Exporting—Financing and Pricing

Related Terms: Exporting

The financing of export sales concerns arrangements to get payment for the goods shipped or the services pro-vided—exactly the same issue domestically as well, but in the foreign setting the seller's power and leverage, ability to assess credit-worthiness, and his or her ability to collect are constrained by distance and differences in the legal system. For this reason export financing is a specialty and is handled as a distinct transaction of all export deals. Export pricing, similarly, is the same issue as domestic pricing but it must be based on the conditions prevailing in a foreign economy.

MODES OF PAYMENT

In the overwhelming majority of business-to-business transactions domestically, the payment mechanism used is "open account," meaning that goods are shipped by the seller and then billed, with payment expected within 30 days. Occasionally the seller will require "payment in advance" from customers who have a poor credit rating or credit history. Occasionally as well, by prior arrangement, goods are shipped "on consignment" to a buyer, meaning that payment is received only after the buyer in turn has sold the goods and not before.

All three of these modes of payment are used in foreign trade, but because of the special situation prevailing between distant sellers and buyers in different countries, what best suits the seller very rarely pleases the buyers, and vice versa. The respected foreign buyer, for example, does not want to pay in advance—risking that some little business far away fails to deliver. The relatively weak seller does not wish to sell on open account—risking very costly collection efforts if the buyer, far away, fails to pay. Shipping on consignment has the same risks for the seller—with the additional problem of waiting for a sale hundreds or thousands of miles away. For these reasons two other major forms of payment are commonly used in foreign trade: letters of credit and documentary collection.

Letters of Credit

Letters of credit (LCs) are issued by banks and, in effect, guarantee that the importer's credit is good. Under this arrangement, the bank makes payment to the importer. Financial experts note that if a letter of credit comes from a U.S. bank, it virtually eliminates the commercial credit risk of an export sale. In other words, the exporter is assured of receiving his or her due compensation for the sale. The terms of an irrevocable letter of credit cannot be changed without the express permission of the exporter once it has been opened. The letter of credit also extends some protection to importers: it includes steps that ensure that the exporter has fully complied with the terms of sale discussed in the LC. But some importers balk at the added costs that LC arrangements bring on them.

Documentary Collection

Documentary Collection, also known as a draft, is roughly equivalent to cash on delivery. Under this system of payment, a draft is drawn that requires the buyer to make payment either on sight (sight draft) or by a specified date (time draft). Legal possession of the products does not pass from the exporter to the importer until the draft has been paid or accepted. Analysts note that this arrangement serves to protect both parties, although an exporter may still have to pursue legal options to secure payment if the buyer defaults.

Trade Financing

Trade financing is borrowing specifically for an export venture, with the loan backed by the export inventory and the accounts payable due to the seller after completion of the sale. Trade finance loans are self-liquidating, meaning that proceeds of the sale are first used to pay off the loan; the remainder, thereafter, is credited to the borrower. These are project-oriented loans and quite unlike ordinary working capital loans. If the business does not need up-front money for raw materials and labor, it may still wish to engage in more limited trade financing, especially if payments of receivables are likely to be slow. This type of financing involves sales of the receivables to a third party or borrowing on the receivables themselves.

Sources of trade financing are 1) banks, 2) factoring houses, 3) export trading companies, 4) export management companies, 5) private trade finance companies, and 6) U.S. government agencies.

The small business's local bank may be a very good source of financing if it is experienced in international trade, has a department specializing in such business, or is affiliated with another bank with which it routinely deals on such transactions. For trade financing particularly, the U.S. Small Business Administration (SBA) recommends the business owner to work with an experienced international banker. As always when obtaining any kind of credit, but especially in dealing with a bank on international ventures, the owner should anticipate having to provide financial statements, business plans, and other documentation all depending on the size and nature of the transaction.

Factoring houses purchase export receivables—but at a discount. They may also act as middlemen (the word "factor" means "agent," derived from "doer"). They will purchase exports but at a certain percentage below invoice value; the percentage rate will be dependent on, among other things, the intended market and the type of buyer. Under this arrangement, the exporter does not receive full value for its goods but gets paid immediately and does not have to worry about future collection hassles with foreign customers who are tardy with their payments. Export trading companies (ETCs) and export management companies (EMCs) provide assistance in arranging financing for exporters. In addition they may offer a wide range of potentially helpful other services, including international market research, legal assistance, insurance, administration, warehousing and distribution, and product design. Private trade finance companies provide a range of financing options to small businesses in exchange for fees, commissions, or outright involvement in the transactions under consideration.

Finally, small business owners may choose to seek assistance from the government. Several federal agencies—and some state agencies—maintain programs that offer financial aid to small enterprises seeking to sell to foreign markets. Loan programs offered by the Small Business Administration, for example, include the International Trade Loan Program, a long-term financing option; the ERLC (Export Revolving Line of Credit) Program, which lasts for up to 36 months, and regular SBA business loans. Businesses may also seek loans through the Small Business Investment Company (SBIC), the Department of Agriculture's Commodity Credit Corporation (CCC), or the Export-Import Bank of the United States (Ex-Im Bank). The latter is an independent federal agency charged with assisting U.S. exporters of goods and services through a wide range of programs. Some of these export assistance programs are maintained in cooperation with various state governments. Lastly, some small business owners choose to secure financing for deals in moderate- to high-risk emerging markets through the Overseas Private Investment Corporation (OPIC), an organization that guarantees and/or provides project loans to American companies in developing nations around the world, or the U.S. Agency for International Development (USAID). USAID makes loans and grants to foreign countries some of which require the country to purchase U.S. supplies. The agency, therefore, is a source of leads for the small business prospecting for business overseas with safe payment arrangements.

 1 | 2  NEXT