Factoring & Forfaiting Factoring Factoring Defined Factoring can be defined as the conversion of credit sales into cash. Factoring is a transaction where the exporter sells its receivables to a financial institution which is usually a bank. The Factoring institution buys the accounts receivable and pays up to 80% of the amount to a company usually a client. Parties Involved in Factoring So, a Factor is, A Financial Intermediary That buys invoices of a manufacturer or a trader, at a discount, and Takes responsibility for collection of payments. The factoring transaction involves three parties: Supplier or Seller (Client) Buyer or Debtor (Customer) Financial Intermediary (Factor) SERVICES OFFERED BY A FACTOR Follow-up and collection of Receivables from Clients. Purchase of Receivables with or without recourse. Help in getting information and credit line on customers (credit protection) Sorting out disputes, if any, due to his relationship with Buyer & Seller. Factoring Process Client concludes a credit sale with a customer Client sells the customer’s account to the Factor and notifies the customer Factor makes part payment (advance) against account purchased, after adjusting for commission and interest on the advance Factor maintains the customer’s account and follows up for payment Customer remits the amount due to the Factor Factor makes the final payment to the Client when the account is collected or on the guaranteed payment date Factoring Process Types of Factoring Types of Factoring Recourse Factoring Non-recourse Factoring Maturity Factoring Cross-border Factoring Recourse Factoring Up to 75% to 85% of the Invoice Receivable is factored. Interest is charged from the date of advance to the date of collection. Factor purchases Receivables on the condition that loss arising on account of non-recovery will be borne by the Client. Credit Risk is with the Client. Factor does not participate in the credit sanction process. In India, factoring is done with recourse. Non-Recourse Factoring Factor purchases Receivables on the condition that the Factor has no recourse to the Client, if the debt turns out to be non-recoverable. Credit risk is with the Factor. Higher commission is charged. Factor participates in credit sanction process and approves credit limit given by the Client to the Customer. Maturity Factoring Factor does not make any advance payment to the Client. Pays on guaranteed payment date or on collection of Receivables. Guaranteed payment date is usually fixed taking into account previous collection experience of the Client. Nominal Commission is charged. No risk to Factor. Cross-Border Factoring It is similar to domestic factoring except that there are four parties:a) Exporter, c) Import Factor, and b) Export Factor, d) Importer. It is also called two-factor system of factoring. Exporter (Client) enters into factoring arrangement with Export Factor in his country and assigns to him export receivables. Export Factor enters into arrangement with Import Factor and has arrangement for credit evaluation & collection of payment for an agreed fee. Notation is made on the invoice that importer has to make payment to the Import Factor. Import Factor collects payment and remits to Export Factor who passes on the proceeds to the Exporter after adjusting his advance, if any. Factor’s Fees and Expenses Commissions: Factors charge commissions for the credit risk they assume and for providing bookkeeping, ledgering, collection and other administrative services to their clients (0.50% to 1.50%) Commitment fees: Factors typically charge commitment fees at inception of the factoring facility Interest: Factors charge interest on prepayment Additional fees: Additional fees may apply in any given factoring agreement. For example, some factors charge minimum monthly discount fees, and early termination fees may also apply if the client wants to terminate the arrangement ahead of its stated expiration date Factoring Companies in India Canbank Factors Limited SBI factors and commercial services Pvt. Ltd HSBC Foremost Factors Limited Global Trade Finance Limited Citibank India Small Industries Development Bank of India (SIDBI) Standard Chartered Bank Forfaiting Forfaiting The terms forfaiting is originated from a old French word ‘forfait’, which means forfeiting or surrender of right. Forfaiting is a mechanism by which the right for export receivables of an exporter (Client) is purchased by a Financial Intermediary (Forfaiter) without recourse to him. Forfaiting International forfaiting is a means to finance an international transaction in which an exporter collects a series of drafts from the importer, all with fairly long-term due dates. The exporter sells these receivables to a forfaiting firm who buys them without recourse, which means that the forfaiting firm is responsible for collecting the funds from the importer. Forfaiting Exporter under Forfaiting surrenders his right for claiming payment for services rendered or goods supplied to Importer in favor of Forfaiter. Bank (Forfaiter) assumes default risk possessed by the Importer. Credit Sale gets converted as Cash Sale. Forfaiting is arrangement without recourse to the Exporter (seller) Operated on fixed rate basis (discount) Finance available up to 100% of value Characteristics of Forfaiting Finance is available at 100% without recourse Exporter is Freed from credit administration Provides long-term credit unlike other forms of credit provided by banks Simple Documentation as Finance is available against bills Converts Deferred Payment to Cash Payment providing liquidity and cash flow to the exporter. Forfaiting transactions are confidential Parties involved 1. Exporter 2. Importer 3. Importers Bank 4. Forfaiting Bank Steps Involved In Forfaiting Step 1 : Forfaiter and Exporter agreed upon a Forfaiting Agreement. Step 2 : Sales Contract has been signed between Exporter and Importer. Step 3 : Shipment is initiated by the exporter. Step 4 : The importer obtains a guarantee from his bank. Step 5 : The importer sends documents to the exporter. Step 6 : Exporter gives documents to forfaiter. Step 7 : Forfeiter controls the documents pays for them as indicated on the Forfaiting Agreement. Step 8 : Forfeiter presents documents to bank at maturity date. Step 9 : Importer pays to bank at maturity date. Step 10 : Bank pays to forfeiter at maturity date. Costs involved In Forfaiting Commitment Fee:- Payable to consideration of forfaiting services. Forfaiter by Exporter in Discount Fee:- Discount rate based on LIBOR for the period concerned. Documentation Fee:- where elaborate legal formalities are involved. Service Charges:- payable to Bank. Advantages of Forfaiting Eliminates Risk Removes country (i.e. political and transfer) and commercial risk Provides financing for 100% of contract value Protects against risks of interest rate increase and exchange rate fluctuation Enhances Competitive Advantage Enables sellers of goods to offer credit to their customers, making their products more attractive by offering credit terms and at the same time cash the sales Helps sellers to do business in countries where the risk of non-payment would otherwise be too high against the risk premium to be added with the discounting interest Improves Cash Flow Forfaiting enables sellers to receive cash payment while offering credit terms to their customers Removes accounts receivable, bank loans or contingent liabilities from the balance sheet of the seller Disadvantages of Forfaiting 1. Forfaiting is not available for deferred payments especially while exporting capital goods for which payment will be made on a deferred basis by the importer. 2. There is discrimination between Western countries and the countries in the Southern Hemisphere which are mostly underdeveloped (countries in South Asia, Africa and Latin America). 3. There is no International Credit Agency which can guarantee for forfaiting companies which affects longterm forfaiting. 4. Only selected currencies are taken for forfaiting as they alone enjoy international liquidity FACTORING vs. FORFAITING Points of Difference Factoring Forfaiting The Forfaiting Bank relies on the creditability of the Avalling Bank. Recourse Usually 75 – 80% of the value of the invoice Short-term finance (90 to 150 days or more) Factor does the credit rating in case of nonrecourse factoring transaction Day-to-day administration of sales and other allied services With or without recourse Sales By Turnover By Bills Extent of Finance Finance Credit Worthiness Services provided 100% of Invoice value Long Term Finance (180 days to 7 years) No services are provided Always without recourse
