With forfaiting exporters can receive cash straightaway — through selling their receivables.
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What is forfaiting?
Forfaiting is a type of trade financing that enables exporters to receive immediate payment — for goods sold. It works by exporters selling their accounts receivables or invoices, to an intermediary, at a discounted price.
The intermediaries that buy such receivables are specialist financial services firms (or departments of banks) — known as forfaiters.
The simplicity and flexibility of forfaiting, are the two key reasons for its popularity in export finance.
Forfaiting — considerations
Accounts receivable (invoices) is simply the money an importer owes to an exporter. As well as invoices, forfaiters can purchase promissory notes, bills of exchange and letters of credit. All of these financial instruments are fundamentally importer promises — to pay an exporter.
Forfaiter arrangements are commonly “non-recourse” or “without recourse”. This means that an exporter has no liability — should an importer default on payment. In other words, it is the forfaiter that accepts the risk of non-payment. Conversely, a recourse agreement means that the exporter is personally held liable for any default, and can be chased for the debt.
Forfaiting works in a similar way to invoice factoring — where funds are also advanced ahead of their actual payment date. However, there are differences:
- Forfaiting is mainly limited to international trade — where factoring is both domestic and international
- Forfaiting deals with medium and longer-term receivables — while factoring is mostly concerned with short-term invoices
- Forfaiting is typically used for capital goods — while factoring is used for a variety of different products and services (ordinary goods)
- Forfaiting can advance up to 100% of the value of export — in contrast factoring is usually at 80-90%
- Forfaiting is almost exclusively non-recourse — whereas factoring can be recourse or non-recourse
- Forfaiting covers other debt instruments such as bills of exchange — while factoring is focused on accounts receivable
- Forfaiting allows for the trade of bills and promissory notes — between different financial institutions
- Forfaiting can support both importer and exporter — where factoring supports only the seller (exporter)
How does forfaiting work?
As an exporter, interested in optimizing your cash flow, you may seek specialist financial services firms, that deal with trade finance — specifically forfaiting.
The forfaiter would need information on your business in order to check if you meet lending criteria. Details of your trading history, statement of accounts and credit ratings — will all be required. Forfaiters would also need to look into your expected receivables.
Similar information on the importer’s business will also be needed, as they are ultimately the ones that will pay the forfaiter — should funding be approved.
All this information will also be used to assess the risk lending to you presents, and should the forfaiter be willing to lend, at what discounted rate and under what terms.
If a forfaiter agrees to purchase your receivables — they will do so at a discount. As mentioned before, the discount depends on risk, but is also based on the lenders own policies.
Additionally, forfaiters may add extra charges (often to be paid upfront) e.g. commitment fees and services charges. Accordingly, it is important that you study the terms and conditions — before committing to any arrangement.
On or before the date agreed, the importer (or its bank) is to pay the full value of the invoice — to the forfaiter.
Between drafting an agreement with the forfaiter and them receiving payment, conventional import and export processes are followed. However, there is the added step of the forfaiter paying the exporter — as soon as payment has been guaranteed by the importer’s bank and goods are shipped:
- Exporter and importer sign a sales contract
- Importer’s bank guarantees payment
- Exporter ships the goods to the importer
- Exporter presents documents to forfaiter
- Forfaiter forwards payment documents to importer’s bank
- Forfaiter pays the exporter
- At maturity importer’s bank pays the forfaiter
It is important to note, that with forfaiting, importers can also approach a forfaiting bank — instructing them to make a financing offer to the beneficiary (exporter). In other words, importers may apply for forfaiting themselves — in order to defer payment to an exporter.
Benefits of forfaiting
- Risk for exporter not being paid is removed — with non-recourse forfaiting
- Sales for an exporter is immediately turned into cash — great for cash flow
- Serves as an alternative to both export credit and insurance
- Importers receive goods — but pay later
Limitations of forfaiting
- Can be an expensive form of financing
- Not suitable for short-term transactions
- Minimum transaction values apply
- Applies to only capital goods (non-consumer items)
- Forfaiters may not operate in certain high-risk countries
- Generally not available for unstable currencies
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