Factoring and Forfaiting- Financial services, Financial Markets and Institutions | Financial Markets and Institutions - B Com PDF Download

What is Forfaiting?

• Forfaiting is financing in which an exporter sells its medium or long-term accounts receivables to a third party, i.e., a forfeiture, at a discount to receive an immediate cash payment.
• A forfeiture could be a financial institution, bank, insurance underwriter, trading firm, or any specialized individual/entity involved in purchasing foreign receivables from exporters. 
• The forfeiture pays the entire invoice amount upfront after deducting its margin. Then, it’s the forfeiture's responsibility to collect dues from the importer upon the maturity of the credit period. 
• With this, the risk of default or non-payment gets transferred to the forfeiture. Since this arrangement works purely on a non-recourse basis, the exporter can no longer be liable if the importer fails to pay by the due date.

Example: For instance, if an invoice (bill receivable) amounts to Rs. 1000 and the forfeiture's discount rate is 7%, the bills receivable would be purchased at Rs. 930, where Rs.70 would be the forfeiture's margin or service fee.

What is Factoring?

• Factoring is financing in which a business sells its accounts receivable/invoice to a third party, known as a factor, in exchange for an immediate advance on the invoice amount. 
• The factor who purchases the invoice then immediately advances up to 80% of the total invoice amount. The 20% balance amount, minus the factoring fee, is paid only at the end of the maturity period once the customer pays the factor.
• Under this arrangement, it’s the factors’ responsibility to collect payments from the buyer (customer), while the seller has no role in collecting dues. Hence, businesses can fulfill their urgent cash flow requirements, as factoring ensures the immediate availability of funds. 
• The factor charges a nominal service fee, typically in the 2% to 6% range. This fee depends upon various factors like market condition, size of the deal, type of factoring, quality of the portfolio, seller’s creditworthiness, etc.

Comparison Between 

Forfaiting and 

Factoring