Factoring vs Forfaiting: Differences and When to Consider
TL;DR - Summary
- What is factoring? - Factoring is a financial transaction in which a business sells its short-term invoices to a factor at a discount, in exchange for most of the invoice value upfront. The factor then collects cash from the buyer.
- What is forfaiting? - Forfaiting is a financial transaction that allows exporters to sell their medium to long-term trade receivables to the forfaiter, in exchange for immediate cash. Such transactions are generally supported by negotiable instruments like bills of exchange or promissory notes.
- What is the difference between factoring and forfaiting? - Factoring is generally used for short-term receivables and recurring transactions whereas forfaiting is used for larger export transactions with longer payment terms.
- Which one costs more? - The cost will vary depending on the transaction value, payment period, buyer creditworthiness, and the country risk.
- Who may not need it? - Many service exporters, like IT companies, consultants, designers, and freelancers, may not require receivables financing. If your customers pay on time, a low-cost international payment collection solution becomes more relevant.
What Is Factoring?
Factoring is selling unpaid invoices to a third party, known as a factor, for immediate cash. Businesses can get working capital from outstanding invoices instead of waiting for customers to pay.
Generally, a factor advances 80% to 90% of the invoice value upfront, then collects payment from the buyer when the invoice comes due. The remaining sum is released to the seller minus applicable fees once the payment is received.
Factoring is generally used for short-term receivables, with credit periods varying from 30 to 180 days. It is useful for businesses that sell regularly on credit and can support both domestic and international trade.
Here are some facts about the structure of factoring:
- The factor takes over your collections, so you are out of the payment-chase business.
- In recourse factoring, the seller bears the cost of any losses if the buyer fails to pay.
- Non-recourse factoring shifts the risk of non-payment by the buyer to the factor, as per the agreement
- Service fees are usually 1% - 5% of the invoice value depending on the size of the transaction, quality of the buyer, and the nature of the factoring arrangement.
Example of Factoring
Assume a handicrafts exporter in Jaipur who sends goods to a UK retailer for ₹10 lakh on a 60-day credit. So instead of waiting for two months to get paid, the exporter sells the invoice to a factoring company for ₹9.5 lakh.
The exporter gets instant working capital and the factoring company collects the full invoice amount from the buyer when it is due. This will help improve cashflow and reduce the work involved in chasing up international payments.
While a bank can act as a factor, many factoring companies are specialized non-banking financial companies (NBFCs) or independent financial firms.
💡 QUICK INSIGHT
Factoring is not a loan because the financing is based on receivables, not collateral. But the fees involved can make it pricier than some traditional financing options.
What Is Forfaiting?
Forfaiting is also the sale of receivables, particularly medium to long-term trade receivables, that are evidenced by negotiable instruments such as bills of exchange or promissory notes. Here, the comparison with factoring largely stops. Forfaiting generally applies to larger export transactions, longer payment terms and receivables guaranteed by a bank.
When a forfaiter buys the debt, he collects payment directly from the importer. The exporter gets his funds upfront instead of waiting months or years for it to come in.
Forfaiting is mostly used for exports of capital goods like machinery, engineering equipment and infrastructure components where payment is deferred over a long period.
What is structurally different about forfaiting:
- It generally applies to receivables with maturities of 6 months to 7 years.
- It is normally structured on a non-recourse basis.
- Minimum transaction sizes are often above $100,000.
- Receivables are generally secured by bills of exchange or promissory notes guaranteed by the bank of the importer.
- These instruments could then be traded on a secondary market, providing liquidity to financial institutions.
Example of Forfaiting
Suppose an Indian manufacturer seals a contract to supply heavy machinery worth ₹5 crore to a buyer in the UK. The buyer agrees to make a series of payments over three years, rather than one payment, in the form of promissory notes.
To escape waiting years for the payment, the exporter sells those promissory notes to a forfaiter for ₹4.8 crore and receives the money in advance. The forfaiter then receives payments from the UK buyer on the agreed schedule.
This can help the exporter improve cash flow, reduce collection responsibilities, and focus on business operations rather than managing long-term receivables.
Factoring vs Forfaiting: Key Differences
Both factoring and forfaiting allow companies to convert future receivables into immediate cash. But what is right depends on what you are selling and who you are selling to, how big the transaction is and how long it takes the buyer to pay.
