4 min read4 December 2019
Confused about forfaiting trade finance? Then read on to find out whether it could be the right source of finance for your business.4 December 2019
In this article, we’ll break down what forfaiting is, and take a look at the pros and cons. For a quick list of the key takeaways of forfaiting, click here.
Forfaiting is a form of trade finance that enables exporters to receive immediate payment for goods by selling their receivables (the sum an importer owes to an exporter) at a reduced price through an intermediary.
A forfaiter is the financial intermediary that buys the right to the receivables in return for a cash payment to the creditor – the exporter. Forfaiters are usually specialist financial institutions or departments in a bank.
An exporter may want to ease pressure on their cash flow by receiving immediate payment for medium or long–term receivables – the amount owed by the importer for the exported goods. The exporter will approach a forfaiter, who is a specialist in trade finance. The forfaiter purchases the receivables at a discount and so prevents any delay in payment. The importer will then pay the full value of the receivables to the forfaiter.
Forfaiting works a bit like invoice financing. With invoice financing a businesses can unlock the value of a customer's due invoices by receiving a percentage of their value in advance of their payment date.
The following are key stages in a typical forfaiting transaction:
Like invoice finance arrangements, forfait agreements are defined as ‘without recourse’ or ‘non–recourse’. With non-recourse forfaiting the exporter – having borrowed money from the forfaiter – has no liability if the importer defaults on payment. It is the forfaiter, not the exporter, who accepts the risk of non–payment.
A recourse debt is where the borrower – or exporter – is held personally liable in the event of non–payment and can be pursued for the debt.
There are several types of financial agreement that a forfaiter can purchase and convert into debt instruments:
Promissory notes are issued by importers and provide a written promise to pay the exporter
Bills of exchange are similar to promissory notes and are written orders that bind an importer to pay an exporter a fixed sum
Account receivables show the amount of money owing, and they are listed as yet to be paid on the current balance sheet
Letters of credit are issued by banks and provide a guarantee that a debt will be paid even if the importer defaults.
While forfaiting and invoice factoring are both trade finance solutions to secure money from receivables they differ in a number of ways. Here are some of the main differences:
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