What is international factoring? How does it differ from forfaiting? Explain the mechanism of international factoring.
Factoring is a financial tool that is used by firms in order to be financed and receive cash. Factoring is defined as the process where a factor buys receivables at a lower price from a firm to then look for the full amount with the debtors.
Answer and Explanation:
International factoring is a financing option used by exporters where there are three main parties involved, the debtor (importer), the seller (exporter) and the factor. International factoring takes place when a factor purchases the receivables of the seller (exporter) at discount and then the factor looks for receiving the full amount from the debtor (importer).
International factoring and forfeiting are similar, however there are key differences between these two options. The main difference is that factoring is used for short term receivables whereas forfeiting is used for medium or long term receivables. Another important difference is that level of finance that the exporter or seller receives, for instance in factoring, the exporter usually is financed with 80% to 90% of the total value of the goods or services, on the other hand, forfeiting finance 100% of the total value of the goods. Factoring finance the receivables of ordinary goods and forfeiting of capital goods. Finally in factoring there is not secondary market and forfeiting has the option of a secondary market.
The mechanism of international factoring is the following:
- An agreement between the seller (exporter) and the factor should be made providing all the details of the deal.
- When a sale is completed, the seller (exporter) provides with a sales document to the debtor (importer) which should contain all the information to make the payment to the factor.
- When the payment is received by the factor, the seller (exporter) is credited on its account by the factor including the costs of fees.
- It is important to notice that the factor can pay in advance the receivables to the seller (exporter) if it was agreed in the original agreement.
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from Corporate Finance: Help & ReviewChapter 8 / Lesson 7