Factoring is defined as ‘a continuing legal relationship between a financial institution (the factor) and a business concern (the client), selling goods or providing services to trade customers (the customers) on open account basis whereby the Factor purchases the client’s book debts (accounts receivables) either with or without recourse to the client and in relation thereto controls the credit extended to customers and administers the sales ledgers’.
Functions of factors are divided between export factor and import factor
Import factor provides a link between export factor and the importer and serves to solve the international barriers like language problem, legal formalities and so on. He also underwrites customer trade credit risks, collects receivables and transfers funds to the export factor in the currency of the invoice
Exporter Importer Country A Country B Export Factor Import Factor Goods and invoices – Stage I Copy Invoice Stage II Prepayments Stage III Copy Invoices Stage IV Statements Stage V Payments Stage VI Payments Stage VII Payment of Commission Stage VIII
It is a highly flexible technique that allows an Exporter to grant attractive credit terms to foreign Buyers, without tying up cash flow or assuming the risks of possible late payment or default. Simultaneously, the Exporter is fully protected against interest and/or currency rates moving unfavourably during the credit period Forfaiting is a highly effective sales tool, which simultaneously improves cash-flow and eliminates risk.