Characteristics of forfaiting
What is „forfaiting“
Forfaiting is a method of financing primarily international commercial transactions and is a kind of medium-term financing of the export of goods of production use. Before concluding the contract, the exporter, if unable to credit the foreign importer, has the option of financing the transaction from an external source (a forfaiter). In other words, in forfaiting a third party (the forfaiter) purchases the receivables from the foreign importer to the exporter, whose only responsibility is to produce and deliver the agreed product. Underlying this process is the purchase of various debt instruments, without recourse, such as letters of credit, bills of exchange, promissory notes or other negotiable instruments for the furure repayment of liabilities. The forfaiter charges interest (discount) for the entire loan period and pays the net proceeds immediately. Actually, the exporter transforms his sale, based on credit, into a cash transaction.Debt instruments are drawn by the exporter (seller), accepted by the importer (buyer) and the forfaitable liability is most often guaranteed by aval or unconditional guarantee. In principle, the guarantee is issued by the bank of the importer, but there are rare cases, when the forfaiting is done without guarantee. The forfaiter either holds the instrument to maturity, or endorses it without recourse. Most often this is used in transactions for over 100 000 dollars (the minimum for forfaiting is 25 000 dollars). The purchased receivables have a credit repayment period of between 180 days and 10 years.
Common case
To illustrate how the process of forfaiting practically works, we will consider the following most common situation, in which the seller and buyer are from different countries. The following steps are taken:
A/ During the negotiations between the exporter and the importer on the supply of goods, the importer wishes to be granted credit.The exporter investigates the possibility for the transaction to be financed through forfaiting.
B/
Having been contacted, the forfaiter requires the following
information:
• What is the importer‘s country
• The name of the importer
• What type of goods will be transported
• Delivery period
• Currency, amount and period of the liability
• Form of the liability
•Whether the liability of the importer will be guaranteed by a bank or in some other way
The
importer is investigated, his creditworthiness is checked, following
the relevant routines.
C/ After the investigation, the forfaiter
submits a proposal to the exporter, which is valid for 48 hours, for
the purchase of receivables. The discount, the commission and
other terms and conditions of the contract are given. At this
stage none of the three parties is bound in any way.
D/ When the
exporter accepts the proposed terms and conditions, the main clauses
are agreed upon and the basic documents, such as debt documents
(bills of exchange and promissory notes), guarantees, etc. are
described. Before the final signing of the contract, the
exporter requests that the forfaiter prepares an agreement, whereby
the latter undertakes to purchase the receivable, formed as a result
of the commercial transaction between the exporter and the
importer.
E/ The forfaiter issues such an agreement, which is
approved by the exporter and is binding for both parties. It
contains the following main points:
• Details of the major commercial transaction.
• The essence of the debt instruments to be purchased by forfaiter.
•The discount(interest) to be charged, as well as other charges.
• Documents
that prove that the debt which the forfaiter will purchase, is valid
and lawful.
F/ A contract is concluded for the transaction between
the exporter and the importer. A period of binding, which lasts
from 3 to 6 months, follows. During this time the exporter
ships the goods, collects all the documents that the forfaiter needs
and delivers them to him. The latter cannot abandon his
obligation under the contract.The exporter pays the relevant
charges.
G/ The importer appoints a guarantor for his liability
and submits the documents that the exporter needs to complete the
forfaiting. This exchange of documents is usually done by a bank and
most commonly a letter of credit is used to reduce the risk of the
exporter.
H/ The exporter submits these documents to the forfaiter
who, after checking their authenticity, purchases the liability of
the importer (the bill of exchange or the promissory note is
endorsed) and pays the exporter.
I/ Collection of receivables from the original debtor and closing the transaction. As the endorsement is without recourse, the exporter has no longer interest in the transaction. The forfaiter is the one who has to collect the payments from the importer and the entire risk remains with the forfaiter.
Diagram 1 The process of forfaiting
An example of a forfeiter
Forfaiting as a method of financing is a relatively new procedure, not very familiar. In Europe (Italy and Germany) this technique is well-known, however, and most of the demand for this service is from these countries. The English, Scandinavian, Spanish and French exporters are enthusiastically embracing the use of this technique to finance international transactions. On the other hand, countries like the U.S. and Canada are slowly adopting this method, which, some experts suspect, is due to the simplicity of the method, besides the lack of complex documents.
For the participation of a country like Bulgaria in international trade the knowledge of this method is of crucial importance. This statement is especially true for small countries whose markets have a low absorption capacity. The companies of such countries seek to penetrate foreign markets to ensure profitable production. Governmental bodies, on the other hand, rely on an active trade balance and hence the additional budget revenues and robust growth in gross domestic product.Therefore, a variety of measures are used, companies are established, state-owned or private, to boost the foreign trade operations of local enterprises. It is for this reason that forfaiting in Bulgaria should be encouraged. Unfortunately, few institutions offer this service and one of them is First Investment Bank. The Bulgarian First Investment Bank, with the West London Branch, offers forfaiting, the discounting of future receivables. The new product is for companies exporting goods to the country, with a high risk of importers and their banks.
