1 Trade Finance Guide A Quick Reference for U.S. Exporters
2 Trade Finance Guide: A Quick Reference for U.S. Exporters is designed to help U.S. companies, especially small and medium-sized enterprises, learn the basic fundamentals of trade finance so that they can turn their export opportunities into actual sales and to achieve the ultimate goal of getting paid especially on time for those sales. Concise, two-page chapters offer the basics of numerous financing techniques, from open accounts, to forfaiting to government assisted foreign buyer financing.
3 TRADE FINANCE GUIDE Table of Contents Introduction...1 Chapter 1: Chapter 2: Chapter 3: Chapter 4: Methods of Payment in International Trade...3 Cash-in-Advance...5 Letters of Credit...7 Documentary Collections...9 Chapter 5: Open Account Chapter 6: Consignment Chapter 7: Export Working Capital Financing Chapter 8: Government-Guaranteed Export Working Capital Loan Programs Chapter 9: Export Credit Insurance Chapter 10: Export Factoring Chapter 11: Forfaiting Chapter 12: Government-Assisted Foreign Buyer Financing Chapter 13: Government-Backed Agricultural Export Financing Chapter 14: Foreign Exchange Risk Management Published November 2012 The International Trade Administration s mission is to create prosperity by strengthening the competitiveness of U.S. industry, promoting trade and investment, and ensuring fair trade and compliance with trade laws and agreements. To learn more about the ITA write to: International Trade Administration, Office of Public Affairs, U.S. Department of Commerce, Washington, DC or visit the ITA s Web site at
5 TRADE FINANCE GUIDE Introduction Opportunities, Risks, and Trade Finance 1 Welcome to the third edition of the Trade Finance Guide: A Quick Reference for U.S. Exporters. This guide is designed to help U.S. companies, especially small and medium-sized enterprises (SMEs), learn the basic fundamentals of trade finance so that they can turn their export opportunities into actual sales and to achieve the ultimate goal of getting paid especially on time for those sales. This guide provides general information about common techniques of export financing. Accordingly, you are advised to assess each technique in light of your specific situation or needs. This edition includes two new chapters on Consignment and Government-Backed Agricultural Export Financing with minor updates on other chapters. The Trade Finance Guide will be revised and updated as needed. Future editions may include new chapters discussing other trade finance techniques and related topics. Benefits of Exporting The United States is the world s second largest exporter, with $2.06 trillion in goods and services exports in 2011, according to the World Trade Organization s World Trade Report In 2011, the United States was the top exporter of services and second largest exporter of goods, behind only China. However, 95 percent of the world s consumers live outside of the United States. So if you are selling only domestically, you are reaching just a small share of potential customers. Exporting enables SMEs to diversify their portfolios and insulates them against periods of slower growth in the domestic economy. Free trade agreements (FTAs) have helped to open markets such as Australia, Canada, Central America, Chile, Israel, Jordan, Korea, Mexico, and Singapore. FTAs create more export opportunities for U.S. businesses. The Trade Finance Guide is designed to provide U.S. SMEs with the knowledge necessary to grow and become competitive in overseas markets. Key Players in the Creation of the Trade Finance Guide A QUICK GLANCE Trade Finance Guide A concise, simple, and easy-to-understand guide designed to help U.S. small and medium-sized exporters learn quickly how to get paid from their foreign customers in the most effective manner. Trade Finance A means to turn export opportunities into actual sales and to get paid for export sales especially on time by effectively managing the risks associated with doing business internationally. Opportunities Reaching the 95 percent of potential customers worldwide who live outside the United States Diversifying customer portfolios Risks Non-payment or delayed payment by foreign buyers Political and commercial risks as well as cultural influences The International Trade Administration (ITA) is an agency within the U.S. Department of Commerce whose mission is to foster economic growth and prosperity through global trade. ITA provides practical information to help you select your markets and products, ensures that you have access to international markets as required by our trade agreements, and safeguards you from unfair competition such as dumped and subsidized imports. ITA is made up of the following four units: (a) Manufacturing and Services, the industry analysis unit that supports U.S. industry s domestic and global competitiveness; (b) Commercial Service, the trade promotion unit that helps U.S. businesses at every stage of the exporting process; (c) Market Access and Compliance, the country-specific policy unit that keeps world markets open to U.S. products and helps U.S. businesses benefit from our trade agreements with other countries; and (d) Import Administration, the trade law enforcement unit that ensures that U.S. businesses face a level playing field in the domestic marketplace. For more information, visit or contact the
