What Is International Factoring?
International factoring is a practice wherein companies engaged in cross-border trade can sell their accounts receivables/or trade receivables to a factoring company (factor) in exchange for an immediate advance on the invoice amount.
The amount is owed by the foreign company and the company availing the factoring service can be paid in a foreign currency of their choosing.
In many ways, an international factoring solution is quite similar to basic business factoring, apart from a few differences. Namely,
In international factoring programs, the currency for making the payment is not as straightforward as is in the case of domestic factoring, where the domestic currency is used. Several factoring companies, including Drip Capital, offer borrowers the option of choosing the currency in which the payment will be made.
International factoring companies also need to have a strong understanding of global markets, legal implications of payment defaults and knowledge of regularly importing companies from a given country.
International trade is tricky and rife with compliance processes, documentation, customs processes and intricate logistics systems. International factoring companies need to know how to navigate through these complexities and build these processes into their offerrings.
Why Should Companies Choose International Factoring Services?
Apart from the usual benefits of factoring, one of the main reasons why companies would want to opt for international factoring is because they lack the local expertise or trust when it comes to dealing with an unknown buyer and would like to hedge the risk by opting for a non-recourse, international factoring solution.
Under this arrangement, the exporter is freed from the responsibility of chasing the customer/importer for payments. Instead, the factoring company becomes an intermediary and is responsible for collecting payments from the importer. Depending on the recourse clause in the factoring contract, the risk of default/non-payment is either transferred to the factoring company or retained by the exporter.
Exporters prefer that the factor and its associated partners in the foreign countries deal with the importers as the exporter himself tends to have little to no cultural understanding or methods of verifying the authenticity of the importer and would like to transfer the risk associated with non-payment to another third party.
With a continually growing volume of international trade, international factoring allows entrepreneurs to conduct secure trade transactions, solve their working capital woes and thereby increase revenue significantly.
In some cases, the role of an international factoring company goes beyond mere finance. Due to a wealth of information, expertise and data, the factor can also advice the exporters on key markets to tap, based on the industry and also connect them with importers looking to forge newer partnerships.
How Many Parties are Involved in International Factoring?
There are two factors involved in the process of international factoring. However, single factoring arrangements are far more common.
1.Export Factor :
The factor located in the exporter’s country is the export factor responsible for collecting the exporter’s documents and funding their invoices, i.e., ensuring timely payments.
In most cases, the export factor is the only intermediary involved in a transaction. However, the export factor may have local partnerships, especially in countries with a high import volume. These agencies or partners aren’t part of any formal factoring agreement; they simply assist the factor in dealing with local customs, laws, regulations, and collection practices.
The factor situated in the importer’s country is called the import factor and is responsible for assessing the buyer’s credibility and financial worthiness. The import factor thoroughly evaluates the buyer’s payment history, chances of default, etc.
Moreover, timely collection of payments/dues from the importer is also a vital responsibility of the import factor. The import factor guarantees the payment on behalf of the importer.
Not all international factoring arrangements have an import factor. Drip Capital acts as the sole factor in all the export factoring services we've offerred in India.
Different Types of International Factoring
Listed below are the three types of international factoring:–
- Single-factoring system
This is the most commonly used form of international factoring. Under this system, the exporter enters into a factoring agreement with the factor, stating that only one factoring firm would perform all the financing functions. The company undertakes due diligence and credit assessment of the exporter and importer, but the exporter is the initiator of the transaction.
- Two-factor system
Under this system, four parties are involved- exporter, importer, import factor in the importer’s country, and export factor in the exporter’s country. The export factor is generally equipped to deal with the exporter’s credit profile, export performance, and financials. The import factor undertakes checks to ascertain the importer’s creditworthiness, track record of completed imports, financials etc.
- International reverse factoring
International reverse factoring is popularly known as Supply Chain finance (SCF). It is a financing arrangement where the importer/buyer initiates the factoring arrangement on behalf of the seller.
