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Source: Small Business
Management
Exporters
naturally want to get paid as quickly as possible, and importers usually prefer delaying
payment at least until they have received and resold the goods. Because of the intense
competition for export markets, being able to offer good payment terms is often necessary
to make a sale. Exporters should be aware of the many financing options open to them so
that they may choose the one that is most favorable for both the buyer and the seller.
An exporter may need (1) preshipment financing to produce or purchase the product or to
provide a service or (2) postshipment financing of the resulting account or accounts
receivable, or both. The following factors are important to consider in making decisions
about financing:
The need for
finance export to make the sale. In some cases, favorable payment terms
make a product more competitive. If the competition offers better terms and has a similar
product, a sale can be lost. In other cases, the exporter may need financing to produce
the goods that have been ordered or to finance other aspects of a sale, such as promotion
and selling expenses, engineering modifications, and shipping costs. Various financing
sources are available to exporters, depending on the specifics of the transaction and the
exporter's overall financing needs.
The cost of different methods of
finance export.
Interest rates and fees vary. The
total costs and their effect on price and profit should be well understood before a pro
forma invoice is submitted to the buyer.
The length of time financing is required. Costs increase with the length of
terms. Different methods of financing are available for short, medium, and long terms.
However, exporters also need to be fully aware of financing limitations so that they can
obtain the financing required to complete the transaction.
The risks associated with financing the transaction. The greater the risks
associated with the transaction - whether they actually exist or are only perceived by the
lender - the greater the costs to the exporter as well as the more difficult financing
will be to obtain. Financing will also be more costly.
The creditworthiness of the buyer directly affects the probability of payment to the
exporter, but it is not the only factor of concern to a potential lender. The political
and economic stability of the buyer's country also can be of concern. To provide financing
for either accounts receivable or the production or purchase of the product for sale, the
lender may require the most secure methods of payment, a letter of credit (possibly
confirmed), or export credit insurance.
If a lender is uncertain about the exporter's ability to perform, or if additional
credit capacity is needed, a government guarantee program may enable the lender to provide
additional financing.
The availability of the exporter's own financial resources. The company may be
able to extend credit without seeking outside financing, or the company may have
sufficient financial strength to establish a commercial line of credit. If neither of
these alternatives is possible or desirable, other options may exist, but the exporter
should fully explore the available options before issuing the pro forma invoice.
EXTENDING CREDIT TO FOREIGN BUYERS
Exporters need to weigh carefully the credit or financing they extend to foreign
customers. Exporters should follow the same careful credit principles they follow for
domestic customers. An important reason for controlling the credit period is the cost
incurred, either through use of working capital or through interest and fees paid. If the
buyer is not responsible for paying these costs, then the exporter should factor them into
the selling price.
A useful guide for determining the appropriate credit period is the normal commercial
terms in the exporter's industry for internationally traded products. Buyers generally
expect to receive the benefits of such terms. With few exceptions, normal commercial terms
range from 30 to 180 days for off-the-shelf items like consumer goods, chemicals, and
other industrial raw materials, agricultural commodities, and spare parts and components.
Custom-made or higher-value capital equipment, on the other hand, may warrant longer
repayment periods. An allowance may have to be made for longer shipment times than are
found in domestic trade, because foreign buyers are often unwilling to have the credit
period start before receiving the goods.
Foreign buyers often press exporters for longer payment periods, and it is true that
liberal financing is a means of enhancing export competitiveness. The exporter should
recognize, however, that longer credit periods increase any risk of default for which the
exporter may be liable.
Thus, the exporter must exercise judgment in balancing competitiveness against
considerations of cost and safety. Also, credit terms once extended to a buyer tend to set
the precedent for future sales, so the exporter should carefully consider any credit terms
extended to first-time buyers.
Customers are frequently charged interest on credit periods of a year or longer but
infrequently on short-term credit (up to 180 days). Most exporters absorb interest charges
for short-term credit unless the customer pays after the due date.
Obtaining cash immediately is usually a high priority with exporters. One way they do
so is by converting their export receivables to cash at a discount with a bank. Another
way is to expand working capital resources. A third approach, suitable when the purchase
involves capital goods and the repayment period extends a year or longer, is to arrange
for project financing. In this case, a lender makes a loan directly to the buyer for the
project and the exporter is paid immediately from the
loan proceeds while the bank waits for payment and earns interest. A fourth method,
when financing is difficult to obtain for a buyer or market, is to engage in countertrade
to afford the customer an opportunity to generate earnings with which to pay for the
purchase.
The options that have been mentioned normally involve the payment of interest, fees, or
other costs. Some options are more feasible when the amounts are in larger denominations.
Exporters should also determine whether they incur financial liability should the buyer
default.
COMMERCIAL BANKS
The same type of commercial loans that finance domestic activities - including loans
for working capital and revolving lines of credit - are often sought to finance export
sales until payment is received. However, banks do not usually extend credit solely on the
basis of an order.
