Banking activates take different shapes to serve the community. There are many new areas, apart from classical business, covered by banks around the globe. New areas cover, factoring, forfaiting and others. In last years, factoring and forfaiting have gained momentum, as one of the sources of export financing. I am writing because some are mixing, however, the two terms are different, in their nature, concept, and scope.
Factoring is a financial affair which involves the sale of a firm receivables to another party known as a factor at discounted prices. Whereas, forfaiting means relinquishing the right, wherein the exporter renounces his right due at a future date, in exchange for instant cash payment at an agreed discount. The most important distinguishing point here is that, factoring can be with or without recourse, but forfaiting is always without recourse.
Factoring is an arrangement that converts receivables into ready cash and you don’t need to wait for payment of receivables at a future date. Whereas, forfaiting implies a transaction in which to claim in return for cash payment. Always, cost of factoring borne by the seller client and cost of forfaiting borne by the overseas buyer. Forfaiting, in difference from factoring, involves dealing in negotiable instrument as bills of exchange and promissory notes.
In factoring, the borrower sells trade receivables to the factor and receives an advance against it. The advance provided to the borrower is the remaining amount, a percentage of the receivable is deducted as the margin or reserve, the factor commission is retained by him and interest on the advance. After that, the borrower forwards collections from the debtor to the factor to settle down the advances received. Forfaiting is from financial intermediary to provide assistance in international trade. It is a financial transaction to help in financing contracts of medium to long term for the sale of receivables on capital goods.
Factoring refers to a financial arrangement whereby the business sells its trade receivables to the factor (bank) and receives the cash payment. They deal in receivable that falls due within 90 days. Forfaiting deals in the accounts receivables whose maturity ranges from medium to long term. Factoring cost is incurred by the seller or client and forfaiting cost is incurred by the overseas buyer.
Factoring and forfaiting are two methods of financing international trade and are mainly used to secure outstanding invoices and account receivables. Both services are providing finance to the seller and their main objective is to provide smooth cash flow to the sellers. However, in difference, forfaiting is a long term receivables to over 90 days up to 5 years while factoring is short term receivables of 90 days.
This gives us an example of banking business expansion to serve clients. Both options, mentioned above, are available, with their concepts and differences, to assist you in your international trade activities.