Factoring
Factoring is a financial service where a business sells its accounts receivable (invoices) to a third party, known as a factor, at a discount. This is a common method used by businesses to get quick cash flow instead of waiting for their customers to pay.
- How it works:
- A seller sells goods to a buyer on credit and raises an invoice.
- The seller then sells this invoice to a factor.
- The factor immediately pays the seller a large portion of the invoice amount (usually 75-90%).
- The factor takes over the responsibility of collecting the payment from the buyer.
- Once the buyer pays the full amount to the factor, the factor pays the remaining balance to the seller, after deducting its fee (discount) and interest.
- Recourse: Factoring can be “with recourse” (the seller is liable if the buyer doesn’t pay) or “without recourse” (the factor bears the loss of non-payment).
Forfaiting
Forfaiting is a form of export financing where an exporter sells its medium to long-term foreign accounts receivable at a discount to a forfaiter. This is used specifically for international trade.
- Key Feature: Forfaiting is always “without recourse.” Once the exporter sells the receivables to the forfaiter, the exporter is completely free from the risk of non-payment by the importer. The forfaiter assumes 100% of the risk.
- Instruments: It usually involves financial instruments like bills of exchange or promissory notes, which are often guaranteed by the importer’s bank.
Trade Receivables Discounting System (TReDS)
TReDS is an online electronic platform set up by the RBI to facilitate the financing or discounting of trade receivables of Micro, Small, and Medium Enterprises (MSMEs).
- How it works:
- An MSME seller supplies goods to a corporate buyer and raises an invoice.
- The seller uploads this invoice onto the TReDS platform.
- The corporate buyer approves this invoice on the platform.
- This approved invoice becomes a “factoring unit.” Multiple financiers (banks, factors, NBFCs) on the platform then bid against this unit.
- The MSME seller accepts the best bid, and the money is credited to their account in a day or two.
- On the due date, the corporate buyer pays the financier directly.
- Purpose: TReDS solves the problem of delayed payments for MSMEs by giving them easy and quick access to credit at competitive rates.
Summary of Differences
| Feature | Factoring | Forfaiting | TReDS |
| Trade Type | Primarily Domestic | Exclusively International | Exclusively Domestic |
| Recourse | Can be with or without recourse | Always without recourse | Always without recourse |
| Client | Any business | Exporters | Exclusively MSMEs |
| Mechanism | Bilateral agreement | Involves bank guarantees | Online auction platform |
| Finances | Short-term receivables | Medium to long-term receivables | Short-term receivables |