What is factoring?
Factoring may be defined as an agreement between the financial institution and the business concern that is selling the goods on credit.
Factoring and Forfaiting – Meaning, Procedure, Advantages
Factoring is the process of selling invoices to a company in return for funds in advance. The factor records, collects and protects the book debts and purchases the bills of receivable of the seller.
Factoring helps the seller or the entrepreneur to sell goods on credit and provides immediate funds to the seller. It provides liquidity to the seller. It also minimizes the bad debts and functions as an effective financial service.
Procedure of Factoring
The following procedures are involved in factoring.
1. After selling the goods to the buyer the seller or the entrepreneur who sold goods on credit prepares a bill and raises the invoice.
2. The factor pays at least 80% of the invoice value to the seller and prepares the statement of accounts for the buyer.
3. The factor sends the statement of accounts to the buyer.
4. The buyer settles the transaction with the factor.
5. The factor after paying the balance amount to the seller obtains the commission.
Advantages of Factoring
Some of the advantages of factoring are listed below.
1. It provides liquidity to the business concern that sells goods on credit.
2. It minimizes labor cost as the factor records, collects and controls the book debts.
3. Factoring provides Credit Services such as credit screening and monitoring, early detection of customer service.
4. Factoring reduces bad debts through timely collections on invoices.
5. It allows the business to increase credit sales and expand business. It helps the seller to concentrate on sales without worrying about bad debts.
6. It provides liquidity to supplier. This money of the seller is not locked up in business due to credit transaction.
7. Factoring companies offer a degree of credit management, saving time and resources in managing the debtors.
8. It allows the seller to sell goods on credit.
What is Forfaiting?
Forfaiting is the discounting of international trade receivables such as promissory notes and bills of exchange, in exchange for cash. This is an arrangement under which the exporter is provided finance against his bill by forfaitor. Forfaitor is usually a bank or finance company.
Procedure of Forfaiting
The importer places an order with the the exporter.
The exporter will refer the order to forfaiting bank and ask whether forfaiting bank can provide forfaiting services.
Forfaiting bank after checking the credit worthiness of importer accepts to provide service.
Now the exporter sells the goods and receives the bills of exchange from the importer.
The exporter collects money from forfeiting bank against the bill.
Forfeiting bank collects the money from the importer. The advantage for exporters is that exporter gets funds immediately. Bad debt is avoided in export transactions as guarantee is given by the bank.
Advantages of forfeiting
1. It provides liquidity and improves cash flow.
2. Working capital is not locked as the exporter gets funds from forfeiting bank.
3. Political, transfer and currency risks are eliminated.
4. The possibility of bad debt caused by importers or guarantor banks unable to pay is completely eliminated.
5. Forfeiting is an excellent tool for the exporters who wishes to expand sales in international market.
6. It acts as a protective tool when it comes to international finance. It is better tool than insurance, mainly because it provides the exporter with cash at the time of shipment.
7. In countries where protection against credit, economic and political risks is higher, forfeiting can be a very dependable tool for exporter’s.
8. The risk of a debtor’s non-repayment is eliminated and the risk of currency fluctuations and interest rates are also eliminated.