Forfaiting Definition Examples Pros Cons How It Works

Forfaiting Definition

The receivables owed by the importer are sold to the forfaiter at a discounted rate and without recourse in exchange for cash. These are eligible for trading in the secondary markets. The forfaiter usually is a third-party or intermediary, such as a financial institutionFinancial InstitutionFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more or bank capable of taking on the associated risks of the exchange.

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Key Takeaways

Forfaiting refers to an option businesses explore to obtain funding while involved in international trade.The forfaiters are usually financial institutions, banks, insurance underwriters, or trading companies.Forfaiting and factoring are not the same, although both are methods of obtaining funds while involved in a trade. Forfaiting, on average, has more benefits, but it may be more costly to receive funds.A few advantages include mitigating the risk involved with trading and covering 100% of the necessary funding for completing the transaction.

How Does Forfaiting Work?

Many times, businesses in international tradeInternational TradeInternational Trade refers to the trading or exchange of goods and or services across international borders. read more run into the issue of delivering goods or services on time, only to be paid months later. For some companies, this way of doing business is unachievable. So, they need the funds upfront for things like:

Paying their employeesPurchasing necessary suppliesEnsuring the order is complete and on time

These issues can create a dilemma for the supplier (exporter) when they need funds to continue day-to-day operations. Importers also desire to get the products and ensure the order’s accuracy before making payments.

Forfaiting was created in Switzerland in the 1950s to bridge the “payment gap” between the exporter and the importer. Luckily, businesses have options nowadays to finance and receive the funds upfront through forfaiting instead of waiting and receiving the funds from the importer. Now businesses can partner with financial institutions such as banks or insurance underwriters, hiring them as a forfaiter. This process will typically involve selling foreign accounts receivables such as:

Promissory NotesPromissory NotesA promissory note is defined as a debt instrument in which the issuer of the note promises to pay a specified amount to a party on a particular date.read more – A written letter signed by a party stating the intention to pay a specified amount on a specific date.Accounts ReceivablesAccounts ReceivablesAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year.
read more – Claims on money due for sold products or services.Bills of ExchangeBills Of ExchangeBills of exchange are negotiable instruments that contain an order to pay a certain amount to a particular person within a stipulated period of time. The bill of exchange is issued by the creditor to the debtor when the debtor owes money for goods or services.read more is essentially an IOU for goods or services within an outlined amount of time.Letter of CreditLetter Of CreditA Letter of Credit (LC) is issued by a buyer’s bank to ensure timely, full payment to the seller. If the buyers default, the bank pays the sellers on their behalf.read more – A guarantee from a bank ensuring the supplier will get paid.

Steps Involved In Forfaiting

After the forfaiter accepts the receivables, it will draw up a contract that the supplier will sign. The agreement will usually state specifics of the transactions, such as:

The foreign accounts receivables being purchasedThe amount it will be purchased forThe date and any other documents

The forfaiter will typically purchase the goods at a discount rate outlined in the contract. The supplier can use the funds to continue operations rather than waiting to be paid by the importer.

It will then deliver the goods or services to the buyer (importer). Since forfaiting deals are non-recourseNon-recourseA non-recourse loan is one in which the borrower must attach some form of collateral security to the loan contract, such as property, equipment, or bank fixed deposits, in order for the loan to be approved. In the event of default, the lender has the right to seize the collateral in order to clear the dues.read more and the responsibility is transferred to the forfaiter, it would be up to the forfaiter to collect the payments from the buyer.

Real-World Example Of Forfaiting

An example in real life can be observed with several financial institutions and other providers like banks or insurance underwriters. In this example, we will be discussing what the forfaiting process would look like with Swiss Forfait (SF), a financial institution that primarily deals with this.

When a business is looking to export goods or services but does not want to take on the risks associated with the transactionRisks Associated With The TransactionTransaction risk is the uncertainty or loss caused to the contracting party due to a change in the foreign exchange rate or currency risk on delay in settlement of a foreign transaction.read more or does not have the funds necessary to continue operations, they can contact Swiss Forfait (SF) to provide forfaiting services. The process would look like the following:

The seller will contact Swiss Forfait (SF) looking for their services.SF will ask the seller for details about the exchange and request any necessary documents.The financial institution accepts the foreign accounts receivables from the seller.SF will outline the terms and conditions of the agreement, including the goods being purchased and the discount price.The seller and SF will enter into a contract that explicitly states the accounts receivables, purchasing price, the date, and necessary documentation.The seller will deliver the products or services to the buyer.SF will pay the seller the agreed-upon fees.The bank of the importer will then pay SF. SF will collect the payments from the buyer.

Forfaiting vs Factoring

Factoring is another way businesses can obtain funds when needed for international trading. However, these methods do have several differences.

Pros & Cons

Forfaiting has some impressive benefits for all parties involved. However, it also involves a few drawbacks.