Export Factoring

Export factoring is a technique in which the international credit responsibility is outsourced to a "factor." The factor takes over the entire international credit and collection function, analyzing the customer's financial status, establishing lines of credit, and collecting invoices.

The process typically involves two factors: one in the U.S. and one in the customer's country. The exporter assigns the receivable to the U.S. factor. The U.S. factor agrees to pay the invoice amount on collection or to pay the face amount 90 days past the due date. Likewise, the customer's factor (usually a local bank) agrees to pay the U.S. factor on the due date - or to pay the amount 90 days past the due date. However, the invoice is not simply guaranteed, it is sold. 

Most export factors do not assume currency risks meaning that deals must be denominated in U.S. dollars. Those factors that do business in foreign currency charge a hefty fee for the service - based on part on the foreign exchange risk the factor must absorb.  Factors will not purchase every foreign receivable. Each factor judges the foreign customer's creditworthiness and accepts only those receivables that meet its standards.

Evaluation

On first contact, the factor's representative will attempt to learn as much as possible about a factoring prospect's business. This includes present and projected annual sales volume (factors generally look for a minimum annual export sales volume of $1 million, but the average client sales volume is over $5 million annually), product line, number of active customers, the number and type of countries sold to, and the average dollar value of each invoice. The factor will request a list of the prospect's major customers including name, address, bank account if known, terms of sale (anything from sight and time drafts to 180 days open account may be acceptable), and a realistic estimate of a high credit requirement for each account.

The factor's credit/risk management department will do an evaluation of the list to determine its ability to service the prospect's needs. If the prospect requires advances on approved sales, the factor's representative will request financial information and references to determine the prospect's creditworthiness more thoroughly.

Commissions

Export factoring is generally no more expensive than confirmed letters of credit, and it eliminates the risk of nonpayment and the additional cost of collecting delinquent debts, which can be high in foreign countries.
Factors' commission charges range widely on export transactions from 1% to 2% depending on annual sales volume, average size of invoice, number of active accounts, and historic credit losses. A factor looks for a prospective client who expects to do a minimum annual export volume of $1 million, but may agree to handle exports of a lesser amount if the client has the potential and is working to increase its export sales. The average size of each invoice also has bearing on the commission rate. For example, usually a slightly lower rate can be offered if it takes only one hundred invoices to do $1 million in volume rather than five hundred invoices to do $1 million in business. The number of active customers also is considered in setting the factor's commission rate.

If the client does not require financing, the commission charge would be their only cost. Thus, the client avoids wire transfer and other bank charges normally associated with export transactions. When an advance is requested, interest charges typically range from prime to 2% above the prime rate, or more, depending upon the average amount of money in use, the quality of the receivable base, the financial strength of the client, and the percentage of advance on receivables.

Terms

For an export factor, terms of sale for overseas customers must usually be limited to 180 days or less, and factors usually expect terms to be under 90 days. Clients with longer tenors than typical will incur higher commission charges. Terms beyond 180 days generally involve capital equipment sales, which can be financed by the U.S. Export-Import Bank among others.

For export factoring, except in rare cases there must always be a product involved as opposed to a service. The reason is that the performance of a service can easily be disputed. There is very few manufacturers or distributors whose product lines do not lend themselves to export factoring.

Procedures

The factoring arrangement is fairly straightforward. All that is necessary is to obtain credit lines for each customers. Shipments will be automatically credit-approved as long as total receivables outstanding to a customer remain within the approved credit limit. Customers or orders not approved by the factor can be shipped to at the client's [the seller's] own risk. Invoices are assigned to the factor. The purchase price for the receivables is paid to the client (or applied against the client's loan balance if advances are taken) either when the receivables are collected, or on an average monthly basis as the receivables mature, depending on the type of factoring arrangement negotiated. Generally, a full trial balance giving the status of each customer's account is given to the client either once a month or biweekly.

If a dispute arises, the buyer notifies the factor, which in turn notifies the client [the seller] of the dispute. The factor reserves the right to charge back to the client the amount of receivables, attorney's fees, and any other related costs incurred. The client is customarily given 60 days to settle the dispute. At the time of the dispute, any credit risks that had been borne by the factor transfer back to the client.  The incidence of disputes in international transactions is usually less than 3% of all transactions. Of those, the vast majority are resolved by and between the buyer and seller.

Effect on the Client's Balance Sheet

There is no balance sheet liability under any factoring arrangement (under an advance, maturity, or collection arrangement). Instead, an asset is created which has a most favorable effect on the current ratio. For example, note the following balance sheet showing a two-to-one current ratio:

 
The company enters into a factoring arrangement - selling the receivables and taking an 80% advance immediately. The funds are used to reduce payables, as shown in the following balance sheet:

 
Note that the current ratio is now close to three-to-one. There is no new debt, since the company sold an asset [its accounts receivable] and was paid for it. In this example, factoring has improved the current ratio. Factoring can improve a company's ability to obtain credit.*

For more information, visit these Web sites:

American Receivable Corporation (http://www.amer-rec.com)
International Factoring Group (http://www.ifg-ltd.com)

Forfaiting

Forfaiting is the purchase of an exporter's trade receivables at a discount to their face value "without recourse" to the exporter. The discount implies a fixed rate of interest to the importer's obligation at maturity. Once the goods have been shipped and the necessary documentation obtained (such as shipping documents and commercial invoices), the discounting bank, or "forfaiter," is able to purchase the trade receivables (the importer's debt obligations) and so assume the responsibility for the debts.