In
forfaiting are used deferred payment letters of credit, promissory
notes, bills of exchange:
A/ Discounting of sight letters of
credit - when confirmation has been received by the foreign bank for
payment, also when customer transfers have been received for a future
maturity date.
B/ First Investment Bank has signed a contract with
BEIA, Ltd. (The Bulgarian Export Insurance Agency) for cooperation
in financing export-oriented companies or projects.
Characteristics of factoring
What is „Factoring“?
Digram 2 The Process of factoring
Factoring is a form of financing, based on current assets, in which the credit is based on the value of the receivables of the supplier, i.e. of the payments payable by the customers to the supplier.
Unlike the other major form of financing , based on real assets, with factoring the receivables are acquired by the factor. This means that the ownership of the receivables is transferred from the seller to the factor.
In addition to financing, factoring generally includes other services, too. Basically these are crediting and collection of receivables.
This set of services is one of the advantages of factoring over other types of crediting, especially for companies that lack the skills or resources to manage credit activities and the collection of receivables.
Most importantly, factoring is not crediting, factoring is:
collection of receivables
financing
аdministration of customer receivables.
Prerequisites for a start
Criteria for factoring:
Receivables should be negotiable, qualifying for factoring and receivable without any legal restrictions.
The company should have a business record of at least one year.
Terms of deferred payment - an account opened within 120 days.
Procedures before the conclusion of the factoring contract
Preliminary request for factoring
Preliminary assessment of the credit-worthiness of the buyers, conducted by the Factor
Request for factoring
Submission of all documents, requested by the Factor
Establishing of restrictions of the debtor (buyer) and approval by the Factor
Consent on the part of the debtor (buyer) to transfer the receivables
Submission of bargain and sale contracts between the client and his buyers
Signing of a factoring contract between the client and the factor
Transfer of receivables
Guiding principles in the service of factoring
Bulbank is the first financial institution in Bulgaria, which offers domestic factoring, following its extensive international presence and experience and striving to achieve the best standards in the industry. Bulbank is the most powerful financial group not only in Bulgaria but also across all of Eastern Europe.
The
service of factoring:
Financing and
collecting the
receivables of
clients
with the primary objective to
optimize the
client's business and help its
growth.
For these reasons the objective is to provide:
SPEED
Up to one week for initial analysis, evaluation for decision taking
Up to one day for approval of the submitted invoices and transfer of advance payment to customer
Minimum documentation and administrative burdens
QUALITY OF SERVICES
Instant and direct communication
Wide range of related financial and business consulting
COMMERCIAL FLEXIBILITY
Adaptation of the factoring scheme to the way the client works and his relations with his customers
Determination not to complicate the trade relations between the Client and his customers.
Who is factoring for ?
Manufacturers, trading companies or companies, providing certain types of services and supplying goods or services:
Regular customers with an opened account and a period of deferred payment of between 30 and 120 days
Receivables are negotiable and collectable with no legal restrictions
Receivables have not fallen due
The percentage of credit notes, discounts on old debts, etc. is low
There is no relation (mostly - property and /or management) between the Supplier and his client
There is no practice of bilateral offsetting
The supplier has a business record of at least one year
The customer (payer) agrees that the receivables be sold and he pays them on account of the Factor
Advantages of the use of financing receivables
It is not strictly oriented to the current record of the customer . It helps fast-growing companies by providing them with the cash that the development of their business requires.
Factoring is a type of crediting and provides cash without debt, i.e. it allows the company to raise cash when there is no opportunity or desire to increase the size of its debt, and also releases securities for other projects
It converts receivables with a maturity of 30, 60, 90 and 120 days into cash within hours, i.e. it provides cash for capital expenditures and /or pay quickly when the customer needs it
Opportunity to purchase goods at a discount rather than on more expensive payment terms. Faster acquisition of materials and faster execution of orders
It allows the customer to provide better conditions (e.g. a period of deferred payment) to his customers, thereby facilitating sales
It does not require long-term commitments
Conclusion
Finally, factoring and forfaiting,as forms of financing, are relatively higher in price than the standard bank credit or discounting, which derives from the various additional commissions that are charged, as well as the fact that with them a value- added-tax is levied. They are fast and flexible methods to improve the cash flow of companies, attractive and competitive terms of payment to customers.
References
Балабанов И. Т., Основы финансового менеджмента, как управлять капиталом?, изд. „Финансы и статистика“, М., 1996 г.
Димитров Й. С., Финансов мениджмънт – част 2, изд. „Питагор“, С., 2009 г.
Ненков Д., Финансов мениджмънт, Университетско издателство „Стопанство“, С., 2000 г.
Bringham E., I. Gapenski, Financial management – theory and practice, The Dryden press, 1994
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