What is Forfaiting? Types, Working & Real-world Example
TL;DR - Summary
- What is forfaiting? - Forfaiting is when an exporter sells their trade receivables (bills of exchange or promissory notes) to a financial institution called a forfaiter (at a discount) and gets cash immediately instead of waiting for the buyer to pay.
- Is forfaiting a loan? - No, forfaiting is not a loan. The exporter sells the receivable outright rather than using it as collateral for a loan. This means there is generally no repayment obligation after the transaction is completed.
- How is forfaiting different from factoring? - Factoring is for short-term invoices, generally 30 to 180 days. Forfaiting covers large, long-term export contracts with credit periods ranging from 6 months to 7 years.
- Who uses forfaiting? - It is most often used in large international trade transactions involving capital goods, machinery, infrastructure projects and other high-value exports with long payment terms, usually on deals starting around $100,000 and concentrated at $250,000 and above. This is not for freelancers or small invoice exporters.
- When is forfaiting a good option? - This can be helpful for exporters who want instant liquidity, less exposure to buyer default and the ability to offer longer payment terms to overseas customers.
What is Forfaiting?
Forfaiting is a trade finance arrangement in which an exporter sells their future payment receivables, typically backed by a promissory note or bill of exchange, to a specialized financial institution known as a forfaiter. In return, the exporter gets cash now instead of months or years later when the buyer pays.
In practice, an exporter ships goods to an overseas buyer and agrees to allow that buyer to pay at a later date, sometimes years later. Instead of waiting for that payment, the exporter sells the receivable to a forfaiter today, at a price slightly below its face value. From that point forward, it is the forfaiter's job to collect from the buyer when payment falls due.
This one move shifts the risk of buyer default (and often the political and currency risk tied to the buyer's country) onto the forfaiter. And it removes the receivable from the exporter's balance sheet, because once the exporter sells it, he no longer owns that asset.
⚠️ COMMON MISCONCEPTION
Forfaiting is often mistaken for a loan. In truth, the exporter is not borrowing against an asset. Rather, the receivable is sold to the forfaiter.
Who Uses Forfaiting?
Forfaiting is basically for two users on opposite sides of a trade deal.
Exporters and manufacturers selling expensive, hard-to-finance goods are the primary users. They turn to forfaiting when they need cash sooner than the buyer's payment timeline will allow and want to hand off the risk of non-payment, currency movement or political instability in the buyer's country.
Importers benefit too, as forfaiting allows for deferred payment terms from several months to several years, depending on the transaction. This allows buyers to buy capital-intensive goods without having to pay the total cost upfront.
Forfaiters themselves are specialised players. These are dedicated trade finance firms, international banks or forfaiting divisions of larger banks that buy these receivables at a discount, earning their margin on the difference between what they pay and what they ultimately collect.
In order for a receivable to be tradeable at all, the importer normally needs a guarantee from their own bank (an aval, a standby letter of credit or similar instrument) that the deferred payment will be honored even if the importer gets into trouble. Many forfaiting transactions are based on avalised bills of exchange or other payment instruments guaranteed by the banks. The avalisation strengthens the quality of the payment obligation and makes the receivable more attractive to forfaiters.
Forfaiting in India sits within an established regulatory framework. The Reserve Bank of India permits EXIM bank and AD Category I banks to undertake forfaiting for financing export receivables. Hence, exporters working with these institutions are not operating in a gray area.
It is most commonly seen in deals worth $100,000 or more, especially where long credit periods are part of the commercial agreement. Examples include capital equipment manufacturing, infrastructure projects, aerospace, energy and pharmaceutical exports.
How Does Forfaiting Process Work: A Step-by-Step Guide
In a forfaiting transaction, the exporter ships the goods, sells the future payment obligation to a forfaiter at a discount, receives immediate cash, and exits the transaction. The forfaiter then assumes the payment risk and collects the amount from the importer when it becomes due.
- Step 1: Negotiate the trade contract: The exporter and importer agree on the commercial terms of the transaction, including delivery schedules, price and payment terms.
- Step 2: Contact a forfaiter early: Prior to finalising the deal, the exporter approaches a forfaiter to know the probable discount rate and other charges. This further helps the exporter to take financing costs into account while negotiating the final contract value.
- Step 3: Forfaiter's risk assessment: The forfaiter reviews the transaction by evaluating the importer's capacity to pay, the strength of any supporting bank guarantee, and risks related to the buyer's country. If the deal satisfies its criteria, the forfaiter will then issue a commitment with the proposed terms.
