Forfaiting – definition
In a nutshell, forfaiting is a form of corporate financing that involves the purchase of term receivables relating usually to foreign transactions. These receivables take the form of bills of exchange.
Four parties are involved in the forfaiting process: the forfaiter (the person or company ordering the forfaiting service – the exporter), the forfaiter (the institution that buys the receivable and pays the resulting money to the forfaiter), the debtor (the importer) and the debtor’s bank. In a forfaiting agreement, only the first two entities are parties.
We distinguish between forfaiting commercial receivables, bills of exchange and leasing receivables.
Chronology of forfaiting
- Initially, before the need for forfaiting arises, a company exporting goods out of the country signs a trade agreement with the importer. From now on, the importer becomes a debtor.
- The exporter then orders a forfaiting service from a bank or other financial institution. The forfaiter redeems the debt before the due date and, depending on the type of debt, charges a discount interest and/or assumes the risk of the debtor’s insolvency.
- The next step in the process is the delivery of goods or services specified in the commercial contract (see Section 1.).
- Subsequently, it is necessary to secure the acquired claim. It can take the form of a surety or aval. A surety can be granted by a bank after assessing the debtor’s creditworthiness. The valuer, in turn, usually becomes the debtor’s bank.
- Once the importer has come to an agreement with his bank, the importer must provide documents proving the surety or aval to the forfaiter. This allows the forfaiter – assured of the debtor’s solvency – to provide a forfaiting service to the exporter.
- Thus, the forfaiter pays the amount of the claim less its own commission. At this point, the forfaitist-exporter’s participation ends. He has received the money owed to him, has secured himself against the insolvency of the debtor, and can continue the operation of his company with the funds raised.
- Many days usually pass between the sixth and seventh steps, as the terms of the receivables that are the subject of forfaiting agreements oscillate from one to as much as ten years (although shorter terms also occur). The last stage is the repayment of receivables. Depending on the situation, payments are made by the debtor or guarantor.
Forfaiting vs. factoring – what are the differences?
At first glance, the two services are quite similar. However, there are significant differences between them. The first is the duration. While a factoring agreement can be concluded for a fixed term (e.g. 12 months) or indefinitely, forfaiting always covers only one receivable. Financing several foreign transactions through forfaiting requires writing separate agreements for each transaction.
The second major difference is the area of operation – factoring operates both domestically and internationally, while forfaiting, on the other hand, applies only to international transactions.
Costs tip the scales again in favor of factoring – For forfaiting you will pay more, mainly because the service includes responsibility for possible solvency problems of debtors, but also because forfaiting service usually lasts much longer – up to 10 years.
A very important aspect that should also be compared is the amount paid out. In the forfaiting service, 100% of the value of the claim is paid immediately. In factoring, on the other hand, the factor’s account is usually credited with 80-90% of the financing upfront, with the rest after the recipient settles the payment. The exception to this is factoring involving the financing of single invoices, where, as with forfaiting, 100% of the receivables are paid upfront.
Who is forfaiting for?
Technically speaking, forfaiting can be used by legal entities, unincorporated business entities and sole proprietors.
Although forfaiting is most often used for international transactions, there are no legal obstacles to using the service domestically – in such cases, assignment of receivables is usually chosen.
Forfaiting is also worth considering if you expect fluctuations in the exchange rate of the currency in which you conduct the transaction – entering into a forfaiting agreement protects you against adverse changes. Keep in mind, however, that these criteria are also taken into account by forfaiting institutions.
