Factoring vs Forfaiting: The Differences
The average small business has in excess of £11,000 less in funding than they need to grow, according to new research. Many businesses, large and small, spread across many different sectors, often find themselves in need of a cash injection.Sometimes this might be for short-term running costs such as materials, staff wages and general overheads. Other times, businesses require money to fund long-term growth or take advantage of an opportunity that only has a small window of opportunity.
Attaining funds quickly is something that many businesses need, but is something that is often hard to do.
Small Business Alternative Funding
Banks, whilst lending more freely than in the previous few years, are still very guarded with their money. Even if a business does gain loan approval, it can often take weeks or months for funds to come through. For many firms, this delay is just too long.
Factoring and forfaiting represent different ways for businesses to generate money. Often, they are much quicker than bank loans and come with different stipulations.
This article will look at how the factoring and forfaiting work, as well as their differences.
Forfaiting: The Ins and Outs
Forfaiting has long been a common financing tool used in Europe, with German and Italian markets long making use of this relatively simple process to generate funds.
It is gaining a large amount of traction in other European markets such as the UK, Spain, France and Scandinavia.
There are a number of important differences between factoring and forfaiting.
How it Works
Used in international trading transactions, forfaiting generates money via the exporter (the business) selling their owed invoices, often known as receivables, to a company – the forfaiter. The forfaiter is then responsible for collecting the balance of the receivables, paying the exporting business.
How much the business receives depends on a few different factors; interest rates relevant to the country of the receivables bought, the credit risk of the receivables, commitment fees and the forfaiter’s refinancing costs.
The receivables that the forfaiter purchases from the exporting business almost always come with a guarantee from a bank, which removes risk for the forfaiter of buying bad debts. The forfaiter can then collect receivables or sell the receivables on the secondary market.
Differences to Factoring
- Factoring involves selling receivables to a factoring company over time, generating a steady stream of income. Forfaiting is a single transaction of accounts receivable for a single fee.
- Unlike the majority of factoring, the risk of non-payment resides with the forfaiter once a transaction goes through.
- Forfaiting deals in much longer maturities than factoring, often running from a few months up to ten years.
- Factoring financing usually follows a low-value, but high-volume model. This is why many small businesses like it as a funding solution. Forfaiting, on the other hand, deals in low-volume, high-value receivables.
- Factoring, which is normally a long-term finance solution, usually comes with a relationship between factoring company and business. Forfaiting is often a single, high-value transaction with little to no background between the parties.
Factoring: The Ins and Outs
Factoring is often attractive to businesses for a number of reasons. One feature that appeals to businesses is the speed with which they can attain the funds that they need. For example, most factoring services dispense money to the business in 24 hours or less. For businesses used to wrangling with banks and waiting weeks to months, this can prove a breath of fresh air.
Another attractive point of factoring is the fact that the generated funds come from the business’s own invoices. So, whilst they are technically borrowing money the pressure is not the same as a high-interest business loan from a bank or third party investor.
How it Works
Factoring is a type of finance known as ‘Invoice Finance’. Businesses can raise money for their day-to-day needs or long-term running by giving their unpaid invoices to a factoring company.
Factoring differs from other business finance sources like loans or business overdrafts in a number of important ways. A loan provides a lump sum of cash that the business receives once and then pays back over time, including interest and other associated fees. A business overdraft provides room for movement for a business and provides a limited amount of funds. Factoring is different from both loans and overdrafts because it can provide a long-term stream of cash, without putting the business in peril.
In the simplest terms, the business gives their unpaid invoices to a factoring company. The factoring company then pays the business a percentage of the invoice value to the company – varying from 80 up to 90 percent.
The factoring company then pursues the unpaid invoices on the business’s behalf. Once they have collected the amounts owed, the factoring company pays the business the remainder of the balance, minus pre-arranged fees.
Aside from quick payment and less risk than borrowing from a bank, there are a number of other reasons that businesses use factoring.
- A business that lacks assets or collateral, which prohibits them from attaining a loan, can use their invoices as assets. This enables smaller businesses to access much-needed finance.
- Handing over sales invoices to a factoring company removes the burden of collection from the business. The factoring company does the work and the business can focus on day-to-day business and growth.
- Factoring is flexible and tied to the success of the business. The more the business grows, the more funding becomes available to fund the growth.
- Instead of waiting up to 90 days for clients to pay invoices, factoring can improve business cash flow within days.