Factoring & Forfaiting

The need for factoring Business Transactions both at retail and wholesale level take place on part credit and part cash basis The sellers extend credit (trade credit) to the buyers during this interval of time (credit period) between receipt of goods and payment of cash These dues are called trade receivables (payables) from the point of view of the seller (buyer) As managers the choice is between enhanced sales through extending credit and increasing financial costs ( interest & risk ) Choice of collecting the receivables or handing over the job to specialized agencies

Factoring Factoring is a continuous arrangement between a factoring concern and the seller of goods and services (on credit) whereby the factor purchases the accounts receivables for immediate cash and also provides other services such as sales ledger maintenance, collection and credit protection.

Factoring - Product features Financing the seller by prepaying upto 90% of the invoice value/ Bill value Protection against default in payment by the buyer by arranging for insurance cover (optional) Collection of receivables Maintenance of accounts relating to accounts receivables (A/R)

Characteristics of factorable transactions Seller’s performance obligations should be completed at the time the seller presents an invoice for prepayment There should be multiple shipments or a continuous sales flow on an ongoing basis with the same buyer or buyer(s) Factoring transactions necessarily require credit terms and are best suited for credit periods of upto 120 days. LC's are not required Factoring facilities are typically provided for "open account" transactions and can also be structured for transactions involving negotiable instruments (bills of exchange or promissory notes) Factoring requires the assignment of whole turnover with a buyer. All credit sales to a buyer have to be assigned to a factor on a continuous basis once the factoring arrangement is in place

Features of Factoring Factor is a firm (Financial Institution typically) which manages the collection of Accounts Receivables (AR) of the companies on their behalf and bears the credit risk associated with those accounts. Factoring means selling, with or without recourse, the receivables by the firm to a factor.

Factoring Factoring relieves the firm of the organization, procedures, and internal expenses of collecting the receivable. The main parties to a factoring process are: Client (seller) Customer (buyer) Factor The arrangements are governed by the contract between the factor and the client The factoring process is continuous – as new ARs accumulate they get sold.

The process of factoring The customer is notified of the contract and the customer is then told to pay directly to the factor The factor then has to manage the whole receivable cycle The factor gets paid a fees and interest for having Serviced the receivables Bearing the risk Providing finance The relatively long credit period (compared to international practices) has made factoring a risky proposition thereby hindering its growth

Forfaiting Forfaiting is the discounting of international trade receivables on a 100% "without recourse" basis. Forfaiting transforms the supplier's credit granted to the importer into cash for the exporter, protecting him from all the risks associated with selling overseas on credit.

The term "a forfait" in French means, "relinquish a right" It now refers to the exporter relinquishing his right to a receivable due at a future date in exchange for immediate cash payment, at an agreed discount, passing all risks and responsibilities for collecting the debt to the forfaiter

Forfaiting is the discounting of international trade receivable on a 100% "without recourse" basis It is a form of suppliers credit involving the sale or purchase of receivables falling due at some future date The exporter is, of course, responsible for the validity of his order and execution thereof, but once documentation has been delivered and accepted and discounting is done, there is absolutely no recourse to the Exporter, with the exception of an underlying fraudulent transaction Forfaiting effectively transforms a credit sale into a cash sale. Forfaiting transforms the supplier's credit granted to the importer into cash transaction for the exporter protecting him completely from all the risks associated with selling overseas on credit

Forfaiting - Regulatory Aspects Forfaiting as an export financing option in India has been approved by the Reserve Bank of India. The Forfaiting facility is to be provided by an international forfaiting agency through an Authorised Dealer. Forfaiting proceeds, on a without recourse basis, are to be received in India as soon as possible after shipment but definitely within the 180 day period specified by RBI for all exports. A Forfaiting transaction is to be routed through an Authorised Dealer, who apart from handling documentation will also provide Customs Certification for GR Form purposes.

Characteristics of Forfaiting 100% financing without recourse to the seller of the obligation. Importer's obligation is normally supported by a local bank guarantee. The debt is typically evidenced by Letter of credit, Bills of Exchange, Promissory Notes. Credit periods can range from 90 days to 10 years Amounts financed to be upwards of USD 2,50,000/- Contract in any of the world's major convertible currencies can be financed. Finance to be either on a fixed (market norm) or floating rate basis

Risk Elimination - associated with cross border transactions Commercial Risk - The risk of non-payment by a non-sovereign or private sector buyer or borrower in his home currency arising from insolvency. Political Risk - The risk of the borrower country government actions, which prevent or delay the repayment of export credits. Transfer Risk - The risk of an inability to convert local currency into the currency in which debt is denominated. Interest Risk - The risk of interest rate fluctuations during the credit period of the transaction. Exchange Risk - The risk of exchange rate fluctuations.