Apart from factoring a source of receivables, working capital financing is bill discounting arrangement offered by banks and finance companies.
Similarities: Factoring is somewhat similar to bills discounting in the sense that both these services provide short term finance. Again discount account receivables which the client would have otherwise received from the buyer at the end of the credit period.
Differences: Nonetheless, the two receivables financing arrangements differ in important respects.
1. Bill discounting is always with recourse whereas factoring can be either with recourse or without recourse.
2. In bill discounting the drawer undertakes the responsibility of collecting the bills and remitting the proceeds to the financing agency, while the factor usually undertakes to collect the bills of the client.
3. Bills discounting facility implies provision of finance and only that, but a factor also provides other services like sales ledger maintenance and advisory services.
4. Discounted bills may be rediscounted several times before they mature for payment. Debts purchased for factoring cannot be rediscounted, they can only be refinanced.
5. Factoring implies the provision of bulk finance against several unpaid trade generated invoices in batches; bill financing is individual transaction oriented i.e. each bill is separately assessed and discounted.
6. Factoring is an off balance mode of financing
7. Bills discounting does to involve assignment of debt as is the case with factoring.
Forfaiting is a form of finance of receivables pertaining to international trade. IT denotes the purchase of trade bills/promissory notes by a bank/financial institution without recourse to the seller. The purchase is in the form of discounting the documents covering the entire risk of nonpayment in collection. All risks and collection problems are fully the responsibility of the purchaser (forfeiter) who pays cash to the seller after discounting the bills/notes. The salient features of forfaiting as a form of export related financing are summarized below:
In pursuance of a commercial contract between an exporter and importer, the exporter sells and delivers the goods to the importer on deferred payment basis.
The importer draws a series of promissory notes in favor of the exporter for payment including interest charge. Alternatively the exporter draws a series of bills which are accepted by the importer. The bills/notes are sent to the exporter. The promissory notes / bills are guaranteed by a bank which may not necessarily be the importer’s bank. The guarantee by the bank is referred to as an Aval which is defined as an endorsement by a bank guaranteeing payment by the buyer (importer).
The exporter enters into a forfaiting arrangements with a forfaiter which is usually a reputed bank including exporter’s bank. The exporter sells the avalled notes/bills to the bank (forfaiter) at a discount recourse. The agreement provides for the basic terms of the arrangement such as cost of forfaiting margin to cover risk, commitment charges, days of grace, fee to compensate the fortfaiter for loss of interest due to transfer and payment delays, period of forfaiting contract, installment of repayment, usually bi-annual installment, rate of interest and so on. The rate of interest/discount charged by the forfaiter depends upon the terms of the note/bill the currency in which it is denominated, the credit rating of the avalling bank, the country risk of the importer etc.
Payment to forfaiter by the exporter of the face value of the bill/note less discount:
The forfaiter may hold these notes/bills till maturity for payment by the importer’s bank. Alternatively, he can secure them and sell the short term paper in the secondary market as high yielding unsecured paper.