Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business. Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables (essentially a financial asset), not the firm’s credit worthiness. Secondly, factoring is not a loan – it is the purchase of a financial asset (the receivable). Finally, a bank loan involves two parties whereas factoring involves three.
It is different from the forfaiting in the sense that forfaiting is a transaction based operation while factoring is a firm based operation - meaning, in factoring, a firm sells all its receivables while in forfaiting, the firm sells one of its transactions.
Factoring is a word often misused synonymously with invoice discounting - factoring is the sale of receivables whereas invoice discounting is borrowing where the receivable is used as collateral.
In trade finance, forfaiting involves the purchasing of receivables from exporters. The forfaiter will take on all the risks involved with the receivables. It is different from the factoring operation in the sense that forfaiting is a transaction based operation while factoring is a firm based operation - meaning, in factoring, a firm sells all its receivables while in forfaiting, the firm sells one of its transactions.
Benefits for using forfaiting include eliminating risks (political, transfer and commercial risks) and improving cashflows. Increases cash flow. Forfaiting converts a credit-based transaction in to a cash transaction.
The characteristics of a forfaiting transaction are:
1. Credit is extended by the exporter for period ranging between 180 days to 7 years.
2. Minimum bill size should be US$ 250,000/- (US$ 500,000/- is preferred)
3. The payment should be receivable in any major convertible currency.
4. An L/C or a guarantee by a bank, usually in importer's country.
5. The contract can be for either goods or services.
At its simplest the receivables should be evidenced by any of the following debt instruments:
1. Promissory note.
2. Bill of exchange.
3. Deferred payment letter of credit.
4. A letter of guarantee.
Very nice different explanation thanks