The prerequisite for a factoring service is the establishment of factoring relationship between “client” and the “Factor”. On the basis of evaluation, “Factor” fixed credit limits for various customers of client indicating the extent and period for which factor is prepared to accept client debts on various customers.
The client sells goods to his customer and sends the invoice to the factor. The invoice is accounted for in the client account in the Factor sales ledger The Factor advises advance amount to the client after retaining margin. On maturity customer makes payment of invoice to the Factor The margin money retained released to client.
Thus there are three parties:
ADVERTISEMENTS:
1. Factor – (usually bank)
2. Seller-supplies/client
3. Customer-Buyer
Image Source: horizonundergroundinc.com
For Faiting:
ADVERTISEMENTS:
It means purchase of trade Bills or Promissory notes by a bank or other financial institution without recourse to seller. This takes form of discounting the bills and also taking up entire risk of Non-Payment. The Purchases who takes up risk is called FarFater who pays cash to the seller after discounting bills
In India EXIM-BANK got permission from Reserve Bank to finance exports to convert overseas credit sale into cash through the process of discounting export receivables.
(i) Factoring is usually for short term trade credits whereas ForFaiting is for credit transactions of long term maturities.
(ii) Factoring can be “With-Recourse” or “Without-Recourse” depending upon the terms of transactions between FACTOR AND SELLER. FORFAITING is without Recourse to the exports. All risks are taken/borne by the ForFeiter
ADVERTISEMENTS:
(iii) Cost of Factoring is usually borne by the seller while of ForFaiting is borne by the overseas Buyer.
For successful ForFaiting existence of Secondary Market is essential. A ForeFeite sells bills in the market and also can buy or sell bills like any other securities. In that case, reputation of the ForFeites is important.
As a method of Post Shipment Finance, ForeFaiting is permitted in India. It involves endorsement “Without Recourse” to exporter. It is a modification of Bill Discounting and does not lockup limits.