Factoring Vs. Forfaiting: What’s the Difference?
Ezra Cabrera | April 13, 2022
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
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
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.
2. TIMING
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.
Factoring: It can be recourse or non-recourse.
Forfaiting: Always non-recourse.
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.
Wrapping Up
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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FAQ
Invoice factoring allows you to sell your unpaid invoices to third-party companies at a discount in exchange for upfront funding. The lender can advance up to 90% of the invoice value, and you’ll receive the remaining percentage once your customers pay their invoices.
The answer will ultimately depend on your business's current needs. In general, invoice factoring is best for companies with large capital tied up to unpaid customer invoices and need quick access to cash. Additionally, invoice factoring is a viable choice if:
- You work with reputable and highly credible customers.
- Your business can afford the fees and other charges associated with the financing.
- You have no collateral to pledge other than your customer’s unpaid customer invoices.
- You’re working with a low credit score and can’t qualify for other types of loans (since factoring companies usually puts more weight on the customers’ credit standing than the borrowing company’s)
If that sounds like your business, invoice factoring might be an excellent decision for your company.
Invoice factoring fees (also known as discount rate) may vary from one lender to the next. Typically, the cost of factoring, unpaid accounts receivables will range from 1% to 5% of the total value of the invoices.
Certain factors may also come to play when lenders determine the fees charged to business owners. This includes the volume of the invoices financed, business industry, whether the financing is a recourse or non-recourse factoring, customer creditworthiness, and the invoice term.
Moreover, the lenders may also charge additional fees for the late payment of invoices. For instance, a factor may charge 1.5% of the total invoice value for every 30 days the invoice remains unpaid. As you research the best factoring for your business, be sure to ask about their terms to avoid confusion in the future.
Businesses under the following industries usually use invoice factoring to get additional capital:
- Trucking
- Construction
- Freight
- Transportation
- Business Services
- Wholesale
- Manufacturing
- Technology
- Consulting
- Distributors
- Logistics
One of the biggest advantages of forfaiting is that it’s mainly a non-recourse factoring. That means the exporter using the financing won’t be liable in the event that their customers fail to pay the invoices. Since the business owners have forfeited their rights to their accounts receivable ledger, they won’t be responsible for the payment collection, resulting in more cash savings.
Forfaiting is also flexible. The forfaiter can tailor the financing terms so it suits the exporter’s needs and allow them to conduct business internationally.
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