Definition
Forfaiting is a financial transaction involving the purchase of an exporter’s receivables (the amount an importer owes the exporter) at a discount by paying cash. Here, the forfaiter—usually a financial institution or a specialized forfaiting company—purchases without recourse, meaning they assume all the risk of non-payment by the importer. The receivable instruments can be a promissory note, bill of exchange, or letter of credit with maturities commonly ranging from one to three years. In simple terms, forfaiting enables exporters to convert credit sales into cash sales, receiving immediate payment at a discount whilst transferring the risk of payment default to the forfaiter.
Examples
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Example 1: Promissory Note in Forfaiting
- A German exporter delivers machinery to a Saudi Arabian company and secures a promissory note payable in two years. Instead of waiting for the payment, the exporter sells the promissory note to a forfaiter at a discount and receives immediate cash.
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Example 2: Bill of Exchange in Forfaiting
- An Indian exporter of textiles sells goods to a retailer in the UK and issues a 18-month bill of exchange. Instead of bearing the credit risk and waiting period, the exporter sells this bill to a forfaiter for immediate cash, transferring the default risk to the forfaiter.
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Example 3: Letter of Credit in Forfaiting
- An American exporter of aerospace parts receives a letter of credit from a French importer. To avoid the credit risk and get immediate funds, the exporter sells the receivable to a forfaiting company at a discount, ensuring cash flow without the risk of non-payment.
Frequently Asked Questions (FAQ)
What is forfaiting?
Forfaiting is a form of finance where an exporter sells its receivables from foreign buyers to a forfaiter, typically a bank or a financial institution, at a discount and without recourse.
Who bears the risk of non-payment in forfaiting?
In forfaiting, the risk of non-payment is entirely transferred to the forfaiter, meaning the forfaiter takes on the credit risk associated with the foreign receivable.
What types of receivables are involved in forfaiting?
The receivables involved in forfaiting are usually in the form of promissory notes, bills of exchange, or letters of credit.
What are the typical maturities for forfaited receivables?
Typical maturities for forfaited receivables range from one to three years.
How does forfaiting benefit exporters?
Forfaiting benefits exporters by providing immediate cash flow, removing the credit risk associated with foreign trade, and simplifying their balance sheets.
Related Terms with Definitions
- Promissory Note: A financial instrument containing a written promise by one party to pay another party a definite sum of money either on demand or at a specified future date.
- Bill of Exchange: A written order binding one party to pay a fixed sum of money to another party on demand or at a predetermined date.
- Letter of Credit: A document from a bank guaranteeing that a buyer’s payment to a seller will be received on time and for the correct amount.
- Export Financing: Financial instruments and products that allow exporters to receive immediate payment for their exported goods and services, thus freeing them from the credit risk associated with foreign trade.
Online References
Suggested Books for Further Studies
- “International Trade and Forfaiting: A Guide to Export Finance” by Anamaria Aguiar
- “The Complete Guide to International Trade Finance” by Andrew Miller
- “Finance of International Trade” by Eric Bishop
Accounting Basics: “Forfaiting” Fundamentals Quiz
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