Forfeiting and factoring are services in international market given to an exporter or seller. Its main objective is to provide smooth cash flow to the sellers. The basic difference between the forfeiting and factoring is that forfeiting is a long term receivables (over 90 days up to 5 years) while factoring is a shorttermed receivables (within 90 days) and is more related to receivables against commodity sales.
Definition of Forfeiting
The terms forfeiting is originated from a old French word ‘forfait’, which means to surrender ones right on something to someone else. In international trade, forfeiting may be defined as the purchasing of an exporter’s receivables at a discount price by paying cash. By buying these receivables, the forfeiter frees the exporter from credit and the risk of not receiving the payment from the importer.
How forfeiting Works in International Trade
The exporter and importer negotiate according to the proposed export sales contract. Then the exporter approaches the forfeiter to ascertain the terms of forfeiting. After collecting the details about the importer, and other necessary documents, forfeiter estimates risk involved in it and then quotes the discount rate.
The exporter then quotes a contract price to the overseas buyer by loading the discount rate and commitment fee on the sales price of the goods to be exported and sign a contract with the forfeiter. Export takes place against documents guaranteed by the importer’s bank and discounts the bill with the forfeiter and presents the same to the importer for payment on due date.
Documentary Requirements
In case of Indian exporters availing forfeiting facility, the forfeiting transaction is to be reflected in the following documents associated with an export transaction in the manner suggested below:
- Invoice : Forfeiting discount, commitment fees, etc. needs not be shown separately instead, these could be built into the FOB price, stated on the invoice.
- Shipping Bill and GR form : Details of the forfeiting costs are to be included along with the other details, such FOB price, commission insurance, normally included in the "Analysis of Export Value "on the shipping bill. The claim for duty drawback, if any is to be certified only with reference to the FOB value of the exports stated on the shipping bill.
Forfeiting
The forfeiting typically involves the following cost elements:
1. Commitment fee, payable by the exporter to the forfeiter ‘for latter’s’ commitment to execute a specific forfeiting 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.
Benefits to Exporter
- 100 per cent financing : Without recourse and not occupying exporter's credit line That is to say once the exporter obtains the financed fund, he will be exempted from the responsibility to repay the debt.
- Improved cash flow : Receivables become current cash in flow and its is beneficial to the exporters to improve financial status and liquidation ability so as to heighten further the funds raising capability.
- Reduced administration cost : By using forfeiting , the exporter will spare from the management of the receivables. The relative costs, as a result, are reduced greatly.
- Advance tax refund: Through forfeiting the exporter can make the verification of export and get tax refund in advance just after financing.
- Risk reduction : forfeiting business enables the exporter to transfer various risk resulted from deferred payments, such as interest rate risk, currency risk, credit risk, and political risk to the forfeiting bank.
- Increased trade opportunity : With forfeiting, the export is able to grant credit to his buyers freely, and thus, be more competitive in the market.
Benefits to Banks
Forfeiting provides the banks following benefits:
- Banks can offer a novel product range to clients, which enable the client to gain 100% finance, as against 8085% in case of other discounting products.
- Bank gain fee based income.
- Lower credit administration and credit follow up.
Definition of factoring is very simple and can be defined as the conversion of credit sales into cash. Here, a financial institution which is usually a bank buys the accounts receivable of a company usually a client and then pays up to 80% of the amount immediately on agreement. The remaining amount is paid to the client when the customer pays the debt. Examples includes factoring against goods purchased, factoring against medical insurance, factoring for construction services etc.
Characteristics of Factoring
1. The normal period of factoring is 90150 days and rarely exceeds more than 150 days.
2. It is costly.
3. Factoring is not possible in case of bad debts.
4. Credit rating is not mandatory.
5. It is a method of offbalance sheet financing.
6. Cost of factoring is always equal to finance cost plus operating cost.
Different Types of Factoring
1. Disclosed
2. Undisclosed
1. Disclosed Factoring
In disclosed factoring, client’s customers are aware of the factoring agreement.
Disclosed factoring is of two types:
Recourse factoring: The client collects the money from the customer but in case customer don’t pay the amount on maturity then the client is responsible to pay the amount to the factor. It is offered at a low rate of interest and is in very common use.
Nonrecourse factoring: In nonrecourse factoring, factor undertakes to collect the debts from the customer. Balance amount is paid to client at the end of the credit period or when the customer pays the factor whichever comes first. The advantage of nonrecourse factoring is that continuous factoring will eliminate the need for credit and collection departments in the organization.
2. Undisclosed
In undisclosed factoring, client's customers are not notified of the factoring arrangement. In this case, Client has to pay the amount to the factor irrespective of whether customer has paid or not.
