Forfaiting: a concise guide for businesses

Forfaiting helps exporters improve cash flow, mitigate risks, and eliminate the burden of managing international receivables. In this article, we’ll break down what forfaiting is, and take a look at the pros and cons.

What is forfaiting?

Forfaiting is a type of trade finance that enables exporters to receive immediate payment for goods by selling their accounts receivables (the invoices owed to them by importers) at a reduced price through an intermediary, known as a forfaiter. This could be a specialist trade finance firm, or a bank dealing with international trade.

What is a forfaiter?

A forfaiter is the financial intermediary that buys the right to the receivables in return for a cash payment to the creditor – the exporter. Forfaiters are usually specialist financial institutions or departments in a bank.

How does forfaiting work?

An exporter may want to ease pressure on their cash flow by receiving immediate payment for medium or long–term receivables – the amount owed by the importer for the exported goods. The exporter will approach a forfaiter, who is a specialist in trade finance. The forfaiter purchases the receivables at a discount and so prevents any delay in payment. The importer will then pay the full value of the receivables to the forfaiter.

Forfaiting works a bit like invoice financing. With invoice financing, a business can unlock the value of a customer's due invoices by receiving a percentage of their value in advance of their payment date.

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Forfaiting example

The following are key stages in a typical forfaiting transaction:  

• The exporter and forfaiter draft an agreement based on expected receivables, or invoice payments
• The exporter and importer form a sales contract  
• The exporter delivers the goods to the importer
• The importer’s bank provides a payment guarantee
• Trade documents are exchanged between the importer and the exporter
• The exporter and forfaiter exchange trade documents
• The forfaiter pays the exporter
• The forfaiter presents documents for payment to the importer’s bank
• The importer’s bank pays the forfaiter

What does recourse mean?

Like invoice finance arrangements, forfait agreements are defined as ‘without recourse’ or ‘non–recourse’. With non-recourse forfaiting the exporter – having borrowed money from the forfaiter – has no liability if the importer defaults on payment. It is the forfaiter, not the exporter, who accepts the risk of non–payment.

A recourse debt is where the borrower – or exporter – is held personally liable in the event of non–payment and can be pursued for the debt.  

What are the different types of forfaiting?

There are several types of financial agreement that a forfaiter can purchase and convert into debt instruments:

Promissory notes are issued by importers and provide a written promise to pay the exporter

Bills of exchange are similar to promissory notes and are written orders that bind an importer to pay an exporter a fixed sum

Account receivables show the amount of money owing, and they are listed as yet to be paid on the current balance sheet

Letters of credit are issued by banks and provide a guarantee that a debt will be paid even if the importer defaults.

The difference between forfaiting and factoring

While forfaiting and invoice factoring are both trade finance solutions to secure money from receivables they differ in a number of ways. Here are some of the main differences:

• Factoring applies to domestic and international trade, whereas forfaiting is limited to international trade
• Factoring deals with short–term receivables, whereas forfaiting is for medium and long–term receivables
• Factoring is normally for ordinary products or services, whereas forfaiting is for capital goods
• Factoring can be recourse or non–recourse, whereas forfaiting is almost always non–recourse
• While factoring focuses on accounts receivables, forfaiting also covers negotiable instruments such as promissory notes and bills of exchange
• Factoring usually provides 80–90% of the accounts receivable, whereas forfaiting can in some cases provide up to 100%
• Factoring supports the seller, whereas forfaiting supports both the buyer (importer) and the seller (exporter).

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The pros and cons of forfaiting

Pros

With non-recourse forfaiting the risk that an exporter might not receive payment is removed. It means that a sale can be turned into an immediate cash transaction, ensuring cash flow for the seller and meaning the accounts receivable liability can be removed from its balance sheet. Forfaiting can also serve as an alternative to export credit and credit insurance.

Cons

Forfaiting is usually more expensive than other forms of commercial financing, tends to be limited to transactions with a minimum value of $100,000, and is not suitable for short-term transactions. Additionally, it applies only to capital goods (non-consumer items) and is restricted to major currencies for stability. A further disadvantage is that forfaiters may not operate in high–risk regions, and not all banks will be accepted as suitable guarantors.

What are the risks?

While risk is mostly removed from the exporter’s side, there is no legal framework to protect the forfaiter or the bank. Because it is a foreign transaction, forfaiting is subject to political and currency risks. From the moment a forfaiter commits to provide finance, up to the time of repayment, it will be exposed to risk. For example, interest rate fluctuations.

Costs

Forfaiting usually involves the following costs:

• A commitment fee is charged by the lender, or forfaiter, for agreeing to set aside funds to lend to the exporter
• A discount fee (interest payment), based on Libor, is applied from the date the forfaiter undertakes the financing until the date of discounting
• Documentation fees may apply if the transaction requires extensive paperwork

Where to find a forfaiter

When looking for a forfaiter, a good starting point is the International Trade and Forfaiting Association. Based in Switzerland, the IFTA is the global trade body for businesses engaged in trade and forfaiting. It includes a wide number of forfaiting banks and financial institutions who can help with export finance.

Key takeaways on forfaiting

• Forfaiting enables exporters to receive immediate cash
• It eliminates risk for exporters, with 100% financing available
• It mostly protects against credit risk, transfer risk, and the risk from foreign exchange and interest rate changes
• Forfaiters are typically banks or other financial intermediaries who purchase the receivables from the exporter. The importer then pays the receivables to the forfaiter
• Forfaiting usually works with promissory notes, bills of exchange, or letters of credit
• It is restricted to capital goods, and medium and long–term contracts