6 Trade Information Center, USA-TRADE or the Commercial Service s global network of domestic Export Assistance Centers and overseas posts. To find the nearest Export Assistance Center or overseas Commercial Service office, visit Partnership and Cooperation The Trade Finance Guide was created in partnership with FCIB The Finance, Credit, and International Business Association a prominent business educator of credit and risk management professionals in exporting companies ranging in size from multinational to SMEs. FCIB s parent, the National Association of Credit Management, is a non-profit organization that represents nearly 16,000 businesses in the United States and is one of the world s largest credit organizations. This Trade Finance Guide was also created in cooperation with the U.S. Small Business Administration, the U.S. Export-Import Bank (Ex-Im Bank), the International Factoring Association, the Association of Trade & Forfaiting in the Americas, and BAFT- IFSA, the association for organizations actively engaged in international transaction banking. (BAFT-IFSA was formed by the merger of the Bankers Association for Finance and Trade (BAFT) and the International Financial Services Association (IFSA).) Their contact information is listed below and provided in other sections of the Trade Finance Guide. Trade Finance Guide in Spanish ITA has published a Spanish version of the Trade Finance Guide in partnership with the California Centers for International Trade Development (CITD) to help facilitate U.S. exports to Spanish-speaking countries. The CITD is a state-funded non-profit organization that promotes California s international trade and global competitiveness. With offices across California, the CITD assists local SMEs with expanding their global presence, especially in Mexico and Latin America, where Spanish is the primary language. Through this collaboration with CITD, the Spanish language Trade Finance Guide will enable ITA to reach thousands of potential new exporters. Visit for more information. For More Information about the Guide The Trade Finance Guide was created by ITA s Office of Financial Services Industries (OFSI). A part of ITA s Manufacturing and Services unit, OFSI is dedicated to enhancing the domestic and international competitiveness of U.S. financial services industries and providing internal policy recommendations on U.S. exports and overseas investment supported by official finance. For more information, contact the project manager and author of the Guide, Yuki Fujiyama, tel. (202) ; How to Obtain the Trade Finance Guide The Trade Finance Guide (both English and Spanish versions) is available online for free download at Export.gov, the U.S. government s export portal. Print copies of the Guide may be available upon request at FCIB. Where to Learn More about Trade Finance As the official export credit agency of the United States, Ex-Im Bank regularly offers trade finance seminars for exporters and lenders. These seminars are held in Washington, DC and in many major U.S. cities. For more information about the seminars, visit or call EXIM (3946). For more advanced trade finance training, FCIB offers the 13-week International Credit and Risk Management online course, which was developed with a grant awarded by the U.S. Department of Commerce in For more information about the course, visit or call BAFT-IFSA also offers trade finance events and educational programs. For more information about the events and programs, visit or call (202) U.S. Department of Commerce International Trade Administration
7 TRADE FINANCE GUIDE Chapter 1 Methods of Payment in International Trade 3 To succeed in today s global marketplace and win sales against foreign competitors, exporters must offer their customers attractive sales terms supported by the appropriate payment methods. Because getting paid in full and on time is the ultimate goal for each export sale, an appropriate payment method must be chosen carefully to minimize the payment risk while also accommodating the needs of the buyer. As shown in figure 1, there are five primary methods of payment for international transactions. During or before contract negotiations, you should consider which method in the figure is mutually desirable for you and your customer. Figure 1: Payment Risk Diagram Consignment Open Account Documentary Collections Letters of Credit Cash-in-Advance Cash-in-Advance Letters of Credit Documentary Collections Open Account Consignment Key Points International trade presents a spectrum of risk, which causes uncertainty over the timing of payments between the exporter (seller) and importer (foreign buyer). For exporters, any sale is a gift until payment is received. Therefore, exporters want to receive payment as soon as possible, preferably as soon as an order is placed or before the goods are sent to the importer. For importers, any payment is a donation until the goods are received. Therefore, importers want to receive the goods as soon as possible but to delay payment as long as possible, preferably until after the goods are resold to generate enough income to pay the exporter.
