This research paper includes factoring, forfaiting and bankers' acceptances. I will add leasing system which is another important financial technique method a short time later.
1) Factoring
Factoring means that account receivables such as short term check and promissory notes of exporters are purchased by factors which are factoring firms as in advanced. That is, it is the sale of account receivables by exporters. And credit risks are transferred to factors.
There are four parties in factoring transactions. These parties are exporter, importer, exporter’s factor and correspondent factor (importer factor). Correspondent factors are very significant for minimizing risks of exporter’s factor so exporter’s factor so exporter’s factors should carefully choose correspondent factor which are the member of international association of factoring companies such as Factors Chain International.
According to Parasiz (1991), the system works that exporter applies in factoring firm of their own country with account receivable certificate of transfer. Then, factoring firm notifies to correspondent factoring firm in country of importer. If correspondent factor guarantees and confirms for transfers of account receivables, exporter’s factoring firm purchases account receivables. In this step, exporter dispatches goods to importers. However, if correspondent factor doesn’t guarantee, exporter’s factor doesn’t purchase receivables.
Advantages
Factoring provides important opportunities to exporters.
• Factors guarantee account receivables of exporters as they undertake default risks of importers. Even if importers have payment problem, account receivables are paid to exporter. Thus, exporters minimize default risk of expected cash flow.
• Exporters don’t deal with cash receipt and follow of accounting receivable as they transferred receivables so they spare more time with marketing, productions etc. That is, firms will be managed more efficient.
Although factoring has important advantages, this is costly. Factoring firms take specific fees for transactions. If an exporter firm transfer big amount of account receivables, it may narrow profit margin and maybe face losses.
Sample Cost Calculation of Factoring
Shapiro (2006) mentioned that factors charges exporters’ receivables at fee per month and extra fee for nonrecourse financing. If maturity increases, cost will be higher because of monthly fee but nonrecourse financing fee is stable and it is collected once. Although factoring has high cost, it minimizes credit risk associated with receivables so exporters which have doubt for receivables should apply factors.
Amount of receivable ...................... 1000000
Less: 1.75% nonrecourse fee ...................... -17500
Less:2.5%monthly factoring fee (for 3 months) ..... -75000
Amount received by exporter ..................... 907500
Resource: Multinational Financial Management,8e
2) Forfaiting
Another method for international trade financing is forfaiting. Like factoring, exporters sell and transfer receivables to forfaiters. Thus, exporters minimize their risks.
Although operations and process of forfaiting and factoring are similar, there are several differences between them. These are maturity, content of financing, specification of goods, and contracts.
According to Ceylan (1998), the most important difference is maturity. Factoring is short term financing method (generally until 180 days) but forfaiting is long term financing instruments. It’s over 6 months (generally between 180 days-10 years). Another difference is related to coverage of financing. Although factoring firm covers and purchases 80% of receivables, forfaiting firm finance exporters total receivables. Moreover, factoring is implemented in trade of consumption goods such as meat and shoes but it is capital goods such as machinery and construction equipment in forfaiting transactions. Final important difference is related to contracts. In factoring, there may be contract between parties. However, there is not contract between parties in forfaiting.
3) Bankers’ Acceptances
According to Shapiro (2006), “banker’s acceptance is a time draft drawn on a bank. By accepting the draft, the bank makes an unconditional promise to pay holder of draft s stated amount on specified day”.
Shapiro (2006) mentioned that importers which need fund for purchasing goods from exporters can apply acceptance financing. Firstly, importer’s bank issue letter of credit for importer. Letter of credit is issued in bank name. Secondly, exporter (holder of draft) prepares a time draft in order to be paid its exported goods and gives it its bank. After preparation of draft by exporter, importers’ bank endorses draft to importer’s bank. Finally, when draft will be in importer’s bank, importer’s bank accepts draft and creates a banker’s acceptance.
Briefly, bankers’ acceptance is like postdated check. That is, importer bank which issue letter of credit for importer is responsible for payment to holder of acceptance (exporter). Similarly postdated check, bankers’ acceptance has maturities. Generally maturities are 60 days or 90 days. According to Eun and Resnick (2009), “if exporter suddenly needs funds prior to maturity date, Bankers’ Acceptance can be sold discount in the money market”. That is, it can be traded in secondary markets. And as banks create bankers’ acceptances like postdated check, it is very safe assets for using this in secondary markets.
References:
1) Ceylan, Ali, "Finansal Teknikler" (1998)
2) Shapiro, Alan C., "Multinational Financial Management" (2006)
3) Parasiz, İlker, "Para Banka ve Finansal Piyasalar" (1991)
4) Eun and Resnick, "International Financial Management" (2009)
