Financial Arrangement & Payment

All sellers want to get paid as quickly as possible, while buyers usually prefer to delay payment, at least until they have received and resold the goods. This is true in domestic as well as international markets.

Increasing globalization has created intense competition for export markets. Importers and exporters are looking for any competitive advantage that would help them to increase their sales. Flexible payment terms has become a fundamental part of any sales package.

Selling on open account, which may be best from a marketing and sales standpoint, places all of the risk with the seller. In essence, the seller ships and turns over title of the product on a promise to pay from the buyer.

Cash-in-advance terms place all of the risk with the buyer as they send payment on a promise that the product will be shipped on time and it will work as advertised. Cash-in-advance often places the seller at a competitive disadvantage. Today, open account terms with extended dating are becoming more common despite the dangers.

Trade finance provides alternative solutions that balance risk and payment. In this overview, we'll outline the two broad categories of trade finance:

- Pre-shipment financing to produce or purchase the material and labor necessary to fulfill the sales order; or

- Post-shipment financing in order to generate immediate cash while offering payment terms to buyers.

General Considerations
The following factors and considerations apply to financing in general.

Financing can 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 or to finance other aspects of a sale, such as promotion and selling costs, 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.

Financing Costs
The costs of borrowing, including interest rates, insurance and fees will vary. The total cost and its effect on the price of the product and profit from the transaction should be well understood before a pro forma invoice is submitted to the buyer.

Financing Terms
Costs increase with the length of terms. Different methods of financing are available for short, medium, and long terms. Exporters need to be fully aware of financing limitations so that they secure the right solution with the most favorable terms for seller and buyer.

Risk Management
The greater the risks associated with the transaction, the greater the cost. The creditworthiness of the buyer directly affects the probability of payment to an exporter, but it is not the only factor of concern to a potential lender. The political and economic stability of the buyer's country are taken into consideration.

Lenders are generally concerned with two questions:
- Can the exporter perform? They want to know that the exporter can produce and ship the product on time, and that the product will be accepted by the buyer.
- Can the buyer pay? They want to know that the buyer is reliable with a good credit history. They will evaluate any commercial or political risk.

If a lender is uncertain about the exporter's ability to perform, or if additional credit capacity is needed, government guarantee programs are available that may enable the lender to provide additional financing.

Export Intermediaries
Many times, small business owners may not have the time or resources to pursue international sales. If there is a demand for the company's product, use of export intermediaries may prove beneficial.

Export Trading Companies (ETCs) and Export Management Companies (EMCs) can help with international sales and marketing efforts. IN some instances, EMCs 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. This eliminates any risks associated with the export transaction as well as the need for financing.

Types of Trade Finance
Trade Finance, Working Capital Loans and Foreign Buyer Financing
Trade finance generally refers to the financing of individual transactions or a series of revolving transactions. In addition, trade finance loans are often self-liquidating—that is, the lending bank stipulates that all sales proceeds are to be collected, and then applied to payoff the loan. The remainder is credited to the exporter's account.

The self-liquidating feature of trade finance is critical to many small, undercapitalized businesses. Lenders who may otherwise have reached their lending limits for such businesses may nevertheless finance individual export sales, if the lenders are assured that the loan proceeds will be used solely for pre-export production; and any export sale proceeds will first be collected by them before the balance is passed on to the exporter.

Given the extent of control lenders can exercise over such transactions and the existence of guaranteed payment mechanisms unique to or established for international trade, trade finance can be less risky for lenders than general working capital loans.

Working Capital Loans
For exporters, working capital loan programs are normally associated with pre-shipment financing. Many small businesses need pre-export financing to cover the operating costs related to a sales order or contract. Loan proceeds are commonly used to finance three different areas:

- Labor: The people needed to build or buy the export product.
- Materials: The raw materials needed to produce the export product.
- Inventory: The costs associated with buying the export product.

Term Financing for Foreign Buyers
Frequently, foreign buyers don't have the cash on hand to pay for major purchases. So the buyers ask for extended credit terms and/or financing. Few exporters can manage the cash flow dilemma or commercial and political risks caused by these long-term contracts.

Buyer Credit Programs are often an effective solution that benefits the exporter, their buyer and commercial lenders providing the loans. Programs typically provide loan guarantees to commercial lenders. These kind of programs benefit all the parties involved. The exporter benefits because they’re paid cash on delivery and acceptance of the product or service. The foreign buyer benefits because they get extended credit terms at markets rates or better. And the lender benefits because guarantees, many backed by the U.S. Government, mean full repayment of the loan and a reasonable return on funds loaned.

Trade Finance Products
Factoring
Once a product has been shipped, that inventory is converted to an Account Receivable (A/R). A list of all Accounts Receivable are maintained on an aging report while the exporter waits for final payment. If there is a need for immediate cash, it's possible to sell the A/R at a discount. This solution is called Factoring.

Factoring is the discounting of foreign accounts receivable that do not involve drafts as the method of payment. A Factor (an organization that specializes in the financing of accounts receivable) takes title for immediate cash at a discount from the face value. Although factoring is often done without recourse to the exporter, verify these specific arrangements.

Factors typically provide 70% of the face value with 3-5 working days, and assume responsibility for collection from the buyer. After final payment, the Factor will pay the remaining 30% - less a service fee of 4% - 5%.

Forfaiting
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 are active in the U.S. market. Because forfaiting may be done either with or without recourse, verify all of the specific the specific arrangements.

Purchase Order Financing
A Purchase Order (P.O.) is a legal agreement signed by a buyer requesting a seller to provide goods or services. Purchase Orders normally list the amount of goods or services required and the terms and conditions of delivery and payment.

Major domestic buyers will normally issue a P.O. with Net 30 to 60 day terms. Overseas suppliers will usually ask for OD or sight draft Letter of Credit terms. For an importer, this difference in terms of sale means that there won’t be any cash coming in during the manufacturing process or the transit period. Unless a bank or factor will finance the A/R period, the importer is out of cash until the invoices are finally paid off.

Purchase Order Financing can be an alternative solution to this cash flow dilemma. P.O. Financing is a short-term funding technique used to finance the purchase or manufacture of goods that have been presold to a creditworthy customer. Lenders that offer this specialized form of financing will assist in the purchase of product inventory by using the inventory and confirmed purchase orders as collateral.

Importers, Exporters, Distributors or Manufacturers can use Purchase Order Financing. Funds are used for issuing Letters of Credit, payment to suppliers for finished goods, raw materials or direct labor. Purchase Order Funding is a risky form of financing and therefore costs more than traditional financing. It requires extensive due diligence, and lenders are highly selective. If you can meet the prerequisites there are some excellent P.O. lenders available to offer you a financial solution.