8 Cash-in-Advance With cash-in-advance payment terms, an exporter can avoid credit risk because payment is received before the ownership of the goods is transferred. For international sales, wire transfers and credit cards are the most commonly used cash-in-advance options available to exporters. With the advancement of the Internet, escrow services are becoming another cash-in-advance option for small export transactions. However, requiring payment in advance is the least attractive option for the buyer, because it creates unfavorable cash flow. Foreign buyers are also concerned that the goods may not be sent if payment is made in advance. Thus, exporters who insist on this payment method as their sole manner of doing business may lose to competitors who offer more attractive payment terms. Letters of Credit Letters of credit (LCs) are one of the most secure instruments available to international traders. An LC is a commitment by a bank on behalf of the buyer that payment will be made to the exporter, provided that the terms and conditions stated in the LC have been met, as verified through the presentation of all required documents. The buyer establishes credit and pays his or her bank to render this service. An LC is useful when reliable credit information about a foreign buyer is difficult to obtain, but the exporter is satisfied with the creditworthiness of the buyer s foreign bank. An LC also protects the buyer since no payment obligation arises until the goods have been shipped as promised. Documentary Collections A documentary collection (D/C) is a transaction whereby the exporter entrusts the collection of the payment for a sale to its bank (remitting bank), which sends the documents that its buyer needs to the importer s bank (collecting bank), with instructions to release the documents to the buyer for payment. Funds are received from the importer and remitted to the exporter through the banks involved in the collection in exchange for those documents. D/Cs involve using a draft that requires the importer to pay the face amount either at sight (document against payment) or on a specified date (document against acceptance). The collection letter gives instructions that specify the documents required for the transfer of title to the goods. Although banks do act as facilitators for their clients, D/Cs offer no verification process and limited recourse in the event of non-payment. D/Cs are generally less expensive than LCs. Open Account An open account transaction is a sale where the goods are shipped and delivered before payment is due, which in international sales is typically in 30, 60 or 90 days. Obviously, this is one of the most advantageous options to the importer in terms of cash flow and cost, but it is consequently one of the highest risk options for an exporter. Because of intense competition in export markets, foreign buyers often press exporters for open account terms since the extension of credit by the seller to the buyer is more common abroad. Therefore, exporters who are reluctant to extend credit may lose a sale to their competitors. Exporters can offer competitive open account terms while substantially mitigating the risk of non-payment by using one or more of the appropriate trade finance techniques covered later in this Guide. When offering open account terms, the exporter can seek extra protection using export credit insurance. 4 Consignment Consignment in international trade is a variation of open account in which payment is sent to the exporter only after the goods have been sold by the foreign distributor to the end customer. An international consignment transaction is based on a contractual arrangement in which the foreign distributor receives, manages, and sells the goods for the exporter who retains title to the goods until they are sold. Clearly, exporting on consignment is very risky as the exporter is not guaranteed any payment and its goods are in a foreign country in the hands of an independent distributor or agent. Consignment helps exporters become more competitive on the basis of better availability and faster delivery of goods. Selling on consignment can also help exporters reduce the direct costs of storing and managing inventory. The key to success in exporting on consignment is to partner with a reputable and trustworthy foreign distributor or a third-party logistics provider. Appropriate insurance should be in place to cover consigned goods in transit or in possession of a foreign distributor as well as to mitigate the risk of non-payment. U.S. Department of Commerce International Trade Administration
9 TRADE FINANCE GUIDE Chapter 2 Cash-in-Advance 5 With the cash-in-advance payment method, the exporter can eliminate credit risk or the risk of non-payment since payment is received prior to the transfer of ownership of the goods. Wire transfers and credit cards are the most commonly used cash-in-advance options available to exporters. With the advancement of the Internet, escrow services are becoming another cash-in-advance option for small export transactions. However, requiring payment in advance is the least attractive option for the buyer, because it tends to create cash-flow problems, and it often is not a competitive option for the exporter especially when the buyer has other vendors to choose from. In addition, foreign buyers are often concerned that the goods may not be sent if payment is made in advance. Exporters who insist on cash-in-advance as their sole payment method for doing business may lose out to competitors who are willing to offer more attractive payment terms. Key Points Full or significant partial payment is required, usually via credit card or bank or wire transfer or escrow service, before the ownership of the goods is transferred. Cash-in-advance, especially a wire transfer, is the most secure and least risky method of international trading for exporters and, consequently, the least secure and an unattractive method for importers. However, both the credit risk and the competitive landscape must be considered. Exporters may select credit cards as a viable cash- in-advance option, especially for small consumer goods transactions. CHARACTERISTICS OF CASH IN-ADVANCE Applicability Recommended for use in high-risk trade relationships or export markets, and appropriate for small export transactions Risk Exporter is exposed to virtually no risk as the burden of risk is placed almost completely on the importer. Pros Payment before shipment Eliminates risk of non-payment Cons May lose customers to competitors over payment terms No additional earnings through financing operations Exporters may also select escrow services as a mutually beneficial cash-in-advance option for small transactions with importers who demand assurance that the goods will be sent in exchange for advance payment. Insisting on cash-in-advance could, ultimately, cause exporters to lose customers to competitors who are willing offer more favorable payment terms to foreign buyers. Creditworthy foreign buyers, who prefer greater security and better cash utilization, may find cash-inadvance unacceptable and simply walk away from the deal.
