Chapter_18

file:///D:/iiem/exportimportfinance/chapter18.html

CHAPTER 18
FORFAITING &
FACTORING
Proper financing is a crucial part of any business, more so in exports where the cost of finance is affected by domestic as well as
international factors. Availability of a variety of suitable financing options can encourage small and medium export businesses where
raising of money to finance exports is often more an issue than actual receipt of orders. Conventional financing methods like bank loans,
equity financing etc. come with a lot of conditions and strings attached which new or small exporters find difficult to meet. For instance
new firms may find it difficult to raise bank loans (since there is no proof that business will be viable, no balance sheets to show healthy
profits). Equity participation implies a more long-term commitment and accountability towards the shareholders.
In this context the two financing methods of factoring and forfaiting could provide viable options. Both provide immediate cash to the
exporter that virtually wipes out (for the exporter) the credit period extended to the importer. This credit period extends from the time of
shipment of goods to the time of receipt of payment from the buyer abroad. The credit period can extend from a couple of months to
several years (in the case of deferred payment contracts, project exports etc.) and hits the liquidity of many export businesses. Forfaiting
and factoring are similar in that a third (factoring or forfaiting) agency takes over the accounts/trade receivables of the exporter at a
certain discount. The exporter in turn receives immediate reimbursement of the receivables less the discount due to the factoring or
forfaiting agency. However the conditions and stipulations governing factoring and forfaiting are a little different.

Forfaiting
The Government of India has recently permitted a new form of post shipment financing called Forfaiting as part of its efforts to promote
exports from the country.

Definition :
Forfaiting is the sale by an exporter of export trade receivables, usually bank guaranteed, without recourse to the exporter. Such
receivables include Letters of Credit (with or without Bills of Exchange) Promissory Notes with Aval (guarantee), Bill of Exchange with
Aval, Bank Guarantees Payable to an Exporter in one country from an Importer in another country.
Forfaiting as a financing concept has been in use across the world since the 1960s. The word forfait means to forgo one's right to
something. In the context of export finance, the exporter forgoes his right to receive payment from the importer at later date and
surrenders the right to collect payment to a third party or agency (known as forfaiter). Instead the exporter receives an immediate
reimbursement of his payment less certain discounts from the forfaiter. Normally, these payments are due at a later date, forcing the
exporter to bear the cost for the intervening period, as well as being exposed to the risks of exchange rate fluctuations, political situations
etc. These are risks which expose a small or medium exporter to significant erosion of profits. With forfaiting finance, the exporter passes
on his debts as well as attendant risks to the forfaiting agency. This form of financing is referred to as without recourse financing (in case
the debt cannot be recovered there is no risk for the exporter). Forfaiting is a medium term financing option typically for the three to
seven year time frame.

Forfaiting comes with the following terms and conditions

there is a discounting of the amount to be received from the importer
discounting is on a fixed rate
debt is in the form of bills of exchange or promissory notes guaranteed by a bank
such financing is without recourse to the seller
100% of the amount receivable can be financed in this manner

Forfaiting
The parties/agencies involved in a forfaiting transaction include the exporter, the importer, a forfaiting agency, a bank that stands
guarantee (aval) for the bills of exchange or promissory notes (this is normally the importers bank) and the Exim bank in India acts as the
facilitating agency between the Indian exporter and the forfaiting agency Typically the exporter negotiates terms like price, payment
currency, credit period and the like with their overseas buyer. The exporter then approaches the Exim Bank with these terms. The Exim
Bank obtains a tentative forfaiting quotation from a forfaiting agency. Armed with this quote the exporter can now finalise the contract
with the buyer. The exporter should ensure that most of the forfaiting charges are passed on to the buyer. Once the terms have been
settled with the buyer, a final forfeiting quote is obtained by the Exim Bank. If this quote is acceptable, the exporter signs the contract with
the buyer as well as a separate one with the forfaiting agency. Once shipment of goods has taken place the exporter obtains availed
(guaranteed) bills of exchange from the importer (through a bank) or availed promissory notes. These bills of exchange or promissory
notes are endorsed by the exporter and are routed to the forfaiting agency through the Exim Bank. The forfaiting agency will then remit
the payment due to the exporter to an account of the exporter's bank in the country where the forfaiting agency is based. This bank then
transfers the amount to the exporter in India, and the exporter will be provided with a Certificate of Foreign Inward Remittance as proof.
When the promissory notes/bills of exchange reach maturity, the forfeiting agency collects the payment from the aval (the bank or agency

1 of

5/26/2012 10:21 AM

that stands guarantee irrespective of whether the importer has paid the aval).

