Difference Between Factoring and Forfeiting

Factoring vs Forfeiting
 

Factoring and forfeiting are both mechanisms used in financing international trade transactions to secure receipts of unpaid invoices and receivables. In both, the risk of debt collection is passed down from the seller to a third party, and depending on whether the agreement is recourse or non-recourse the third party bears the risk of non-payment . The article offers a clear overview of these terms and explains the similarities and differences between  factoring and forfeiting.

What is Factoring?

Factoring is a financial transaction in which companies sell its receivables to financial institutions known as factors at a discounted rate. The factor then recovers the total amount from the debtor. Factoring is a type of invoice financing. A business factors its accounts receivable in order to obtain cash immediately instead of having to wait for the debtors to pay up. Export factoring is frequently used in international trade transactions in which a company recovers its foreign accounts receivable through the process of factoring thereby eliminating credit risk. There are a number of types of factoring which include, non-recourse factoring, recourse factoring, export factoring, debt factoring, commercial factoring and reverse factoring. In non-recourse factoring the factor completely absorbs the risk of non-payment regardless of whether the debtors meet their payment obligation. As with recourse factoring if the receivables are not paid to the factor within 60-120 days, the business has to buy back those invoices. Debt factoring is the process under which the company receives a loan against their accounts receivable and unpaid invoices from the factor. Once the debtors pay up, the factor can recover the funds lent. Commercial factoring is where the factor only offers immediate cash by purchasing accounts receivables but also manages the company’s sales ledger and cash flow. The involvement of the third party factor is kept confidential from clients thereby allowing the company to maintain a good working relationship with their customers. Reverse factoring is also a type of factoring in which the debtor pays the factor funds that are owed by them, and the factor in return pays these funds to the company.

What is Forfeiting?

Forfeiting is very similar to factoring in that receivables are purchased by a forfeiter at a discount, thereby providing security of payment to the business. Forfeiting involves large projects, large value transactions, capital goods and commodities and offers a credit period of a long period such as five years. Forfeiting is popular among companies and exporters that sell high-value capital goods as it offers payment security. It also offers the company an immediate source of cash flow instead of having to wait for an extended period to be paid.

What is the difference between Factoring and Forfeiting?

Factoring and forfeiting are very similar to each other and are services offered to sellers, especially exporters dealing in international trade transactions to secure their receivables. Factoring, also known as invoice factoring is a type of invoice financing in which a company’s invoices and accounts receivables are purchased by a factor at a discount. Forfeiting is also very similar to factoring. The only major difference between factoring and forfeiting lies in the types of goods and credit period. While factoring deals with receivables on ordinary goods, forfeiting deals with capital goods, commodities and mainly high value transactions. With regards to the credit period, factoring is for short term receivables that usually become due within 90 days, whereas forfeiting is for longer term receivables that typically extend up to five years.

Summary:

Factoring vs Forfeiting

• Factoring and forfeiting are both mechanisms used in financing international trade transactions to secure receipts of unpaid invoices and receivables.

• Factoring definition is as follows: factoring is a financial transaction in which companies sell its receivables to financial institutions known as factors at a discounted rate.

• There are a number of types of factoring which include, non-recourse factoring, recourse factoring, export factoring, debt factoring, commercial factoring and reverse factoring.

• Forfeiting is very similar to factoring in that receivables are purchased by a forfeiter at a discount, thereby providing security of payment to the business.

• While factoring deals with receivables on ordinary goods, forfeiting deals with capital goods, commodities and mainly high value transactions.

• With regards to the credit period, factoring is for short term receivables that usually become due within 90 days, whereas forfeiting is for longer term receivables that typically extend up to five years.

 

 

Further Reading:

  1. Difference Between Factoring and Accounts Receivable Financing