10 Wire Transfer: Most Secure and Preferred Cash-in-Advance Method An international wire transfer is commonly used and is almost immediate. Exporters should provide clear routing instructions to the importer when using this method, including the receiving bank s name and address, SWIFT (Society for Worldwide Interbank Financial Telecommunication) address, and ABA (American Bankers Association) number, as well as the seller s name and address, bank account title, and account number. The fee for an international wire transfer can be paid by the sender (importer) or it can be deducted from the receiver s (exporter s) account. Credit Card: A Viable Cash-in-Advance Method Exporters who sell directly to foreign buyers may select credit cards as a viable cash-in-advance option, especially for small consumer goods transactions. Exporters should check with their credit card companies for specific rules on international use of credit cards. The rules governing international credit card transactions differ from those for domestic use. Because international credit card transactions are typically placed using the Web, telephone, or fax, which facilitate fraudulent transactions, proper precautions should be taken to determine the validity of transactions before the goods are shipped. Although exporters must tolerate the fees charged by credit card companies and assume the risk of unfounded disputes, credit cards may help the business grow because of their convenience and wide acceptance. Escrow Service: A Mutually Beneficial Cash-in-Advance Method Exporters may select escrow services as a mutually beneficial cash-in-advance option for small transactions with importers who demand assurance that the goods will be sent in exchange for advance payment. Escrow in international trade is a service that allows both exporter and importer to protect a transaction by placing the funds in the hands of a trusted third party until a specified set of conditions are met. Here s how it works: the importer sends the agreed amount to the escrow service. After payment is verified, the exporter is instructed to ship the goods. Upon delivery, the importer has a pre-determined amount of time to inspect and accept the goods. Once accepted, the funds are released by the escrow service to the exporter. The escrow fee can either be paid in full by one party or split evenly between the exporter and the importer. Cross-border escrow services are offered by international banks and firms that specialize in escrow and other deposit and custody services. Payment by Check: A Less-Attractive Cash-in-Advance Method Advance payment using a check drawn on the importer s account and mailed to the exporter will result in a lengthy collection delay of several weeks to months. Therefore, this method may defeat the original intention of receiving payment before shipment. If the check is in U.S. dollars and drawn on a U.S. bank, the collection process is the same as it would be for any U.S. check. However, funds deposited by non-local checks, especially those totaling more than $5,000 on any one day, may not become available for withdrawal for up to 10 business days due to Regulation CC of the Federal Reserve ( (ii)). In addition, if the check is in a foreign currency or drawn on a foreign bank, the collection process can become more complicated and can significantly delay the availability of funds. Moreover, if shipment is made before the check is collected, there is a risk that the check may be returned due to insufficient funds in the buyer s account or even because of a stop-payment order. 6 When to Use Cash-in-Advance Terms The importer is a new customer and/or has a less-established operating history. The importer s creditworthiness is doubtful, unsatisfactory, or unverifiable. The political and commercial risks of the importer s home country are very high. The exporter s product is unique, not available elsewhere, or in heavy demand. The exporter operates an Internet-based business where the acceptance of credit card payments is a must to remain competitive. U.S. Department of Commerce International Trade Administration
11 TRADE FINANCE GUIDE Chapter 3 Letters of Credit 7 Letters of credit (LCs) are one of the most versatile and secure instruments available to international traders. An LC is a commitment by a bank on behalf of the importer (foreign buyer) that payment will be made to the beneficiary (exporter) provided that the terms and conditions stated in the LC have been met, as evidenced by the presentation of specified documents. Since LCs are credit instruments, the importer s credit with his bank is used to obtain an LC. The importer pays his bank a fee to render this service. An LC is useful when reliable credit information about a foreign buyer is difficult to obtain or if the foreign buyer s credit is unacceptable, but the exporter is satisfied with the creditworthiness of the importer s bank. This method also protects the importer since the documents required to trigger payment provide evidence that goods have been shipped as agreed. However, because LCs have opportunities for discrepancies, which may negate payment to the exporter, documents should be prepared by trained professionals or outsourced. Discrepant documents, literally not having an i dotted and t crossed, may negate the bank s payment obligation. Key Points An LC, also referred to as a documentary credit, is a contractual agreement whereby the issuing bank (importer s bank), acting on behalf of its customer (the importer or buyer), promises to make payment to the beneficiary or exporter against the receipt of complying stipulated documents. The issuing bank will typically use intermediary banks to facilitate the transaction and make payment to the exporter. The LC is a separate contract from the sales contract on which it is based; therefore, the banks are not concerned with the quality of the underlying goods or whether each party fulfills the terms of the sales contract. The bank s obligation to pay is solely conditioned upon the seller s compliance with the terms and conditions of the LC. In LC transactions, banks deal in documents only, not goods. CHARACTERISTICS OF A LETTER OF CREDIT Applicability Recommended for use in higher-risk situations or new or less-established trade relationships when the exporter is satisfied with the creditworthiness of the buyer s bank Risk Risk is spread between exporter and importer, provided that all terms and conditions as specified in the LC are adhered to. Pros Payment made after shipment A variety of payment, financing and risk mitigation options available Cons Labor intensive process Relatively expensive method in terms of transaction costs LCs can be arranged easily for one-time transactions between the exporter and importer or used for an ongoing series of transactions. Unless the conditions of the LC state otherwise, it is always irrevocable, which means the document may not be changed or cancelled unless the importer, banks, and exporter agree.