Forfaiting is especially suited to exporters seeking 100% financing, or for transactions not qualifying for Ex-Im Bank or state-sponsored programs. It can be applied to the sale of capital goods, to small projects, commodities sales, service contracts and even lease contracts. Traditionally, it is a means of providing medium term (3 to 5 year) fixed-rate financing. Transactions are now also structured on a floating rate, interest-bearing basis and for shorter and longer periods of credit (for example, from 90 days to 10 years).

A forfaiting transaction involves four parties: the exporter (supplier), the importer (foreign buyer), the importer's bank (the guarantor), and the discounting bank (the forfaiter). The financial instruments used in forfaiting are usually either [a] promissory notes or [b] bills of exchange. Transactions also can be structured using deferred payment letters of credit, or the financial terms and conditions of a supply contract. In addition to such instruments, the 'aval' or irrevocable and unconditional guarantee of the importer's local bank is required, unless the importer is of such financial standing and international repute that a guarantee is considered unnecessary.

Typical Transaction

Although the full sale price can be financed, in a typical forfaiting transaction the supplier receives 10-20% of the sale price in cash as a down payment shortly after signing the supply contract. After manufacture and delivery of the merchandise, the supplier receives the promissory note or bill of exchange specifying the remaining 80-90% due. These documents usually have incorporated into their face value an element of interest mutually agreed upon by the supplier and the importer.

For example, in a two-year period of credit, four promissory notes or bills of exchange might be issued maturing six months apart [for example, maturing 6, 12, 18 and 24 months after delivery of the goods]. The supplier sells the series of promissory notes or bills of exchange to the forfaiter on a without-recourse basis. The forfaiter deducts interest in the form of a discount at a fixed rate for the entire period of credit involved. The discount rate can be fixed at the time of delivery of the promissory notes or bills of exchange for purchase or up to 12 to 18 months in advance thus enabling the supplier to build the discount costs into his or her sale price.

The forfaiter may either [a] hold the promissory notes or bills of exchange until maturity or [b] may sell them on a non-recourse basis to another forfaiter. The ultimate holder presents them for payment at maturity to the bank at which they are domiciled for payment.

The following steps illustrate the stages of a forfaiting transaction:

1. Commitment letter including fixed discount rate is given by the forfaiter to the supplier. 
2. A sales contract agreed between the supplier and the foreign buyer. 
3. The goods are manufactured and delivered. 
4. In exchange for title to the goods, a series of promissory notes or bills of exchange are delivered to the supplier. 
5. The supplier endorses the promissory notes or bills of exchange to the forfaiter on a without-recourse basis. 
6. The forfaiter deducts interest at the discount rate from the face value of the promissory notes or bills of exchange and pays the discounted proceeds to the supplier. 
7. At maturity, the forfaiter presents each promissory note or bill of exchange for payment. 
8. The forfaiter receives payment.

Advantages

The features of forfaiting include the following:

1. Up to 100% financing 
2. Without-recourse financing to the exporter 
3. Fast approval time 
4. Fixed rate 
5. Minimum amount, usually $1 million 
6. Financing periods: (may vary by country and avalizing bank)

- Commodities: 90 days to 18 months 
- Capital Goods: 1 to 5 years 
- Heavy industrial equipment: 5 to 10 years

World Bank

The World Bank is the world's largest source of development assistance, providing nearly $16 billion in loans annually to its client countries. It uses its financial resources, trained staff, and extensive knowledge base to help each developing country onto a path of stable, sustainable, and equitable growth.

The World Bank:

• Seeks to promote the economic development of the world's poorer countries 
• Assists developing countries through long-term financing of development projects and programs 
• Provides services to the poorest developing countries 
• Offers special financial assistance through the International Development Association (IDA) 
• Encourages private enterprises in developing countries through its affiliate
• Occurs when 50% or less of an entity's stock is held by the parent company., the International Finance Corporation (IFC) 
• Acquires most of its financial resources by borrowing on the international bond market 
• Has an authorized capital of $184 billion, of which members pay in about 10 percent 
• Has a staff of 7,000 drawn from 180 member countries 

For more information, visit the World Bank website (http://www.worldbank.org).

Ex-Im Bank

Ex-Im Bank (The Export-Import Bank of the United States) is an independent U.S. government agency, which helps to finance and facilitate the export of U.S. goods and services. It was founded in 1934 to stimulate foreign trade during the Depression. Since that time, it has contributed financing support for over $300 billion in U.S. exports, creating extensive markets for American products internationally and sustaining U.S. jobs.

Ex-Im Bank programs fit into four major categories:

1. Working Capital - The Working Capital Guarantee Program significantly reduces a lender's risk on working capital loans made to creditworthy U.S. companies for export-related activities. 
2. Direct Loans Direct loans to foreign buyers enable exporters to overcome financing gaps and compete against foreign subsidized competition with the lowest interest rates allowed under international guidelines. 
3. Guarantees By reducing repayment risks, guarantees allow lenders to offer financing to exporters' foreign customers with fixed or floating competitive rates. 
4. Insurance Ex-Im Bank offers various export credit insurance policies to exporters and financial institutions to reduce repayment risks on foreign receivables due to political or commercial events. Policies may cover single or repetitive sales to single or multiple buyers. As determined by the product, repayment terms are available for short-term sales (up to 180 days, exceptionally 360 days) and medium-term sales (one to five years). Goods and services sold on repayment terms of one year or more are eligible for loans, guarantees, and insurance.

By limiting the risks inherent in international lending, Ex-Im Bank programs enable lenders to assist their current customers with international sales they otherwise would be unable to finance. Ex-Im Bank programs also help lenders develop new relationships with exporters and foreign buyers, which may grow into long-term, profitable lending relationships.

For more information, visit the Ex-Im bank website (http://www.exim.gov)

*Source: Chase Guide to Dynamics of Trade Finance

Edited by Michael Dennis, author of "Credit and Collection Handbook"