Forfaiting Vs Export Factoring

Forfaiting is similar to cross border factoring to the extent both have common features of non-recourse and advance payment. But they differ in several important respects:

1) A forfaiter discounts the entire value of the note/bill. The implication is that forfaiting is hundred per cent financing arrangement of receivables finance. But the extent of advance receivables financing with a factoring arrangement is only partial ranging between 75–85 per cent. The balance is retained by the factor as a factor reserve which is paid after maturity.
2) The availing bank which provides an unconditional and irrevocable guarantee is a critical element in the forfeiting arrangement. The forfaiter’s decision to provide financing depends upon the financial standing of the availing bank. On the other hand, in a factoring deal, particularly non-recourse type, the export factor bases his credit decision on the credit standards of the exporter and participates in the credit extension and credit protection process.
3) Forfaiting is a pure financing arrangement while factoring also includes ledger administration, collection and so on.
4) Factoring is essentially a short term financing deal. Forfaiting finances notes/ bills arising out of deferred credit transaction spread over 3 -5 years.
5) A factor does not guard against exchange rate fluctuations; a forfeiter charges a premium for such risk.

Advantages and Evaluation:

Advantages: factoring, as a financial service, has several positive features from the point of view of the firm (client of the factor) some of these advantages are briefly discussed as follows:

Impact on the Balance sheet: The impact of factoring on the Balance sheet of the client and its implications are illustrated below:

Balance Sheet: Pre-Factoring Scenario (Rs Lakhs) (Table 1)

Current Liabilities Current assets

Bank borrowings: Inventory 100
Cash credit Receivables 80
Against inventory 70
Cash credit against Other current assets 20
Receivables 40 110
Other Current Liabilities (OCL) 40
Net working Capital (NWC) 50
Total current Total current assets 200
Liabilities + NWC 200

Current ratio = 1.33:1

The requirement of NWC is Rs 50 lakh (current assets minus current liabilities). As the borrower carries other current liabilities to the extent of Rs 40 lakh, he is eligible for a Maximum Permissible Bank Finance (MPBF) of Rs 110 lakh. This is bifurcated into cash credit limits of Rs 70 lakh against inventory and Rs 40 lakh against receivable, taking into account the stipulated margins for inventory and receivables and also the proportion of individual levels of inventory of Rs 100 lakh and receivables of Rs 80 lakh.

On the basis of the above configuration, the borrower is eligible for working capital limits aggregating Rs 110 lakh under the second method of lending as recommended by the Tandon Committee.

Assume the borrower decides to factor his debts. The factoring transaction is as follows: Receivables aggregating Rs 80 lakh are purchased by a factor who makes prepayment of 80 per cent i.e. Rs 64 lakh. He retains Rs 16 lakh (factor reserve) which will be repaid on payment by the customer.

Balance Sheet Post Factoring Scenario (Rs lakhs) (Table 2)

Current Liabilities Current assets

Bank borrowings: Inventory 100
Cash credit Due from factor 16
Against inventory 70
Cash credit against Other current assets 20
Receivables 70
Other current liabilities 16

Net working Capital (NWC) 50

Total current assets 136

Liabilities + NWC 136

Current ratio = 1.58 : 1

The impact of factoring on the balance sheet as revealed by above Tables 1 & 2 is three fold.