Online Commerce Classes for B.Com (H) & (G): Forfaiting

Meaning of Forfaiting

The term ‘forfait’ is a French world. It means ‘to surrender something’ or ‘give up one’s right’. Thus forfaiting means giving up the right of exporter to the forfaitor to receive payment in future from the importer. It is a method of trade financing that allows exporters to get immediate cash and relieve from all risks by selling their receivables (amount due from the importer) on a ‘without recource’ basis. This means that in case the importer makes a default the forfaitor cannot go back to the exporter to recover the money. Under forfaiting the exporter surrenders his right to a receivable due at a future date in exchange for immediate cash payment, at an agreed discount.

What is 'Forfaiting'?

Forfaiting is a means of financing used by exporters that enables them to receive cash immediately by selling their medium-term receivables (the amount an importer owes the exporter) ata discount. The exporter also eliminates risk by making the sale without recourse, which means that the exporter has no liability regarding possible default by the importer on paying the receivables. The forfaiter is the individual or entity that purchases the receivables. The importer is then obligated to pay the receivables amount to the forfaiter. A forfaiter is typically a bank or a financial firm that specializes in export financing.

Here the exporter passes to the forfaitor all risks and responsibilities in collecting the debt. The

exporter is able to get 100% of the amount of the bill immediately. Thus he gets the benefit of cash sale. However, the forfaitor deducts the discount charges and he gives the balance amount to the exporter. The entire responsibility of recovering the amount from the importer is entrusted with the forfaitor. The forfaitor may be a bank or any other financial institution. In short, the non-recourse purchase of receivables arising from an export of goods and services by a forfaitor is known as forfaiting.

Forfaiting is not the same as international factoring. The tenure of forfaiting transaction is long. International factoring involves short term trade transactions. In case of forfaiting, political and transfer risks are also borne by the forfaitor. But in international factoring these risks are not borne by the factor.

Characteristics of Forfaiting

The main characteristics of forfaiting are:

1. It is 100% financing without recourse to the exporter.

2.The importer’s obligation is normally supported by a local bank guarantee (i.e., ‘aval’).

3. Receivables are usually evidenced by bills of exchange, promissory notes or letters of credit.

4. Finance can be arranged on a fixed or floating rate basis.

5. Forfaiting is suitable for high value exports such as capital goods, consumer durables, vehicles, construction contracts, project exports etc.

6. Exporter receives cash upon presentation of necessary documents, shortly after shipment.

Advantages of Forfaiting

The following are the benefits of forfaiting:

1. The exporter gets the full export value from the forfaitor.

2. It improves the liquidity of the exporter. It converts a credit transaction into a cash transaction.

3. It is simple and flexible. It can be used to finance any export transaction. The structure of finance can be determined according to the needs of the exporter, importer, and the forfaitor.

4. The exporter is free from many export credit risks such as interest rate risk, exchange rate risk,

political risk, commercial risk etc.

5. The exporter need not carry the receivables into his balance sheet.

6. It enhances the competitive advantage of the exporter. He can provide more credit. This increases the volume of business.

7. There is no need for export credit insurance. Exporter saves insurance costs. He is relieved from the complicated procedures also.

8. It is beneficial to forfaitor also. He gets immediate income in the form of discount. He can also sell the receivables in the secondary market or to any investor for cash.

Difference between Factoring and Forfaiting

Forfaiting and factoring have similarities. Both have similar features of advance payment and non-recourse dealing. But there are some differences between them. The differences are as follows:

BASIS FOR COMPARISON	FACTORING	FORFAITING
Meaning	Factoring is an arrangement that converts your receivables into ready cash and you don't need to wait for the payment of receivables at a future date.	Forfaiting implies a transaction in which the forfaiter purchases claims from the exporter in return for cash payment.
Maturity of receivables	Involves account receivables of short maturities.	Involves account receivables of medium to long term maturities.
Goods	Trade receivables on ordinary goods.	Trade receivables on capital goods.
Finance up to	80-90%	100%
Type	Recourse or Non-recourse	Non-recourse
Cost	Cost of factoring borne by the seller (client).	Cost of forfaiting borne by the overseas buyer.
Negotiable Instrument	Does not deals in negotiable instrument.	Involves dealing in negotiable instrument.
Secondary market	No	Yes