Factoring is commonly used for short-term invoices and ongoing business transactions. Forfaiting, however, is used for larger export contracts and longer repayment terms. Here are the key differences between factoring and forfaiting in tabular form:
| Parameters | Factoring | Forfaiting |
|---|---|---|
| Meaning | Business sells short-term invoices to a factor for an immediate advance | Exporter sells medium or long-term receivables to a forfaiter for immediate cash |
| Maturity of Receivables | Short-term: 30 - 180 days | Medium to long-term: 6 months to 7 years |
| Type of Goods | Consumer goods, services, raw materials | Capital goods (machinery, infrastructure, equipment) |
| Type of Trade | Domestic and international | Primarily international |
| Recourse | Can be with or without recourse | Always non-recourse |
| Financing percentage | 80% - 90% of invoice value | Up to 100% of receivable value |
| Risk bearer | Seller (recourse) or factor (non-recourse) | Forfaiter assumes the payment risk in a non-recourse arrangement |
| Negotiable Instruments | Not required | Required (bills of exchange, promissory notes) |
| Typical users | SMEs, frequent lower-value transactions | Exporters of high-value capital goods and large one-time deals |
| Documentation | Open account invoices | Negotiable instruments guaranteed by a bank |
Similarities Between Factoring and Forfaiting
Notwithstanding the difference between factoring and forfaiting, they share some common features:
- Both are methods of selling receivables to a third party for immediate cash.
- Both help businesses improve cash flow without waiting for buyers to pay.
- Both can help a company improve its financial position by converting future receivables into available working capital.
- In both cases, the ownership of a financial asset is transferred from a financing intermediary.
- Both require due diligence on the receivables and the parties involved in the transaction.
The two solutions target different kinds of trade transactions, but the underlying objective is identical, i.e. to boost liquidity and reduce the burden of late payments.
Not all cash flow challenges need financing. For many exporters, the bigger problem is delayed settlements, hidden charges and poor visibility of incoming payments. Find out how Indian businesses can collect international payments more efficiently with Skydo.
How Much Do Factoring and Forfaiting Actually Cost?
The cost of factoring and forfaiting depends on a variety of factors such as the buyer's creditworthiness, payment terms, transaction size, country risk and the type of goods being exported. Both solutions help cash flow but there is a major difference in pricing.
Factoring Costs
Factoring costs generally fall into two categories:
- Discount or financing charge: Usually around 1% to 3% per month on the amount advanced to the exporter.
- Service fee: Usually 0.5% and 2.5% of invoice value for collections, administration, credit protection and receivables management.
In practice, the overall cost of factoring is often in the range of 1% and 5% of the invoice value depending on the transaction and risk profile.
Forfaiting Costs
Forfaiting is generally a simple discount of the receivable, and not a combination of financing and service charges. Cost may include:
- A discount rate applied to the full receivable for the full credit period.
- A risk premium based on the quality of the buyer, country risk and tenor of the transaction.
- The commitment fee, usually between 0.5% to 1.5% per annum to secure the funds before the transaction closes.
The rates for forfeiting are usually expressed on an annual basis and may vary depending on the structure and risk profile of the transaction.
What Influences the Cost?
The pricing in factoring and forfaiting is strongly influenced by:
- The creditworthiness of the buyer
- Credit period length
- Volume and value of transactions
- Country and political risk
- Type of goods exported
These costs are usually passed on to the exporter as fees or discounts on the receivable, and do not impact the importer's obligation to pay.
Pro Tip: If you are invoicing less than $10,000 with payment terms of 30 to 90 days, both financing costs and international payment collection costs can consume margins. Before jumping into receivables financing, it might be worth considering if there is a cheaper way to get paid.
How is Bill Discounting Different From Factoring and Forfaiting?
Bill discounting, factoring and forfaiting all offer businesses the opportunity to get cash before a buyer pays. They do, however, differ as per risk, scope and treatment of receivables.
Bill discounting implies that a bank provides an advance against a particular bill of exchange, but the seller is liable if the buyer does not pay. Factoring is the selling of multiple receivables to a factor, who may also handle collections and administration of receivables. Forfaiting, on the other hand, involves medium to long-term export receivables secured by negotiable instruments, with the forfaiter assuming the collection obligation.
