3. Lecture outline
Factoring as trade finance method
Forfaiting as trade finance method
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4. Factoring
Factoring is a transaction where the
exporter sells its receivables to an
institution
The factoring institution buys the
receivables without recourse
Due to increased risk factors demand
discount on the receivables
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5. Types of factoring
Maturity factoring- the factor pays the
exporter at maturity of the accounts
receivable
Advance factoring- the factor pays the
exporter in advance a specified share of
the receivables
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6. The mechanism of factoring
The factoring transaction involves three parties:
The seller-the exporter
The debtor-the importer
The factor
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7. The mechanism of factoring
The receivables sold are usually invoices
for the delivered products
Factoring can take place with or without
notification of the debtor
In the case of notification the factor carries
out the collection, in the case of lack of
notification the exporter carries out the
collection
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8. Advantages
Factoring is advantageous for exporters
because this way they can obtain cash
This can especially beneficial if companies
struggle with liquidity problems
In some industries factoring is the historic
method of finance e.g. in textiles or
apparel branches
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9. Advantages
Factoring enables risk-free export sales
The exporter can offer more attractive
transaction terms
Exporters are relieved from administration
duties
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10. When to use factoring?
Factoring is more expensive than a bank
loan
In fact it is not a loan
It can happen that banks would refuse a loan
to an exporter to provide him with cash but a
factor would buy his receivables
The factor checks the creditworthiness of the
debtor and not of the seller
Especially beneficial for small exporters
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11. Would factors always buy the
receivables?
The credit history of the debtor is a crucial
condition
The current creditworthiness of the debtor
Usually even average credit rating of the
debtor is refused by factors
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12. Is the debtor affected by factoring?
Some types of debtors- usually large firms or
governments have specified procedures when it comes
to transferring the payment from the seller to debtor
This matters especially due to the obligation of the factor
to perform the collection
The distinction between assignment of the responsibility
to perform the work and the assignment of funds to the
factor influences largely the debtor’s processes
Sometimes the debtor wants the seller to perform the
collection
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13. Forfaiting (1)
A transaction where a forfaiting institution buys withoutrecourse the debt resulting from a trade contract which is
due in the future
Forfaiting is usually aimed at medium-term capital goods
financing
The subject of forfaiting transactions are usually fixed
assets
As this type of goods are usually expensive the financing
period may account for several years
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14. Forfaiting (2)
Exporters are not willing to finance importers
over such a long period
This is why the debt of the importer is sold to
forfaiters (usually banks)
Forfaiting financing usually refers to
transactions exceeding 500000 USD
For larger transaction more than one
forfaiting institutions can be involved
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15. Forfaiting (3)
The forfaiting institution takes over the risk of the sales
transaction.
The exporter is liable for the quality and reliability of the
project
The forfaiter has an unconditional payment obligation
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17. Does the bank always agree to
forfaiting?
The bank needs a guarantee that the debt will
be paid off
The debt should be freely transferable
The forfaiting bank requires the debt purchased
to be secured by a credible bank guarantee or
the importer to be a prime buyer, e.g.
government agency or a multinational company
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18. Required documents
The guarantee can take the form of:
promissory notes
bills of exchange,
book receivables
deferred payments under a letter of
credit
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19. Forfaiting paper
All documents guarantying the transaction e.g.
bills of exchange and promissory notes become
the property of the forfaiter
The documents are called forfaiting papers
They are liquid assets with comparatively high
yields
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20. What are the costs of forfaiting?(1)
The forfaiting institution demands cash for
buying the debt
The value of the debt is discounted at a
specified rate,
The forfaiting institution demands also a
risk premium on the transaction
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21. What are the costs of forfaiting?
(2)
The discount margin is the one of the
principal costs of forfaiting
Besides the discount margin the bank
charges a commitment fee
The discount can be computed as straight
discount or discount to yield basis
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22. Advantages of forfaiting for the
exporter
Conversion of a credit transaction into a
cash transaction
Increase of liquidity
Risk elimination (market, transaction and
political risks)
Relieve of administration duties
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23. Advantages of forfaiting for the
importer
The flexibility to pay for his goods
Deferred payment
Fixed interest cost
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24. Summing up
Factoring and forfaiting can be beneficial methods of
trade finance
Both allow to transfer credit transactions into cash
transactions
Factoring serves financing short term transactions while
forfaiting medium term transactions
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25. Discussion
Factoring and forfaiting are withoutrecourse methods of trade finance. Is this
always beneficial? Name examples when
recourse financing would be more
beneficial.
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26. Literature
E. Bishop, Finance of international trade,
Chapter 10. Publication available via
Science Direct Database
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