Successful exporting involves a delicate balance between minimising risk and maintaining competitive edge.
Exporting goods or services is a considerably more intricate and complex process than trading domestically. While numerous parts of the selling process are common to both, there are many more issues and risks involved with exporting.
The two most important moments in any sales transaction occur at the beginning and the end. These are the negotiation of the sales contract and payment terms before goods are shipped or services provided and receipt of payment at the end of the transaction.
The former will materially affect the fulfilment of the latter and, needless to say, without payment there is no profit. So, what are some of the major risks associated with exporting?
* shipping/transport risk–ensuring that the goods are delivered within the contracted time, to the correct location, in the agreed condition
* language barriers
* cultural barriers–local customs
* legal barriers–dealing with foreign legal jurisdictions to be able to enforce the terms of a contract
* credit risk
* currency risk
* sales contracts/commercial risk (disputes)
* repudiation risk
The most straightforward way to mitigate many of these risks is to ask the importer/buyer to either pay cash upfront or provide a Letter of Credit (L/C), which is confirmed by the exporter’s bank and can easily be discounted to obtain finance for that shipment (since payment risk is with the importer’s bank not the importer itself). However, both of these create impositions on the buyer either to come up with cash upfront (and the financing costs involved with that) or incur the costs of setting up an L/C and tie up bank credit lines to do it. It’s a suitable precaution to take when dealing with high-risk countries (poor economic performance or politically unstable), unknown companies where the buyer’s ability to pay is uncertain, or countries with relatively unsophisticated legal systems.
However, increasingly, the trend in international trade is towards exporters providing open account credit terms for up to 120 days. This does involve a higher risk of non-payment since there isn’t a bank underwriting the payment, so the exporter’s bank will find it difficult to provide finance without the security of an L/C or property security.
On the other hand, with more and more companies offering open account terms, exporters risk missing out on business if they don’t offer open account terms when requested by their buyers.
While there are situations where a bank may advance funds against open account sales, this may be only between 50 to 70 percent of the invoice value and only if underwritten by the exporter taking out a credit insurance policy (at its own cost and administration) or utilising some existing property security to provide the bank with comfort. This may seem a cheaper form of finance, but the cost of the insurance and of providing other collateral (e.g., stamp duty, opportunity cost of using the security for other purposes) should also be considered.
There are two other options which rely entirely on the quality of the receivable emanating from the sale transaction, and both provide various risk mitigants as well as higher levels of funding.
This is the most common alternative available in the Australian market and is provided mainly by finance companies and some smaller banks. This arrangement involves the sale of the export invoices to the financier. The financier, through an affiliated overseas factoring company will provide:
* finance on up to 80 percent of the value of the invoices on a non-recourse basis
* credit-checking of debtors
* will take debtor credit risk to mitigate against bad debts (no need to take own credit insurance)
* collection service via the affiliate
* full accounting administration of the debtors ledger.
This option is the most comprehensive risk mitigant in that it provides credit protection against bad debts and will provide an assessment of the buyer, before shipment, by a factor resident in the buyer’s country. If the buyer defaults in making payment the overseas factor is responsible for collecting the money and provides a guarantee that it can collect it within a certain period of time (unless there is commercial dispute). This mitigates against the problem of trying to collect money across time zones, language/cultural barriers, and taking legal action in a foreign jurisdiction since the local factor can do this on their behalf. It is also advisable to involve legal counsel in the drafting of sales contracts to ensure the papers are watertight in the event of a dispute further along in the transaction.
The key matters for the exporter to consider with factoring are whether the cost can be absorbed in the profit margin and the fact that there are two intermediaries involved, the local financier and the overseas factor.
Another issue to consider is that, while mostly the overseas factor will be a well established lender, and often it will be a bank, this is not always the case and the service quality and financial reliability of smaller overseas factoring companies may represent additional risk. This could be overcome by investigating who these overseas factors are going to be in each country.
Ultimately, international factoring is most suitable for smaller exporters or new exporters with less experience in managing the export credit risk and collection process.
This provides finance on up to 90 percent of the value of the shipments, as well as credit protection when the exporter sells the export invoices to the financier. It is very flexible in that the credit protection service can be optional depending on the spread and quality of the risk of the ledger and the needs of the exporter. The key features of invoice discounting are:
* provides funding up to 90 percent of the value of invoices
* may be provided with credit protection or without depending on the situation– if the spread of debtor risk in the ledger is good, the country risk acceptable, and the exporter doesn’t need credit protection (good longstanding relationship with buyers) funding can be provided without credit protection on a full recourse basis
* there is no need for a third party overseas factor to be involved–the exporter can conduct its own collections and this can simplify the process and give greater control to the exporter over the sales relationship
* facility can be undisclosed to the buyer.
Invoice discounting is considerably more cost effective, flexible and simpler to run than factoring, but it is often more suited to more experienced exporters who need the cash flow to grow and who have their own risk mitigation and credit control processes in place internally.
Exporting on open account terms can often be most effectively financed and many of its inherent risks managed by using international factoring or invoice discounting. The crucial elements are having a legally strong sales contract in place with the buyer and ensuring that the buyer’s bona fides are thoroughly checked before shipment. Managing these two areas tightly can reduce the risk of non-payment and facilitate financing of those exports.
Both of these solutions accelerate cash flow into the business by shortening the cash cycle, and they facilitate sales growth. They can also, to various levels, assist in mitigating payment risk. Which of these two is the most appropriate will depend on the exporter’s expertise in managing the buyer risk (including language and cultural issues) and their risk threshold. Ultimately, both of these solutions can accelerate cash flow to finance sales growth and can assist in mitigating risk. The exporter needs to discuss these options with their bank/financier and be clear as to what services
are available and at what cost before determining the best way to finance open account exports. They need to get the best, most flexible structure to meet their needs.
* Alex Fernandez is marketing manager, debtor finance, for HSBC Bank Australia (www.hsbc.com.au)