Below is the difference between factoring and forfaiting and bill discounting:
| Feature | Bill Discounting | Factoring | Forfaiting |
|---|---|---|---|
| Duration | Short-term, up to 90 days | 30 to 180 days | 6 months to 7 years |
| Recourse | Always with recourse | With or without recourse | Always without recourse |
| Scope | Finance only | Finance, collections, ledger management | Finance, manages negotiable instruments |
| Buyer notification | Usually not told | Buyer usually notified, pays factor directly | Buyer or buyer's bank notified |
| Debt type | Single bill of exchange | Bulk receivables, open bills | Promissory notes or bills in foreign trade |
| Secondary market | No | No | Yes |
Note: The key difference is in the degree of support and risk transfer involved. Bill discounting is the most limited option of all. It offers financing against a specific bill, but the seller still is exposed to buyer default risk. Factoring provides more receivables management and collection services. Forfaiting is commonly used for large international transactions and can provide complete transfer of collection and credit risk.
Which Is Better for Your Business: Factoring or Forfaiting?
The right choice depends on 5 factors, i.e., the type of goods you sell, buyer's creditworthiness, payment terms, transaction size, and whether your goal is faster cash flow or risk reduction.
| Choose Factoring When... | Choose Forfaiting When... |
|---|---|
| You sell consumer goods or services | You export capital goods, machinery, or engineering equipment |
| You have frequent, lower-value transactions | You have a large contract with a long payment horizon |
| You need short-term liquidity on a recurring basis | You want to reduce collection and buyer-default risk |
| Payment terms are typically between 30 and 180 days | Payment terms extend from several months to multiple years |
| You have regular export receivables and shorter payment cycles | You are financing a high-value, long-term export transaction |
Forfaiting is generally more appropriate for exporters who are involved in large and long-term international contracts.
The buyer's credit rating also counts. Forfaiting may be more appropriate for stronger buyers with bank-guaranteed instruments, while non-recourse factoring can offer protection where buyer risk is higher.
But, for many Indian IT, consulting and design exporters, the problem is not financing receivables but getting international payments quickly and cost-effectively. In such cases, a payment collection solution may be more relevant than factoring or forfaiting.
How Does Skydo Help?
Factoring and forfaiting solve a financing issue. But the bigger hurdle for a lot of Indian service exporters is to get international payments done quickly, transparently and at a reasonable cost. Hidden bank charges, forex markups, unpredictable settlement timelines, and the need to chase SWIFT copies adds friction to the process.
Skydo is a cross-border payment platform that helps Indian businesses and freelancers receive international payments. It is designed for incoming payments, not for sending money abroad. Users can open virtual receiving accounts in USD, EUR, GBP, SGD, AUD, CAD, generally within 10 to 15 minutes. Overseas clients can then make payments into these accounts as if they were a local account.
Pricing is simple and completely transparent:
- Less than $2,000: $19 flat
- $2,000 - $10,000: $29 flat
- Over $10,000: 0.3%
For every transaction, FIRC certificates are generated automatically, and there are no monthly fees. The platform also offers payment visibility so you don’t need to chase payments or track SWIFT messages.
Skydo is designed for exporters of goods and services, freelancers with valid export documentation, and Amazon sellers generating income overseas. It is not intended for personal transactions, donations, forex trading, jewellery businesses, call centres or transactions with restricted jurisdictions.
For exporters receiving smaller international payments, the cost of collecting funds sometimes has a bigger impact than access to financing. If your invoices are under $10,000, reducing payment collection costs through a transparent flat-fee model may be more beneficial than selling receivables at a discount through factoring or forfaiting.
What is the main difference between factoring and forfaiting for exporters?
Factoring is generally used for short-term invoices and recurring transactions whereas forfaiting is used for bigger export contracts with longer payment terms. Consumer goods and services are often factored. Capital goods and infrastructure projects are often forfaited.
Can Indian service exporters use factoring or forfaiting for IT and consulting invoices?
How do factoring fees compare to cross-border payment platform charges?
Is bill discounting the same as factoring?
When should an exporter choose forfaiting over factoring?
What negotiable instruments are used in forfaiting?
Does forfaiting protect against currency risk?
How much does forfaiting typically finance: 80% or 100%?
Is there a secondary market for factored invoices?
