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Key Difference Between Factoring and Forfaiting

By Annapoorna

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Updated on: Mar 29th, 2023

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10 min read

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Forfaiting and factoring are two of the most important sources of export financing. While these terms might mean the same to an uninitiated person, the major factoring and forfaiting difference lies in the type of transaction they are used for and the length of the term. 

Continue reading to know the difference between factoring vs forfaiting. 

Meaning of Forfaiting with Example 

Forfaiting is a way for companies to get money for goods or services they have already sold to someone in a different country. When a company sells goods in another country, it usually has to wait a long time to get paid. This can make it hard for the company to have enough money to pay for supplies and salaries.

Forfaiting is a way for the company to get some of the money they are owed right away, even if they have to wait a long time (usually 90 days) to get the rest. They sell the money (account receivables) to a bank or finance company. The bank or finance company gives some money to the company immediately, but they keep some of it as a fee for helping the company. The company can then use the money they get right away to pay for things they need, like supplies and salaries.

It is typically used for invoices that are due in the long term, that is, due after more than 90 days. This helps improve their cash flow and makes it easier to run their business.

For example, suppose a company sells a product to a customer in another country and sends them an invoice for Rs. 1,000, due in 180 days. In that case, the company forfeits the invoice to a third party at a discount and gets some of the money they are owed immediately.

Meaning of Factoring With Example 

Factoring is a way for a company to get some of the money they are owed right away, even if they have to wait for less than 90 days to get the rest. It is typically used for short-term accounts receivable (invoices due within 90 days or less). 

For example, if a company sells a product to a customer and sends them an invoice for Rs. 1,000 that is due in 90 days, the company could use factoring to sell the invoice to a third party at a discount and get some of the money they are owed right away.

You can sell the bill to someone else, like a bank or finance company. The bank or finance company will give you some money right away, but they will keep some of it as a fee for helping you. You can then use the money for your day-to-day operations. 

Factoring is especially helpful for companies that sell things to people and have to wait a long time to get paid for them. It can help them improve their cash flow and make it easier to run their business.

Differences Between Forfaiting vs Factoring

Imagine that you have a lemonade stand, and you sell a cup of lemonade to someone for Rs. 5. You give them a bill that says they have to pay you back within a specific number of days. But you need the money right away to buy more supplies for your lemonade stand. 

In this case, you can reach out to a bank and sell the invoices to them. This process is called factoring if the invoice is due within 90 days. However, the process is called forfaiting if the invoice is due in more than 90 days.

Here is a tabular representation of forfaiting vs factoring:

Difference

Factoring

Forfaiting

The type of accounts receivableFactoring is typically used for short-term accounts receivable (invoices that are due within 90 days or less)Forfaiting is typically used for long-term accounts receivable (invoices that are due in more than 90 days)
The type of buyerFactoring is typically used for domestic sales (sales to buyers in the same country as the seller), Forfaiting is typically used for international sales (sales to buyers in a different country).
The risk involvedIn factoring, the factor (the third party buying the invoice) assumes some risk because they are responsible for collecting the payment from the customer. In forfaiting, the forfaiter (the third party buying the invoice) assumes no risk because they are not responsible for collecting the payment from the customer.
Type of transactionFactoring is more commonly used for the sale of short-term, low-value domestic or international receivablesForfaiting is typically used for the sale of long-term, high-value export receivables
The fees involvedFactoring typically involves higher fees than forfaiting because the factor is assuming more risk.Forfaiting involves comparatively lower fees.
Types of goodsUsed for ordinary goodsUsed for capital goods
Finance limit80–90% of the invoice100% of the invoice
Negotiable instrumentIt does not involve a negotiable instrumentThis one involves a negotiable instrument

 

Forfaiting vs Factoring — Which is the Best Option for Businesses? 

Factors that can help you determine whether to go for forfaiting or factoring include the following:

  • Type of Goods/Services Being Sold: Forfaiting is typically used to sell high-value goods, such as machinery or industrial equipment. At the same time, factoring is commonly used to sell low-value goods or services.
  • Creditworthiness of Buyer: If the buyer has a strong credit rating, forfaiting may be a good option, as the buyer is likely to be able to pay the full amount of the invoice on time. If the buyer has a weaker credit rating, factoring may be a better option, as the factor can protect against the risk of non-payment.
  • Length of Payment Term: Forfaiting is typically used for transactions with longer payment terms, while factoring is more commonly used for transactions with shorter payment terms.
  • Size of Transaction: Forfaiting is generally used for larger transactions, while factoring is more commonly used for smaller transactions.
  • Goals of Seller: Forfaiting may be a good option for a seller looking to reduce the risk of non-payment, while factoring may be a better option for a seller looking to improve cash flow and access financing more quickly.

Conclusion

Forfaiting is typically used to sell long-term, high-value export receivables, while factoring is commonly used to sell short-term, low-value domestic or international receivables. Factors to consider when deciding between forfaiting and factoring include the type and value of the goods being sold, the buyer's creditworthiness, the length of the payment term, the size of the transaction, and the needs and goals of the seller.

About the Author

I preach the words, “Learning never exhausts the mind.” An aspiring CA and a passionate content writer having 4+ years of hands-on experience in deciphering jargon in Indian GST, Income Tax, off late also into the much larger Indian finance ecosystem, I love curating content in various forms to the interest of tax professionals, and enterprises, both big and small. While not writing, you can catch me singing Shāstriya Sangeetha and tuning my violin ;). Read more

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