Invoice Factoring
Strictly speaking, this is not a form of factoring because it does not carry the service elements of factoring. Under this arrangement, the factor provides a prepayment to the client against the purchase of book debts and charges interest for the period spanning the date of pre-payment to the date of collection. The salesledger administration and collection are carried out by the client. The client provides the factor with periodical reports on the value of unpaid invoices and the ageing schedule of debts. This facility is usually kept confidential i.e., the customers (whose debts have been purchased by the factor) are not informed of the arrangement. Therefore, this arrangement is also referred as «Confidential Factoring».
A variant of the invoice discounting is the Protected Invoice Discounting arrangement where the factor bears the credit risk of the receivables purchased. Put differently, the factor purchases the debts without recourse but does not offer the services of sales-ledger administration and debt collection. Invoice discounting in general and protected invoice discounting in particular are offered to clients with a sound financial position and with no serious problem of debt collection and debt write-offs.
If the invoice discounting facility is not confidential in nature, the customers of the client are advised to make payment directly to the factor and this facility is referred to as «Bulk Factoring». The need for this facility arises when the factor finds that the client does not fulfill the criteria laid down for invoice discounting and requires the security associated with direct payments from the customers. Bulk factoring offered with a non-recourse feature is referred to as «Agency Factoring» in some countries, because the client acts as an agent of the factor in collecting the debts.
Factoring vs. Forfaiting
The processes of factoring and forfaiting are similar in some ways. But there are also certain differences between the two. Let us take a look at these differences:
Basis of
difference | Factoring | Forfaiting |
Extent of
Finance |
Usually 80% of the value of the invoice isconsidered for advance |
100% Financing |
Credit
worthiness |
Factor does the credit rating of the counterparty in case of a non-recourse factoring transaction |
The forfaiting bank relies on the credibility of the avalling bank |
Services
Provided |
Day-to-day administration of sales and other allied services are provided |
No services are provided |
| Maturity |
Advances are short-term in nature |
Advances are generally mediumterm |
In international trade transactions, forfaiting is a common form of financing export-related receivables. Under this arrangement:
- The exporter sells the goods to the importer on a deferred payment basis spread over 3-5 years.
- The importer draws a series of promissory notes in favor of the exporter for the payments to be made inclusive of interest charges.
- The promissory notes are avalled or guaranteed by a reputed international bank which can also be the importer’s banker. (An aval is an endorsement on the promissory notes by the guaranteeing bank that it covers any default of payment by the buyer).
- The exporter sells the avalled notes to a forfaiter (which can be exporter’s banker) at a discount and without recourse. The discount rate applied by the forfaiter will depend upon the terms of the promissory notes, the currencies in which they are denominated, the credit rating of the avalling bank, the country risk of the importer, and the prevailing market rate of interest on medium-term loans.
- The forfaiter may hold these notes till maturity or sell these notes to groups of investors interested in taking up such high-yielding unsecured paper.
Forfaiting transaction resembles a cross-border factoring transaction with features of non-recourse and advance payment. But then the two transactions are not identical. The important differences are
- In a factoring transaction, the factor does not provide hundred percent finance; he maintains a factor reserve. On the other hand, in a forfaiting transaction the forfaiter discounts the entire value of the promissory notes.
- In a non-recourse factoring transaction, the factor participates in the creditgranting decision of the exporter (the client) whereas in a forfaiting transaction, the forfaiter relies on the unconditional and irrevocable guarantee provided by the avalling bank. So he is more concerned about the financial standing of the avalling bank than with the credit standards applied by the exporter.
- While the factor takes on the responsibilities of receivables accounting, monitoring and collection, the forfaiter does not assume any of these responsibilities.
- The factor purchases receivables which are of a short maturity period whereas the forfaiter buys bills/promissory notes arising out of deferred credit transactions.
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