International Trade Finance Companies: Factoring vs. Forfaiting
You are a business owner. You have just signed off on, sealed, and shipped your company’s product to your number one client in Ireland. They have been your client for years, but every time you bill them on a 30-day invoice, it takes them around 60 to 65 days to pay it. In the meantime, you still must run your business. You need to purchase other manufacturing supplies for next month’s order, pay your employees, and settle other operating expenses. But how are you going to do that in a timely fashion, if you have to wait over two months to get paid from the first job you did for this client?
Sound familiar? You are not alone. A lot of businesses find themselves in this predicament each month, especially when dealing in international trade, and choose to use international trade finance companies.
How does a business mitigate the risk of having to wait over two months to get paid, and keep their ship afloat? The answer is international trade financing via factoring or forfaiting.
What is Factoring?
Factoring is a common financial practice used in the trade financing industry that can be applied to both domestic and international sales. It is a transaction in which a company sells its accounts receivable at a discount to a 3rd party financial institution, or factor, for immediate payment instead of waiting 30, 60, or 90 days until payment is due from its customer.
The relationship that a business has with the factor can be a very successful, and long sustaining one. If the business wants, they can sell their accounts receivable to their factor every month for as long as they, and the factor, are both in business.
When it comes to the contract between the business and the factor, the parties can negotiate if the contract will have recourse or not. Recourse factoring means that if the factor is not able to collect the full amount of the invoice from your client, you will agree to chip in something monetary. Non-recourse factoring means that if the factor is not able to collect the full amount of the invoice from your client, they absorb any and all losses.
What is Forfaiting?
Though the process of forfaiting is very similar to that of factoring, forfaiting is only used in international trade. In this scenario, a business sells its right to trade receivables to international trade finance companies (the forfaiters). For doing this, the business receives a cash payment immediately to keep their business running smoothly.
In factoring, once a business sells its accounts receivables to a factor, they are selling 100% of the invoice. In forfaiting, when a business gives up the right to trade receivables to international trade finance companies, they are giving up 100% of their claim on it to the forfaiter.
Unlike factoring, a forfaiter will usually have to wait much longer than the normal 30-day invoice waiting period. A forfaiter could have to wait several months to make their money back plus profits, or they could even have to wait several years in some rare instances.
Where there could be recourse or nonrecourse in factoring, forfaiting is conducted without recourse. Although forfaiters do like to have some type of guarantees in place from the buyer, they are still assuming all the risk if the buyer does not pay. They also cannot come back to the business, asking them to chip in any monetary compensation.
When it comes to factoring and forfaiting, there are a few things to keep in mind. Factoring is mostly used in domestic trade but can also be used for international trade. Forfaiting is just used for international trade scenarios only.
If you think you are ready to take that next step and sell globally, Tradewind can be your one-stop solution for all your international trade finance needs. Combing financing, credit protection, and collections into a single trade finance facility, Tradewind, a leading international trade finance company, provides streamlined, flexible, and best-in-class services. Consult with them today for more information on how to expand your business to a global audience.