- Step 4: Obtain a bank guarantee: The importer typically arranges a bank-backed guarantee, such as an aval or Letter of Credit to secure the receivable and reduce the forfaiter’s risk.
- Step 5: Ship the goods: The exporter fulfills the contract by dispatching the goods or delivering the agreed service after obtaining the necessary financing.
- Step 6: Submit trade documents: On shipment, the exporter provides the forfaiter with the relevant documentation required for the receivable. This involves invoices, transport documents and the payment instruments.
- Step 7: Receive discounted payment: The forfaiter then buys the receivable and pays the exporter, after deducting the agreed discount and fees, upon verifying the documents.
- Step 8: Risk transfers without recourse: In a typical non-recourse forfaiting transaction, the forfaiter assumes the credit risk associated with the receivable once it is purchased. If the buyer defaults, the forfaiter usually cannot seek repayment from the exporter.
- Step 9: Forfaiter collects at maturity: On the due date of the payment, the forfaiter presents the relevant instruments for collection and is paid through the agreed banking channel.
What Are the Different Types of Forfaiting?
Forfaiting can be classified based on two factors: whether the exporter retains any liability after selling the receivable and the type of payment instrument being forfaited. The most common form is non-recourse forfaiting, where the forfaiter assumes the payment risk after purchasing the receivable.
By Recourse Structure
The first split depends on whether the exporter retains any liability after selling the receivable.
- Recourse forfaiting: The exporter is liable if the importer defaults. The exporter is not entirely off the hook. This is the less common structure.
- Non-recourse forfaiting: If the forfaiter buys the receivable, all credit risk arising from the importer's payment passes to the forfaiter. This is the standard way of forfaiting and why most exporters use it in the first place.
By Instrument Type
A third way to look at forfaiting is by what's actually being sold, as the type of instrument affects how easily a forfaiter can trade it.
- Promissory notes: Legally binding commitments from the importer to pay at a future date.
- Bills of exchange: Written orders directing the importer to pay a fixed amount within a fixed time period and acting as negotiable instruments.
- Letters of credit (LC): Bank guarantee to the exporter of payment. The exporter can be paid based on the basis of the LC's assurance, regardless of the importer's own ability to pay at that moment.
💡 QUICK INSIGHT
Fixed rate and floating rate are pricing options in forfaiting and not separate types. Fixed provides the exporter with certainty of cost in advance, floating tracks the market rates and can swing either way before settlement.
What Are the Advantages and Disadvantages of Forfaiting?
The main advantages of forfaiting are immediate cash flow, risk transfer, and improved working capital. However, these benefits come at a cost, as forfaiting can be more expensive than traditional financing and often involves strict eligibility and documentation requirements.
Advantages of forfaiting
- Immediate cash flow: The exporter is paid upfront instead of waiting for the buyer's payment date.
- Risk transfer: The payment obligation of the receivable is assumed by the forfaiter. Depending on the structure of the transaction, this may cover credit risk and certain political or transfer risks related to the buyer's country.
- Improved working capital: Faster cash collection reduces reliance on short-term borrowing for operations and inventory.
- Competitive positioning: Exporters can offer longer payment terms to buyers without having to wait for payment themselves, making their bids more attractive internationally.
- Off-balance-sheet treatment: The receivable, once sold, is removed from the exporter's books, thus improving financial statements.
- Currency flexibility: Deals can run in major convertible currencies such as USD, EUR, GBP, or CAD.
Disadvantages of forfaiting
Despite this, forfaiting is not suited to every transaction. Exporters should take the costs, documentation requirements and practical limitations into account.
- Higher cost of capital: The discount rate used in forfaiting is generally higher than standard commercial lender financing, especially for higher-risk or longer-term deals.
- Minimum transaction size: Most forfaiting deals require a minimum bill size of $250,000 to $500,000, which excludes smaller exporters.
- Documentation complexity: Commercial contract, shipping documents, signed promissory notes or bills of exchange, insurance certificate and bank guarantee from the importer's bank, may be required. This is a tough ask for new exporters.
- Loss of control: Once the receivable is sold, the exporter can't renegotiate payment terms or pursue the importer directly if a dispute comes up.
- Forfaiter discretion: The forfaiter should be willing to accept the specific instruments offered. Acceptance is not assured.
Forfaiting vs Factoring: Similarities and Differences
Forfaiting and factoring both help businesses convert receivables into immediate cash by selling them to a financial institution. The key difference is that factoring is typically used for short-term, recurring invoices, while forfaiting is used for larger, medium- to long-term export receivables and is usually structured without recourse to the exporter.
What is Factoring?