12 Confirmed Letter of Credit A greater degree of protection is afforded to the exporter when an LC issued by a foreign bank (the importer s issuing bank) is confirmed by a U.S. bank. The exporter asks its customer to have the issuing bank authorize a bank in the exporter s country to confirm (this bank is typically the advising bank, which then becomes the confirming bank). Confirmation means that the U.S. bank adds its engagement to pay the exporter to that of the foreign bank. If an LC is not confirmed, the exporter is subject to the payment risk of the foreign bank and the political risk of the importing country. Exporters should consider getting confirmed LCs if they are concerned about the credit standing of the foreign bank or when they are operating in a high-risk market, where political upheaval, economic collapse, devaluation or exchange controls could put the payment at risk. Exporters should also consider getting confirmed LCs when importers are asking for extended payment terms. Illustrative Letter of Credit Transaction 1. The importer arranges for the issuing bank to open an LC in favor of the exporter. 2. The issuing bank transmits the LC to the nominated bank, which forwards it to the exporter. 3. The exporter forwards the goods and documents to a freight forwarder. 4. The freight forwarder dispatches the goods and either the dispatcher or the exporter submits documents to the nominated bank. 5. The nominated bank checks documents for compliance with the LC and collects payment from the issuing bank for the exporter. 6. The importer s account at the issuing bank is debited. 7. The issuing bank releases documents to the importer to claim the goods from the carrier and to clear them at customs. Special Letters of Credit LCs can take many forms. When an LC is made transferable, the payment obligation under the original LC can be transferred to one or more second beneficiaries. With a revolving LC, the issuing bank restores the credit to its original amount each time it is drawn down. A standby LC is not intended to serve as the means of payment for goods but can be drawn in the event of a contractual default, including the failure of an importer to pay invoices when due. Similarly, standby LCs are often posted by exporters in favor of an importer to pay invoices when due. Standby LCs are often posted by exporters in favor of importers because they can serve as bid bonds, performance bonds, and advance payment guarantees. In addition, standby LCs are often used as counter guarantees against the provision of down payments and progress payments on the part of foreign buyers. Tips for Exporters Consult with your bank before the importer applies for an LC. Consider whether a confirmed LC is needed. Negotiate with the importer and agree upon detailed terms to be incorporated into the LC. Determine if all LC terms can be met within the prescribed time limits. Ensure that all the documents are consistent with the terms and conditions of the LC. Be cautious of discrepancy opportunities that may delay or cause non-payment. 8 U.S. Department of Commerce International Trade Administration
13 TRADE FINANCE GUIDE Chapter 4 Documentary Collections 9 A documentary collection (D/C) is a transaction whereby the exporter entrusts the collection of payment to the exporter s bank (remitting bank), which sends documents to the importer s bank (collecting bank), along with instructions for payment. Funds are received from the importer and remitted to the exporter through the banks in exchange for those documents. D/Cs involve using a bill of exchange (commonly known as a draft) that requires the importer to pay the face amount either at sight (document against payment [D/P] or cash against documents) or on a specified future date (document against acceptance [D/A] or cash against acceptance). The collection cover letter gives instructions that specify the documents required for the delivery of the goods to the importer. Although banks do act as facilitators (agents) for their clients under collections, D/Cs offer no verification process and limited recourse in the event of non-payment. D/Cs are generally less expensive than letters of credit (LCs). Key Points D/Cs are less complicated and less expensive than LCs. Under a D/C transaction, the importer is not obligated to pay for goods before shipment. If structured properly, the exporter retains control over the goods until the importer either pays the draft amount at sight or accepts the draft to incur a legal obligation to pay at a specified later date. CHARACTERISTICS OF A DOCUMENTARY COLLECTION Applicability Recommended for use in established trade relationships, in stable export markets and for transactions involving ocean shipments Risk Riskier for the exporter, though D/C terms are more convenient and cheaper than an LC to the importer Pros Bank assistance in obtaining payment The process is simple, fast, and less costly than LCs Cons Although the goods can be controlled under ocean shipments, they are more Banks role is limited and they do not guarantee payment difficult to control under air and overland Banks do not verify the accuracy of the documents shipments, which allow the foreign buyer to receive the goods with or without payment unless the exporter employs agents in the importing country to take delivery until goods are paid for. The exporter s bank (remitting bank) and the importer s bank (collecting bank) play an essential role in D/Cs. Although the banks control the flow of documents, they neither verify the documents nor take any risks. They can, however, influence the mutually satisfactory settlement of a D/C transaction.
