What is 'Forfaiting'
Forfaiting is a means of financing used by exporters that enables them to receive cash immediately by selling their medium-term receivables (the amount an importer owes the exporter) at a discount, and eliminate risk by making the sale without recourse, meaning the exporter has no liability regarding possible default by the importer on paying the receivables. The forfaiter is the individual or entity that purchases the receivables, so the importer is then obligated to pay the receivables amount to the forfaiter. A forfaiter is typically a bank or a financial firm that specializes in export financing.
BREAKING DOWN 'Forfaiting'A forfaiter's purchase of the receivables, the sum of which is typically guaranteed by the importer's bank, expedites payment and cash flow for the exporter, in addition to eliminating the credit risk involved with making a sale to an importer on credit. Forfaiting expedites payment for the exporter and facilitates the transaction for an importer that cannot afford to pay in full for goods upon delivery.
Forfaiting is most commonly used in regard to large, international sales of commodities or capital goods where the sale price exceeds $100,000.
Through forfaiting, the importer's receivables are converted into a debt instrument that can be freely traded on a secondary market. The receivables are typically in the form of unconditional bills of exchange or promissory notes that are legally enforceable, providing security for the forfaiter or a subsequent purchaser of the debt obligation. These debt instruments can have a wide range of possible maturities, from as short as one month to as long as 10 years. Normally, the maturity falls within one to three years from the time of sale.
Advantages of Forfaiting
Forfaiting eliminates all risk of the exporter not receiving payment, including credit risk and transfer risk, as well as risks posed by foreign exchange rate or interest rate changes.
By transforming a credit-based sale into a cash transaction, forfaiting simplifies the transaction, providing immediate cash flow and eliminating collection costs for the seller and the need to carry the accounts receivables on its balance sheet as contingent liabilities.
Forfaiting is flexible and can be tailor-made to suit the needs of the exporter and adapted to a variety of international transactions. It can be utilized in place of credit or insurance coverage for a sale. It is helpful in situations where a country or a specific bank within the country does not have access to an export credit agency, allowing an exporter to transact business with buyers in countries with high levels of political risk.