Forfaiting explained

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.

What is forfaiting?

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.

What is a forfaiter?

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.

How does forfaiting work?

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 business can unlock the value of a customer's due invoices by receiving a percentage of their value in advance of their payment date.

Forfaiting example

The following are key stages in a typical forfaiting transaction:

• The exporter and forfaiter draft an agreement based on expected receivables, or invoice payments
• The exporter and importer form a sales contract
• The exporter delivers the goods to the importer
• The importer’s bank provides a payment guarantee
• Trade documents are exchanged between the importer and the exporter
• The exporter and forfaiter exchange trade documents
• The forfaiter pays the exporter
• The forfaiter presents documents for payment to the importer’s bank
• The importer’s bank pays the forfaiter

What does recourse mean?

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.

What are the different types of forfaiting?

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.

The difference between forfaiting and factoring

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:

• Factoring applies to domestic and international trade, whereas forfaiting is limited to international trade
• Factoring deals with short–term receivables, whereas forfaiting is for medium and long–term receivables
• Factoring is normally for ordinary products or services, whereas forfaiting is for capital goods
• Factoring can be recourse or non–recourse, whereas forfaiting is almost always non–recourse
• While factoring focuses on accounts receivables, forfaiting also covers negotiable instruments such as promissory notes and bills of exchange
• Factoring usually provides 80–90% of the accounts receivable, whereas forfaiting can in some cases provide up to 100%
• Factoring supports the seller, whereas forfaiting supports both the buyer (importer) and the seller (exporter).