Are you struggling to understand how factoring, forfaiting, and term loans work in banking? Do terms like working capital finance, credit risk, and invoice discounting sound overwhelming? You’re not alone!
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- Factoring – How businesses get instant liquidity by selling invoices.
- Forfaiting – How exporters manage international trade risks.
- Term Loans – How banks finance fixed assets and their repayment structures.
👉 Before we dive in, watch this video for a complete breakdown:
Factoring – Turning Receivables into Cash
What is Factoring?
Factoring, also known as accounts receivable financing, helps businesses maintain cash flow by selling outstanding invoices to a third party (factor).
Imagine a company, ABC Ltd., sells products worth ₹10 lakh to multiple clients on credit. Instead of waiting for payments after 3 months, they approach a factoring company to get instant liquidity.
Types of Factoring:
- Recourse Factoring: If the buyer defaults, the seller (company) is responsible.
- Non-Recourse Factoring: The factoring company bears the risk of default.
- Domestic Factoring: All parties are within the same country.
- International Factoring: Transactions involve cross-border trade.
Advantages of Factoring:
- Improves Cash Flow – No need to wait for client payments.
- Reduces Credit Risk – In non-recourse factoring, risk is transferred.
- No Collateral Required – Only invoices are used as security.
Forfaiting – Financing Export Receivables
Forfaiting is used in international trade, where an exporter sells receivables to a forfaiter (financial institution) without recourse. Unlike factoring, forfaiting deals with medium- to long-term credit.
Forfaiting is particularly beneficial for exporters dealing with high-value transactions and long credit periods. It eliminates the risk of non-payment and ensures exporters receive their dues upfront.
Key Differences Between Factoring and Forfaiting
- Factoring is generally used for short-term financing, while forfaiting is used for medium- to long-term financing.
- Factoring often involves domestic transactions, whereas forfaiting is mainly for international trade.
- Factoring involves multiple invoices, whereas forfaiting typically involves one-time high-value transactions.
Term Loans – Financing Fixed Assets
A term loan is a bank loan used to finance fixed assets like land, buildings, and machinery.
Term loans are structured based on repayment schedules, and interest rates can be fixed or floating. Borrowers typically use term loans for capital expenditures that provide long-term benefits.
Types of Term Loans
- Short-Term Loans: Maturity up to 3 years.
- Medium-Term Loans: Maturity between 3 to 7 years.
- Long-Term Loans: Maturity of 7 years or more.
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