14 When to Use Documentary Collections With D/Cs, the exporter has little recourse against the importer in case of non-payment. Thus, D/Cs should be used only under the following conditions: The exporter and importer have a well-established relationship. The exporter is confident that the importing country is politically and economically stable. An open account sale is considered too risky, and an LC is unacceptable to the importer. Typical Simplified D/C Transaction Flow 1. The exporter ships the goods to the importer and receives the documents in exchange. 2. The exporter presents the documents with instructions for obtaining payment to his bank. 3. The exporter s remitting bank sends the documents to the importer s collecting bank. 4. The collecting bank releases the documents to the importer on receipt of payment or acceptance of the draft. 5. The importer uses the documents to obtain the goods and to clear them at customs. 6. Once the collecting bank receives payment, it forwards the proceeds to the remitting bank. 7. The remitting bank then credits the exporter s account. Documents against Payment Collection With a D/P collection, the exporter ships the goods and then gives the documents to his bank, which will forward the documents to the importer s collecting bank, along with instructions on how to collect the money from the importer. In this arrangement, the collecting bank releases the documents to the importer only on payment for the goods. Once payment is received, the collecting bank transmits the funds to the remitting bank for payment to the exporter. Table 1 shows an overview of a D/P collection: Table 1: Overview of a D/P collection Time of Payment Transfer of Goods Exporter Risk After shipment, but before documents are released After payment is made at sight If draft is unpaid, goods may need to be disposed of or may be delivered without payment if documents do not control possession Documents against Acceptance Collection With a D/A collection, the exporter extends credit to the importer by using a time draft. The documents are released to the importer to claim the goods upon his signed acceptance of the time draft. By accepting the draft, the importer becomes legally obligated to pay at a specific date. At maturity, the collecting bank contacts the importer for payment. Upon receipt of payment, the collecting bank transmits the funds to the remitting bank for payment to the exporter. Table 2 shows an overview of a D/A collection: Table 2: Overview of a D/A collection Time of Payment Transfer of Goods Exporter Risk On maturity of draft at a specified future date Before payment, but upon acceptance of draft Has no control over goods after acceptance and may not get paid at due date 10 U.S. Department of Commerce International Trade Administration
15 TRADE FINANCE GUIDE Chapter 5 Open Account 11 An open account transaction in international trade is a sale where the goods are shipped and delivered before payment is due, which is typically in 30, 60 or 90 days. Obviously, this option is advantageous to the importer in terms of cash flow and cost, but it is consequently a risky option for an exporter. Because of intense competition in export markets, foreign buyers often press exporters for open account terms. In addition, the extension of credit by the seller to the buyer is more common abroad. Therefore, exporters who are reluctant to extend credit may lose a sale to their competitors. However, though open account terms will definitely enhance export competitiveness, exporters should thoroughly examine the political, economic, and commercial risks as well as cultural influences to ensure that payment will be received in full and on time. It is possible to substantially mitigate the risk of non-payment associated with open account trade by using trade finance techniques such as export credit insurance and factoring. Exporters may also seek export working capital financing to ensure that they have access to financing for production and for credit while waiting for payment. Key Points The goods, along with all the necessary documents, are shipped directly to the importer who has agreed to pay the exporter s invoice at a specified date, which is usually in 30, 60 or 90 days. The exporter should be absolutely confident that the importer will accept shipment and pay at the agreed time and that the importing country is commercially and politically secure. Open account terms may help win customers in competitive markets and may be used with one or more of the appropriate trade finance techniques that mitigate the risk of non-payment. CHARACTERISTICS OF AN OPEN ACCOUNT TRANSACTION Applicability Recommended for use (a) in low-risk trading relationships or markets and (b) in competitive markets to win customers with the use of one or more appropriate trade finance techniques Risk Substantial risk to the exporter because the buyer could default on payment obligation after shipment of the goods Pros Boost competitiveness in the global market Help establish and maintain a successful trade relationship Cons Significant exposure to the risk of non-payment Additional costs associated with risk mitigation measures
16 How to Offer Open Account Terms in Competitive Markets Open account terms may be offered in competitive markets with the use of one or more of the following trade finance techniques: (a) export working capital financing, (b) government-guaranteed export working capital programs, (c) export credit insurance, and (d) export factoring. More detailed information on each trade finance technique is provided in Chapters 7 through 10 of this Guide. Export Working Capital Financing Exporters who lack sufficient funds to extend open accounts in the global market need export working capital financing that covers the entire cash cycle, from the purchase of raw materials through the ultimate collection of the sales proceeds. Export working capital facilities, which are generally secured by personal guarantees, assets, or receivables, can be structured to support export sales in the form of a loan or revolving line of credit. Government-Guaranteed Export Working Capital Programs The U.S. Small Business Administration and the U.S. Export-Import Bank offer programs that guarantee export working capital facilities granted by participating lenders to U.S. exporters. With those programs, U.S. exporters can obtain needed facilities from commercial lenders when financing is otherwise not available or when their borrowing capacity needs to be increased. Export Credit Insurance Export credit insurance provides protection against commercial losses (such as default, insolvency, bankruptcy) and political losses (such as war, nationalization, and currency inconvertibility). It allows exporters to increase sales by offering more liberal open account terms to new and existing customers. Insurance also provides security for banks that are providing working capital and are financing exports. Export Factoring Factoring in international trade is the discounting of short-term