FORFAITING COSTS
In a forfaiting transaction the exporter has to bears the following costs
A commitment fee has to be paid to the forfaiter for the period of time from when the commitment is entered into upto the date of
discounting or date of expiry of the contract. The commitment fee typically ranges between 0.5 to 1.5 per cent per annum of the utilised
portion of the forfait amount. This fee has to be paid irrespective of whether the export takes place or not. The second, is the actual
discount fee which is the interest on the receivable amount for the entire period of credit as well as a premium for the various risks
involved. This fee is based on prevailing market interest rates including LIBOR (London Inter Bank Offered Rate). These are the two main
costs involved. In addition there could be documentation costs in case of a lot of paperwork, penalties, handling charges, etc. The Exim
Bank which acts as the facilitator also charges a service fee which can be paid in Indian rupees.
As per RBI regulations it is mandatory that the discount fees and any documentation fees charged by the forfaiter should be passed on to
the overseas buyer. During shipping, it is not necessary that any of the forfaiting fees be shown separately, they can be included in the FOB
value indicated in the invoice. The export contract can be executed in any of the major convertible currencies of the world, in order to be
eligible for forfeiting.

FACTORING
Factoring is a rather more general term for a concept similar to forfaiting. Factoring is the non-recourse sale of accounts receivables of a
business on a daily, weekly, or monthly basis in exchange for payment.
It is a more short term financing based on accounts receivables of a business. Factoring is prevalent in business in various ways. For
instance in retailing, the credit card business is a clear example of factoring. Factoring is often more short-term than forfaiting and is
applicable where receivables are due within around 180 days. Simply put factoring is the process of purchasing accounts receivable, or
invoices, from a business at a discount. Factors provide a vital financing service to mostly small and medium-sized companies who are
short of working capital. The factor fills the money gap between the time a manufacturer or seller makes a sale and the time the customer
pays the bill. For this the factor charges a fee equal to percentage of the invoices purchased.
In the context of the export business, unlike forfaiting, factoring is often with recourse. In a recourse agreement, the exporter has to
repurchase or pay for any invoices the factor cannot collect from the exporter's customers. The factor still agrees to advance money, take
on the collection responsibility, and earn a fee for it. But if the customer doesn't pay, the invoices are returned back to the exporter for
payment. This eliminates any financial risk for the factor, but unlike forfaiting increases the risk for the exporter. Since the risk for the
factor is less, factoring fees tend to be a lower percentage as compared with forfaiting fees. Factoring does not provide safety from nonpayment, political risks and exchange rate fluctuations. Factoring is not fixed rate discounting but depends on the prevalent exchange rate
and political conditions at time of maturity of payment.
The need for cash is common to every business. Factoring rescues these companies by providing them with the liquid assets, or cash, they
need to fuel their growth. Factoring can be particularly valuable for companies with growth potential, but who need an accelerated cash
flow to realize that potential. It is additionally valuable for firms that are seeking new ways to reduce bad debts, and small and mid-size
companies that require working capital or are engaged in seasonal industries. At the same time factoring is not for all companies. While
the advantages of factoring can be great, for some companies the cost would outweigh the value of the services extended by factoring
companies. For example, a company serving a few major customers with excellent credit ratings would probably not benefit from
factoring.
A company with no history, no assets, and no credit couldn't hope for a bank loan, but as long as their customers are creditworthy, a factor
or forfaiter would be keen to do business with them. In essence the factor/forfaiter is not extending credit to the exporter, but actually
purchasing their invoices.
-invoices which represent cash due from their customers. So the factor is concerned with the creditworthiness of the importer customer
and not the exporter.
As we have seen, factoring and forfaiting are two forms of post shipment financing that help exporters to overcome the hurdle of delay in
repatriation of export sale payments. This in turn increases liquidity and cash flow for the exporters business. Forfaiting in particular does
not curtail other borrowing since it is without recourse to the seller and hence does not increase debt. Hence this is an additional rather
than an alternate financing method. Forfaiting and factoring are thus means by which small an medium businesses can raise short to
medium term finance that will help them extend credit to their customers with low or no risks to themselves. This is yet another key to
helping Indian exporters get competitive in the international marketing arena where not just quality and price but even payment terms
can be deciding factors.
Canbank Factors Ltd. (a subsidiary of Canara Bank) offers "Export Factoring" as a substitute for L/C. Details can be had from their website.
www.canbankfactors.com