What is {term}? Forfaiting

Forfaiting is a means of financing exporters use that enables them to receive immediate cash by selling their medium- and long-term receivables -- the amount an importer owes the exporter -- at a discount. The exporter also eliminates risk by making the sale without recourse, which means the exporter has no liability regarding the importer's possible default on the receivables. The forfaiter is the individual or entity that purchases the receivables, and the importer then pays 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 amount of which is typically guaranteed by the importer's bank, expedites payment and cash flow for the exporter. The purchase also eliminates the credit risk involved in a credit sale to an importer. 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 large, international sales of commodities or capital goods where the sale price exceeds $100,000.

With forfaiting, the importer's receivables convert into a debt instrument that it can freely trade 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. These debt instruments have a range of maturities from as short as one month to as long as 10 years. Normally, the maturity falls between one and three years from the time of sale.

Advantages of Forfaiting

Forfaiting eliminates all risk of the exporter not receiving payment. It also protects against credit risk, transfer risk, and the risks posed by foreign exchange rate or interest rate changes. By transforming a credit-based sale into a cash transaction, forfaiting simplifies the transaction by 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. A forfaiter can tailor its offering to suit an exporter's needs and adapt it to a variety of international transactions. Exporters can use forfaiting 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, and it allows an exporter to transact business with buyers in countries with high levels of political risk.

Disadvantages of Forfaiting

Forfaiting is a great way for an exporter to mitigate risks, but it's not without its flaws. First, forfaiting is generally more expensive than commercial lender financing, leading to higher export costs. These higher costs are generally pushed onto the importer as a part of the standard pricing. Also, only transactions in excess of $100,000 with longer terms are eligible for forfaiting, so it cannot apply to every situation.