each note to the bank at which
they are payable, as that fall due.

Forfaiting is a high-value medium and long term financing form. It involves the purchase
of negotiable instruments for not less than $100.000 and from six month to five years
payment terms. The forfeiter needs to know some important information, such as:

•
 • who the buyer is and his nationality

• what goods are being sold

• date and duration of the contract

• interest rate already agreed with the buyer

• negotiable instruments used identity of the guarantor of

payment

Difference between factoring anf forfeiting :

What is the difference between Factoring and Forfaiting and how can it help your
import/export business?

During difficult financial times many import/export businesses are looking for new ideas
to increase their cash crunches. Import/Exporting can have astronomical rewards because
you can make a profit by getting the best benefits of two economies, a low cost
production economy as well as a high purchasing economy. Much of North America and
Western Europe import a large percentage of their goods. There are many opportunities
navigating global economies; however almost all of these opportunities require large
amounts of short term cash for purchasing, production, and transport. Factoring and
Forfaiting are two key strategies to help importers and exporters to get a start in business
as well as increase short term and long term cash flow.

Factoring is when a company trade account receivables that may take 30, 60, 90, or even
120 days for immediate upfront cash to pay for vendors, payroll, supplies, or other
expenses. Factoring involves using a third party company who will provide cash upfront
for a fee. Usually the third party will hold back a portion of the total invoice as surety i.e.
a $100,000 invoice factoring company may give your $60,000 to $80,000. When the
accounts receivable is paid the factoring company will return all of the funds to the
exporter minus any applicable charges. Factoring companies prefer

Forfaiting is usually used for medium and long term debt (1-10 years). Similar to
factoring the Forfaiting company will take full responsibility for receiving the payments
from the purchaser (importer) in exchange for a letter of credit, line of credit, or cash to
the seller (exporter). Forfaiting may by used for only one account or several accounts.
The key difference between forfaiting and factoring is that Forfating companies keep a
portion of the accounts receiveable whereas a factoring company will return the balance
minus their fees.

Both financial devices require a few key parts. First the person or entity buying the goods
or service must be creditworthy and pay their obligations on a timely basis. No one wants
to offer factoring or forfaiting for a client that's a dead beat. In factoring a company that
pays in 90 days versus 60 days may result in an extremely costly price for the exporter or
company seeking the factoring. Remember these are just a new strategy in an arsenal of
an entrepreneur or business buyer. Like all strategies you need to know all the costs
involved, calculate your margins, and be prepared the best strategy for your situation.

Forfaiting

The forfaiting owes its origin to a French term ‘a forfait’ which

means to forfeit (or surrender) ones’ rights on something to

some one else. Forfaiting is a mechanism of financing exports:

a. by discounting export receivables

b. evidenced by bills of exchanges or promissory notes

c. without recourse to the seller (viz; exporter)

d. carrying medium to long-term maturities

e. on a fixed rate basis upto 100% of the contract value.

In other words, it is trade finance extended by a forfaiter to an

exporter seller for an export/sale transaction involving deferred

payment terms over a long period at a firm rate of discount.

Forfaiting is generally extended for export of capital goods,

commodities and services where the importer insists on

supplies on credit terms. Recourse to forfaiting usually takes

place where the credit is for long date maturities and there is no

prohibition for extending the facility where the credits are

maturing in periods less than one year.

Parties to Forfaiting

There are five parties in a transaction of forfaiting. These are

i. Exporter

ii. Importer

iii. Exporter’s bank

iv. Importer’s bank

v. The forfaiter.

Mechanism

1. The exporter and importer negotiate the proposed export

sale contract. Then the exporter approaches the forfaiter to

ascertain the terms of forfaiting.

2. The forfaiter collects details about the importer, supply and

credit terms, documentation etc.

3. Forfaiter ascertains the country risk and credit risk involved.

4. The forfaiter quotes the discount rate.

5. The exporter then quotes a contract price to the overseas

buyer by loading the discount rate, commitment fee etc. on

the sale price of the goods to be exported.

6. The exporter and forfaiter sign a contract.

7. Export takes place against documents guaranteed by the

importer’s bank.

8. The exporter discounts the bill with the forfaiter and the

latter presents the same to the importer for payment on due

date or even sell it in secondary market.

Documentation

1. Forfaiting transaction is usually covered either by a

promissory note or bills of exchange.

2. Transactions are guaranteed by a bank.

3. Bills of exchange may be ‘availed by’ the importer’s bank.

‘Aval’ is an endorsement made on bills of exchange or

promissory note by the guaranteeing bank by writing ‘per

aval’ on these documents under proper authentication.

Costs of forfaiting

The forfaiting transaction has typically three cost elements:

1. Commitment fee, payable by the exporter to the forfaiter

‘for latter’s’ commitment to execute a specific forfaiting

transaction at a firm discount rate with in a specified time.

2. Discount fee, interest payable by the exporter for the entire

period of credit involved and deducted by the forfaiter from

the amount paid to the exporter against the availised

promissory notes or bills of exchange.

3. Documentation fee.

Benefits of forfaiting

Forfaiting helps the exporter in the following ways:

1. It frees the exporter from political or commercial risks from

abroad.
2. Forfaiting offers ‘without recourse’ finance to an exporter. It

does not effect the exporter’s borrowing limits/capacity.

3. Forfaiting relieves the exporter from botheration of credit

administration and collection problems.

4. Forfaiting is specific to a transaction. It does not require

long term banking relationship with forfaiter.

5. Exporter saves money on insurance costs because forfaiting

eliminates the need for export credit insurance.

Problem areas in forfaiting and factoring where legislation is

required.

1. There is, presently, no legal framework to protect the banker

or forfaiter except the existing covers for the risks involved

in any foreign transactions.

2. Data available on credit rating agencies or importer or

foreign country is not sufficient. Even exim bank does not

cover high-risk countries like Nigeria.

3. High country and political risks dissuade the services of

factoring and banking to many clients.

4. Government agencies and public sector undertakings (PSUs)

neither promptly make payments nor pay interest on

delayed payments.

5. The assignment of book debts attracts heavy stamp duty

and this has to be waived.

6. Legislation is required to make assignment under factoring

have priority over other assignments.

7. There should be some provisions in law to exempt

factoring organization from the provisions of money

lending legislations.

8. The order 37 of Civil procedure code should be amended to

clarify that factor debts can be recovered by resorting to

summary procedures.