Factoring and forfaiting differ in nature, scope, and concept, and each has different sets of advantages and disadvantages. Factoring pertains to the selling of a firm’s accounts receivables to a third party (a factoring company or a lender) at a discounted price. In forfaiting, exporters relinquish their rights to the forfaiting company in exchange for immediate cash.
The Definition of Factoring and Forfaiting
So, what exactly is the meaning of factoring and forfaiting?
Factoring – also known as invoice factoring or accounts receivable financing – is the process in which businesses receive advances against their accounts receivables. There are three parties when it comes to factoring: the debtor (buyer of goods), the client (seller of the goods), and the factor (the financier). This type of financing is often utilized to manage book debt.
Forfaiting is a financing option exporters use to receive immediate cash. How it works: The exporter sells its claim on medium and long-term trade receivables to a forfaiter at a discounted rate to receive fast access to cash. The benefit: Exporters minimize the risk of factoring by selling without recourse, which means the exporter is not liable when the importer fails to pay the receivables.
What is the Difference Between Factoring and Forfaiting?
The main difference between the two is that factoring can be used in domestic and international trade, whereas forfaiting only applies to international trade financing.
Here are eight additional key differences between factoring and forfaiting:
1. THE PROCESS
Factoring: A financial arrangement where business owners sell their pending invoices (accounts receivables) to a third party (factoring companies, lenders, or banks) in exchange for fast cash.
Forfaiting: Belongs under export financing in which an exporter sells their rights of trade receivables to a forfaiter to acquire immediate cash payment.
Factoring: Deals with short-term accounts receivables, which typically falls due within 90 days or less.
Forfaiting: Deals with medium- to long-term accounts receivables.
3. SALE OF RECEIVABLES
Factoring: The sale of receivables are usually on ordinary products or services.
Forfaiting: The sales of receivables are on capital goods.
4. PERCENTAGE OF FINANCING RECEIVED
Factoring: Business owners usually get 80% to 90% financing.
Forfaiting: Funds exporters with 100% financing of the value of exported goods.
5. NEGOTIABLE INSTRUMENTS
Factoring: Deals with negotiable instruments, such as promissory notes and bills of exchanges.
Forfaiting: Does not deal with negotiable instruments.
7. SECONDARY MARKETS
Factoring: No secondary market.
Forfaiting: There is a secondary market that increases the liquidity in forfaiting.
8. WHO PAYS FOR THE COST
Factoring: The seller or client pays for the factoring costs.
Forfaiting: The overseas buyer pays for the forfaiting costs.
Factoring and forfaiting tends to be complex and can be difficult to understand. If you have any questions or if you’re interested in learning more about factoring and forfaiting, Let the experts at SMB Compass help. Our friendly, knowledgeable team of finance specialists are one call away!
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