receivables (up to 180 days). The exporter transfers title to his short-term foreign accounts receivable to a factoring house, or a factor, for cash at a discount from the face value. It allows an exporter to ship on open account as the factor assumes the financial liability of the importer to pay and handles collections on the receivables. Factoring houses most commonly work with exports of consumer goods. Trade Finance Technique Unavailable for Open Account Terms: Forfaiting Forfaiting is a method of trade financing that allows the exporter to sell his medium and long-term receivables (180 days to 7 years or more) to a forfaiter at a discount, in exchange for cash. The forfaiter assumes all the risks, thereby enabling the exporter to offer extended credit terms and to incorporate the discount into the selling price. Forfaiters usually work with exports of capital goods, commodities, and large projects. Forfaiting was developed in Switzerland in the 1950s to fill the gap between the exporter of capital goods, who would not or could not deal on open account, and the importer, who desired to defer payment until the capital equipment could begin to pay for itself. More detailed information about forfaiting is provided in Chapter 11 of the Guide. 12 U.S. Department of Commerce International Trade Administration
17 TRADE FINANCE GUIDE Chapter 6 Consignment 13 Consignment in international trade is a variation of the open account method of payment in which payment is sent to the exporter only after the goods have been sold by the foreign distributor to the end customer. An international consignment transaction is based on a contractual arrangement in which the foreign distributor receives, manages, and sells the goods for the exporter who retains title to the goods until they are sold. Payment to the exporter is required only for those items sold. One of the common uses of consignment in exporting is the sale of heavy machinery and equipment because the foreign distributor generally needs floor models and inventory for sale. Goods not sold after an agreed upon time period may be returned to the exporter at cost. Exporting on consignment is very risky as the exporter is not guaranteed any payment and someone outside the exporter s control has actual possession of its inventory. However, selling on consignment can provide the exporter some great advantages which may not be obvious at first glance. For example, consignment can help exporters compete on the basis of better availability and faster delivery of goods when they are stored near the end customer. It can also help exporters reduce the direct costs of storing and managing inventory, thereby making it possible to keep selling prices in the local market competitive. However, though consignment can definitely enhance export competitiveness, exporters should keep in mind that the key to success in exporting on consignment and in getting paid is to partner with a reputable and trustworthy foreign distributor or a third-party logistics provider. Key Points Payment is sent to the exporter only after the goods have been sold by the foreign distributor. Exporting on consignment can help exporters enter new markets and increase sales in competitive environments on the basis of better availability and faster delivery of goods. Consignment can also help exporters reduce the direct costs of storing and managing inventory, thereby making it possible to keep selling prices in the local market competitive. Partnership with a reputable and trustworthy foreign distributor or a third-party logistics provider is a must for success. The importing country should be commercially and politically secure. CHARACTERISTICS OF CONSIGNMENT Applicability Recommended for use in competitive environments to enter new markets and increase sales in partnership with a reliable and trustworthy foreign distributor Risk Significant risk to the exporter because payment is required only after the goods have been sold to the end customer Pros Help enhance export competitiveness on the basis of greater availability and faster delivery of goods Help reduce the direct costs of storing and managing inventory Cons Exporter is not guaranteed payment Additional costs associated with risk mitigation measures Appropriate insurance should be in place to mitigate the risk of non-payment as well as to cover consigned goods in transit or in possession of a foreign distributor. Export working capital financing can help exporters of consigned goods have access to financing and credit while waiting for payment from the foreign distributor.
18 How to Export on Consignment If you believe you are ready to export on consignment, the first step is to select a reputable and trustworthy foreign distributor or a third-party logistics provider who is based in a market of interest. The next step is to ensure that you have access to financing and credit and that appropriate insurance is in place to cover consigned goods against loss or damage as well to mitigate the risk of non-payment. As such, exporting on consignment may require the use of one or more of the following trade finance techniques: (a) export working capital financing, (b) government-guaranteed export working capital programs, and (c) export credit insurance. More detailed information on each trade finance technique is provided in Chapters 7 through 9 of this Guide. Partnership in Exporting on Consignment To succeed in exporting on consignment, the exporter must partner with a reputable and trustworthy foreign distributor or a third-party logistics provider (3PL) that is based in its selected overseas market. A 3PL is a firm that provides logistics services with expertise in pick-up and delivery of shipments for exporters. 3PLs can help exporters reduce costs, mitigate risks, and manage expenses and time factors as well as to ensure that the consignment is shipped on the most economical and optimal route. Here is a real life example of how a partnership in exporting on consignment helped a U.S. company. A Midwest-based manufacturer of packaging equipment faced challenges in meeting market demand for quick delivery of its products to Asia as well as in reducing the costs of storing and managing overseas inventory to keep prices competitive. The U.S. manufacturer entered a consigned inventory arrangement with a Japanese 3PL who receives and stocks the goods in Japan and sells them to the end customers in Asia. The Japanese 3PL receives a commission for sales made, and then sends the net proceeds to the U.S. manufacturer as their goods are sold. The U.S. manufacturer s sales increased substantially because exporting on consignment helped deliver their products faster to the local market and kept prices competitive due to reduced direct costs of storing and managing overseas inventory. Export Working Capital Financing Exporters who sell on consignment in the global market need financing to ensure that they have access to working capital and credit while waiting for payment from the foreign distributor. Export