Forfaiting is a financing technique that involves the purchase of trade receivables, typically arising from the sale of capital goods or projects, by a forfaiter (i.e., a specialized financial institution) from the exporter/seller, without recourse to the exporter/seller. In a forfaiting transaction, the forfaiter purchases the future cash flows of the exporter/seller at a discount and takes over the risk of non-payment from the importer/buyer. The forfaiter then pays the exporter/seller a lump sum in cash or a letter of credit, based on the discounted value of the receivables.
The mechanism of a forfaiting transaction can be explained through the following steps:
- Exporter/seller and importer/buyer agree on the terms of the sale and the payment.
- The exporter/seller delivers the goods or completes the project, and creates a trade receivable for the amount of the sale.
- The exporter/seller approaches a forfaiter to sell the trade receivable at a discount.
- The forfaiter examines the creditworthiness of the importer/buyer and assesses the risk of non-payment.
- If the forfaiter is satisfied with the creditworthiness of the importer/buyer and the risk assessment, it offers a discount rate to the exporter/seller.
- The exporter/seller agrees to the discount rate, and the forfaiter purchases the trade receivable from the exporter/seller.
- The forfaiter pays the exporter/seller the discounted value of the trade receivable in cash or a letter of credit.
- The forfaiter takes over the risk of non-payment from the importer/buyer and collects the payment from the importer/buyer on the due date.
- The forfaiter earns a profit by collecting the full value of the trade receivable from the importer/buyer and by buying the trade receivable at a discount from the exporter/seller.
- The importer/buyer pays the full value of the trade receivable to the forfaiter on the due date.
In summary, forfaiting is a financing technique that allows exporters/sellers to convert their trade receivables into cash without recourse and transfer the risk of non-payment to forfaiters. Forfaiting provides exporters/sellers with immediate cash flow and eliminates the risk of non-payment, while forfaiters earn a profit by taking over the risk of non-payment and collecting the full value of the trade receivables from importers/buyers.