Factoring is a receivables finance solution that allows companies to get cash out of unpaid invoices. A company sells those invoices to a factor and gets most of the invoice amount upfront instead of waiting for customers to pay their dues.
Similarities
Although they cater to different types of transactions, both factoring and forfaiting convert future receivables into immediate funds. In both cases, a third-party financial institution purchases the receivable and is responsible for collecting payment from the buyer. The institution receives a return on the discount paid for the purchase of the receivable.
Key Differences
Although both solutions offer early access to cash, they differ in aspects like repayment period, transaction size, risk allocation and the types of receivables financed.
| Feature | Factoring | Forfaiting |
|---|---|---|
| Transaction term | Short-term, typically 30 to 180 days | Medium to long-term, typically 6 months to several years |
| Typical goods | Everyday consumer goods and standard services | Heavy machinery, infrastructure projects, and capital goods |
| Recourse risk | Can be with or without recourse | Typically without recourse, with the forfaiter assuming the payment risk |
| Notification to buyer | Can be disclosed or undisclosed | The buyer is generally aware of the arrangement |
| Volume and scale | Multiple smaller, recurring invoices | Large, individual, high-value contracts |
| Instruments used | Open-account invoices and trade receivables | Promissory notes, bills of exchange, and other negotiable instruments |
| Financing advance | Typically 80% to 95% of the invoice value upfront | Usually the receivable value minus the agreed discount and fees |
| Trade scope | Domestic and international transactions | Primarily used in international trade and export transactions |
Real-World Example of Forfaiting
To make the mechanism of forfaiting easier, let’s take a look at an example of forfaiting.
Suppose, an Indian machinery manufacturer receives a $2 million export order from a buyer in an emerging market. The buyer wants to pay over 18 months, but the exporter needs to collect money immediately to cover production and operating costs.
Instead of waiting for the buyer to pay over time, the exporter sells the receivable to a forfaiter at a 5% discount and receives $1.9 million in advance. The forfaiter then assumes responsibility for collecting the remaining 2 million from the importer over the agreed period.
Note: This is for illustration purposes only. Actual forfaiting costs vary based on factors such as credit period, transaction size, currency, country risk and the strength of the guaranteeing bank.
⚠️ WATCH OUT
: On deals under $50,000, the fixed costs of structuring a forfaiting deal eat up a disproportionate share of the invoice value. Smaller exporters are usually better served by factoring or simple invoice discounting instead.
How Does Skydo Help?
Forfaiting is used for a very specific type of transaction, i.e., big export contracts with long payment cycles and high credit risk. Most Indian exporters, freelancers, agencies, consultants and SaaS businesses simply want to receive international payments fast, transparently and without unnecessary deductions.
Traditional cross-border payments can involve multiple intermediary banks, opaque fee structures, delayed settlements, manual follow-ups for payment confirmation and limited visibility during the payment transfer process. These issues can complicate international collections more than necessary.
Skydo is a cross-border payments platform built specifically for Indian businesses receiving money from overseas clients, through virtual collection accounts in major currencies like USD, EUR, GBP, CAD, AUD and SGD.
Some of the key features of Skydo include:
- Free virtual collection accounts with no monthly subscription fees or recurring charges.
- Setup global accounts in as little as 5 minutes.
- Transparent pricing: $19 for payments up to $2,000, $29 for payments between $2,001 and $10,000, and 0.3% for payments above $10,000.
- No forex markup, conversions based on real-time market exchange rates.
- Instant FIRA generation for qualifying transactions.
- Real-time tracking and payment visibility throughout the settlement process.
- Settlement timelines of 24 to 48 hours.
The platform is particularly suited for exporters of goods and services, freelancers with relevant export documents, agencies, consultants, SaaS businesses and Amazon sellers who receive international payments from overseas customers.
It is not intended for personal remittance, speculative forex activity, or trading purposes.
What is the minimum deal size where forfaiting makes financial sense?
It is typically used for larger export contracts, often over $100,000. Many forfaiters prefer to do transactions in the $250,000 to $500,000 range or above, as the due diligence, documentation and risk assessment for smaller deals can make them less economical.
How does forfaiting differ from bill discounting under an LC?
Can an Indian exporter use forfaiting if the buyer's bank won't provide an aval?
What discount rate should an exporter expect in a typical forfaiting deal?
Is forfaiting better than factoring for exports with 180-plus-day payment terms?
What documents does an exporter need to complete a forfaiting transaction?
What are the cost components an exporter should account for in forfaiting?
Does forfaiting cover currency risk for Indian exporters?
What types of goods or industries is forfaiting most commonly used for?