A logical first step in obtaining financing is for an exporter to approach its local
commercial bank. If the exporter already has a loan for domestic needs, then the lender
already has experience with the exporter's ability to perform. Many exporters have very
similar, if not identical, preshipment needs for both their international and their
domestic transactions. Many lenders, therefore, would be willing to provide financing for
export transactions if there were a reasonable certainty of repayment. By using letters of
credit or export credit insurance, an exporter can reduce the lender's risk.
For a company that is new to exporting or is a small or medium-sized business, it is
important to select a bank that is sincerely interested in serving businesses of similar
type or size. If the exporter's bank lacks an international department, it will refer the
exporter to a correspondent bank that has one. The exporter may want to visit the
international department - of the exporter's own bank or a correspondent bank - to discuss
its export plans, available banking facilities, and applicable fees.
When selecting a bank, the exporter should ask the following questions:
- What are the charges for confirming a letter of credit, processing drafts, and
collecting payment?
- Does the bank have foreign branches or correspondent banks? Where are they located?
- Can the bank provide buyer credit reports? At what cost?
- What other services, such as trade leads, can it provide?
Banker's acceptances and discounting
A time draft under an irrevocable letter of credit confirmed by a prime bank presents
relatively little risk of default. Also, some banks or other lenders may be willing to buy
time drafts that a creditworthy foreign buyer has accepted or agreed to pay at a specified
future date. In some cases, banks agree to accept the obligations of paying a draft,
usually of a customer, for a fee; this is called a banker's acceptance.
However, to convert these instruments to cash immediately, an exporter must obtain a
loan using the draft as collateral or sell the draft to an investor or a bank for a fee.
When the draft is sold to an investor or bank, it is sold at a discount. The exporter
receives an amount less than the face value of the draft so that when the draft is paid at
its face value at the specified future date, the investor or bank receives more than it
paid to the exporter. The difference between the amount paid to the exporter and the face
amount paid at maturity is called a discount and represents the fees or interest (or both)
the investor or bank receives for holding the draft until maturity. Some drafts are
discounted by the investor or bank without recourse to the exporter in case the party that
is obligated to pay the draft defaults; others may be discounted with recourse to the
exporter, in which case the exporter must reimburse the investor or bank if the party
obligated to pay the draft defaults. The exporter should be certain of the terms and
conditions of any financing arrangement of this nature.
Project finance
Some export sales, especially sales of capital equipment, may sometimes require
financing terms tailored to the buyer's cash flow and may involve payments over several
years. Often the buyer obtains a loan from its own bank or arranges for other financing to
enable it to pay cash to the exporter. If other project financing is required, either the
exporter or the foreign buyer can initiate the proposal.
OTHER PRIVATE FINANCE EXPORT SOURCES
Factoring, forfaiting, and confirming
Factoring, forfaiting, and confirming
Factoring is the discounting of a foreign account receivable that does not involve a
draft. The exporter transfers title to its foreign accounts receivable to a factoring
house (an organization that specializes in the financing of accounts receivable) for cash
at a discount from the face value. Although factoring is often done without recourse to
the exporter, the specific arrangements should be verified by the exporter. Factoring of
foreign accounts receivable is less common than factoring of domestic receivables.
Forfaiting is the selling, at a discount, of longer term accounts receivable or
promissory notes of the foreign buyer. These instruments may also carry the guarantee of
the foreign government. Both U.S. and European forfaiting houses, which purchase the
instruments at a discount from the exporter, are active in the market. Because forfaiting
may be done either with or without recourse to the exporter, the specific arrangements
should be verified by the exporter.
Confirming is a financial service in which an independent company confirms an export
order in the seller's country and makes payment for the goods in the currency of that
country. Among the items eligible for confirmation (and thereby eligible for credit terms)
are the goods themselves; inland, air, and ocean transportation costs; forwarding fees;
custom brokerage fees; and duties. For the exporter, confirming means that the entire
export transaction from plant to end user can be fully coordinated and paid for over time.
Export intermediaries
In addition to acting as export representatives, many export intermediaries, can help
finance export sales. Some of these companies may provide short-term financing or may
simply purchase the goods to be exported directly from the manufacturer, thus eliminating
any risks associated with the export transaction as well as the need for financing. Some
of the larger companies may make countertrade arrangements that substitute for financing
in some cases.
Buyers and suppliers as sources of financing
Foreign buyers may make down payments that reduce the need for financing from other
sources. In addition, buyers may make progress payments as the goods are completed, which
also reduce other financing requirements. Letters of credit that allow for progress
payments upon inspection by the buyer's agent or receipt of a statement of the exporter
that a certain percentage of the product has been completed are not uncommon.
In addition, suppliers may be willing to offer terms to the exporter if they are
comfortable that they will receive payment. Suppliers may be willing to accept assignment
of a part of the proceeds of a letter of credit or a partial transfer of a transferable
letter of credit. However, some banks allow only a single transfer or assignment of a
letter of credit. Therefore, the exporter should investigate the policy of the bank that
will be advising or confirming the letter of credit.
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