working capital facilities, which are generally secured by personal guarantees, assets, or receivables, can be structured to support export sales in the form of a loan or revolving line of credit. Government-Guaranteed Export Working Capital Programs The U.S. Small Business Administration and the U.S. Export-Import Bank offer programs that guarantee export working capital facilities granted by participating lenders to U.S. exporters. With those programs, U.S. exporters can obtain needed facilities from commercial lenders when financing is otherwise not available or when their borrowing capacity needs to be increased. Export Credit Insurance Export credit insurance provides protection against commercial losses (such as default, insolvency, bankruptcy) and political losses (such as war, nationalization, and currency inconvertibility). It gives the exporter conditional assurance that payment will be made if the foreign distributor is unable to pay. Appropriate insurance should be obtained to cover consigned goods in transit or in possession of a foreign distributor. 14 U.S. Department of Commerce International Trade Administration
19 TRADE FINANCE GUIDE Chapter 7 Export Working Capital Financing 15 Export working capital (EWC) financing allows exporters to purchase the goods and services they need to support their export sales. More specifically, EWC facilities extended by commercial lenders provide a means for small and medium-sized enterprises (SMEs) that lack sufficient internal liquidity to process and acquire goods and services to fulfill export orders and extend open account terms to their foreign buyers. EWC financing also helps exporters of consigned goods have access to financing and credit while waiting for payment from the foreign distributor. EWC funds are commonly used to finance three different areas: (a) materials, (b) labor, and (c) inventory, but they can also be used to finance receivables generated from export sales and/or standby letters of credit used as performance bonds or payment guarantees to foreign buyers. An unexpected large export order or many incremental export orders can place challenging demands on working capital. EWC financing, which is generally secured by personal guarantees, assets, or highvalue accounts receivable, helps to ease and stabilize the cash flow problems of exporters while they fulfill export sales and grow competitively in the global market. Key Points Funds may be used to acquire materials, labor, inventory, goods and services for export. A facility can support a single export transaction (transaction-specific shortterm loan) or multiple export transactions (revolving line of credit) on open account terms. A transaction-specific loan is generally up to one year, and a revolving line of credit may extend up to three years. Availability is generally limited to financially-stable corporations or established SMEs with access to strong personal guarantees, assets, or high-value accounts receivable. CHARACTERISTICS OF AN EXPORT WORKING CAPITAL FACILITY Applicability Used to purchase raw materials, supplies, and equipment to fulfill a large export sales order or many small export sales orders Risk Significant risk of non-payment for exporter unless proper risk mitigation measures are used Pros Allows fulfillment of export sales orders Allows exporter to offer open account terms or sell on consignment to remain competitive Cons Generally available only to SMEs with access to strong personal guarantees, assets, or high-value receivables Additional costs associated with risk mitigation measures A government guarantee may be needed to obtain a facility that can meet your export needs. Exporters may need to employ risk mitigation measures to offer open account or consignment terms confidently in the global market.
20 Where and How to Obtain an Export Working Capital Facility Many commercial banks and lenders offer facilities for export activities. To qualify, exporters generally need: (a) to be in business profitably for at least 12 months (not necessarily exporting), (b) to demonstrate a need for transaction-based financing, and (c) to provide documents to demonstrate that a viable transaction exists. Note that personal guarantees, collateral assets, or high-value accounts receivable are generally required for SMEs to obtain commercial EWC facilities. The lender may place a lien on the exporter s assets, such as inventory and accounts receivable, to ensure repayment of the loan. In addition, all export sale proceeds will usually be collected and applied to the principal and interest by the lender before the balance is passed on to the exporter. Fees and interest rates are usually negotiable between the lender and the exporter. Short-term Loans or Revolving Lines of Credit Basically, there are two types of EWC facilities: transaction-specific short-term loans and revolving lines of credit. Short-term loans, which are appropriate for large and periodic export orders, are typically used if the outflows and inflows of funds are predictable over time. Short-term loans can be arranged for 3, 6, 9, or 12 months, and the interest rates are usually fixed over the requested tenors. Revolving lines of credit, however, are appropriate for a series of small export orders because they are designed to cover temporary funding needs that cannot always be anticipated. Revolving lines of credit have a very flexible structure so that exporters can draw funds against their current account at any time and up to a specified limit. Why a Government Guarantee May Be Needed The U.S. Small Business Administration and the U.S. Export-Import Bank offer programs that guarantee EWC facilities on behalf of U.S. exporters to commercial lenders which make the actual loans. These programs allow U.S. exporters to obtain needed credit facilities from participating lenders when commercial financing is otherwise not available or when their borrowing capacity needs to be increased. Advance rates offered by commercial banks on export inventory and foreign accounts receivables are not always sufficient to meet the needs of exporters. In addition, some lenders do not lend to exporters without a government guarantee due to repayment risks associated with export sales. More detailed information is provided in Chapter 8. Why Risk Mitigation May Be Needed While EWC financing certainly makes it possible for exporters to offer open account terms or sell on consignment in today s highly competitive global markets, the use of such financing itself does not necessarily eliminate the risk of non-payment by foreign customers. Some forms of risk mitigation may be needed in order to offer open account or consignment terms more confidently and to obtain EWC financing. For example, a lender may require an exporter to obtain export credit insurance on its foreign receivables as a condition of providing working capital and financing for exports. 16 U.S. Department of Commerce International Trade Administration
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