It is a method of accounts payable financing that refers to a financing arrangement between the buyer and seller who engage regularly and it results in a lower cost of borrowing for the supplier or exporter as he/she leverages the importer’s credit profile to secure working capital funds.
How does International Factoring Work?
The following steps reveal how an international factoring transaction works.
- The exporter receives the purchase order and sends the importer’s information to the factor for credit approval.
- The factor evaluates the importer’s creditworthiness and agrees to finance the deal after the exporter has shipped the goods.
- The buyer agrees to make a complete payment upon the maturity of the credit period, which is usually over 30/60/90 days depending on the industry.
- Immediately after shipping the goods from the country, the exporter sends a copy of the invoice and other shipping documents to the factor.
- Upon receiving the invoice, the factor verifies with the importer.
- As agreed, the factor advances up to 80-90% (varies from one factoring company to another) of the invoice amount upfront to the exporter.
- At the end of the credit period, the factor requests payment from the buyer towards the factored invoice.
- The buyer/importer sends the entire payment directly to the factor.
- The factor deducts the agreed-upon factoring fee from the payment received.
- The remaining amount is then transferred to the exporter.
Benefits of International Factoring
International factoring offers a wide array of benefits to the companies engaged in international trade. Some of these key benefits are listed below.
Consistent cash flows: International factoring helps businesses maintain smooth cash flows and ensures that there is no interruption in capital/funds to carry out day-to-day operations. Especially for small companies, who mostly face a working capital crunch, this process acts as a strong safety net, enabling them to grow the business faster.
Longer payment terms: It allows businesses to offer extended credit periods to their customers, thereby increasing their chances of expanding to incorporate more customers. Longer payment terms are lucrative in international trade, which allows exporting businesses to take higher volumes of orders and further expand their sales.
Business Expansion: Since payments are secured and guaranteed, businesses can easily take the plunge and mark their entry into different geographies due to the mitigated risks. New buyers in new markets can be approached with confidence, which can pave the way for business expansion.
Accumulation of information: The factoring company gathers adequate knowledge and intelligence about the exporter’s current as well as prospective international customers. Information such as their credit worthiness, financial records, market reputation, etc., is also duly verified and collected, which helps businesses choose their trade partners more wisely.
Less documentation: The funding process is quite simple and quick. Unlike traditional loans and advances, there are no extensive documentation requirements or procedures, which grants businesses easy and speedy access to funds.
Protection against bad debts: Non-recourse international factoring offers 100% protection against bad debts and insolvency of international buyers. Although in the case of recourse factoring, businesses do face the risk of bad debts, recourse factoring is far less common, and the interest rates are lucrative to balance its risk.
Seamless collection process: Factors possess the requisite expertise in dealing with multiple businesses in different countries across the world. As they efficiently deal with various importers in their respective local languages, cultural differences no longer hinder the collection process. Thus, international factoring ensures smooth transactions by eliminating the customs and language barriers.
International Factoring V/s Forfaiting
Forfaiting is similar to international factoring. Hence it is crucial to understand the differences between the two thoroughly.
You can learn more about these differences in-depth in this post.
Drip Capital's Global Factoring Solution
Armed with a global expertise in dealing with 10,000+ suppliers across 100+ and having funded $3 Billion + in international factoring solutions, we at Drip Capital are uniquely placed to offer factoring services to companies in India looking to expand across the domestic borders.
Some of the of our global factoring services include;
Collateral-free factoring Drip Capital offers non-recourse and non-collateral-based factoring solutions to fund sales growth with outstanding trade receivables.
Completely digitized processing Technology-enabled credit appraisals and an automated process ensure minimal manual intervention and quick disbursements to address business exigencies.
Flexible Currency Denominations We make payments based on currency of currency of your choice. Including the US Dollar, Euro and the British Pound.
Personalized services A dedicated account manager to handle all interactions and promptly resolve queries and issues.