When engaging in international trade, you have a wide variety of payment terms at your disposal. However, you may have noticed a discrepancy between the methods your sales teams prefer and those preferred by your finance teams. That’s because each approach comes with associated risks and benefits that impact your sales and finance functions differently.
The key is finding the payment terms that benefit your organization as a whole and instituting protocols that will enable your sales teams to meet their goals while protecting the company’s interests.
Determining the payment terms you’ll use when exporting globally depends on your goals and how much exposure you are willing to assume.
Sixty-six percent of small- and mid-sized businesses require cash in advance of shipment on international sales. These terms are obviously beneficial for the exporter as they ensure payment is received up front, making them a preference for finance teams.
Sales teams, however, may find advance terms to be unfavorable as all risk shifts to the buyer. Cash in advance terms are also less popular in other countries, meaning your sales teams could be facing stiffer competition when selling goods overseas.
At the other end of the spectrum, open accounts require U.S. exporters to ship goods before payment is received. Your sales teams will find it easier to sell their goods in an open account environment, as these terms shift associated risks from the buyer to your company. Open account terms are also quite common abroad, so offering them puts your organization on more equal footing with foreign competition, making it easier for sales teams to find willing buyers.
Open account risks run a gamut of possibilities that could negatively impact your business. First and foremost is how you will track down and receive payment from non-paying entities in a foreign country if the buyer doesn’t honor its payment commitment. Open account terms could also negatively impact your cash flow. In most cases, payments from foreign buyers are made 30, 60 or 90 days after goods are received. Add in the time it takes to prepare an order and ship the items, and you’re looking at extending credit for several months without sight of payment.
While businesses may feel secure in offering open account terms to known buyers, and repeat customers, the integrity of the buyer is not all you’ll need to consider when it comes to receiving payment. Market factors, such as the current trade negotiations with China, could have a negative impact on your buyer’s ability to pay.
According to The New York Times, China delayed imports during trade talks last summer through elaborate customs inspections and quarantines of apples, oranges and cherries, resulting in delayed payments for U.S. farmers. Sellers in Canada faced harsher consequences in 2018 as China took similar actions when the country blocked shipments of pork, claiming labeling issues.
Fortunately, there are more moderate solutions available that make it easier for both sales and finance teams to engage in global trade without unduly risking the company’s profitability.
Eighty-two percent of small business owners agree that increasing trade will result in improved economic conditions for the countries involved, according to a FedEx survey conducted by Morning Consult. More than half believe that trade expansion will benefit their own company.
However, to realize the advantages of trade, U.S. exporters need to receive payments for the goods they send overseas. To provide more security during international transactions, several financial instruments have emerged to mitigate risk for both buyers and sellers.
When selling on open account, insuring receivables allows exporters to protect the company against both non-payment by the buyer as well as political risk by purchasing an insurance policy to cover the transaction. Coverage can be obtained on a case-by-case basis or to cover a broader series of sales, including some domestic.
Receivables insurance is available through private insurance carriers, as well as the Export-Import Bank of the United States (EXIM). In the event that payment is not received, the insurance policy kicks in, protecting you from contingencies such as bankruptcy, insolvency or default by the foreign buyer.
Of course, insurance is not the only way that U.S. exporters can protect their business. There are multiple types of payment terms that vary in degree of risk that make it possible to conduct transactions internationally.
If you want reasonable assurance of receiving payment and need cash up front in order to buy supplies for manufacturing or to hire labor to complete the order, factoring could provide you with pre-sale funds while still offering open account terms to your buyer.
With factoring, you receive an advance equaling the value of your accounts receivable, minus a discount, from a factor. Your business gains the cash necessary to fulfill the order, plus a profit. The factor then collects on the total value of the sale from the seller when payment comes due, making money in the process.
Documentary collections provide another method of payment that acts as middle ground between the sales team and finance team.
With documentary collections, the exporter works with a bank to collect payment from the buyer’s financial institution once the product has been received on foreign shores. To ensure that payment is made, the seller’s bank holds certain documents necessary to facilitate the transaction, such as the bill of lading and commercial invoice, until the terms of the agreement have been met.
Letters of credit (LOC) provide another payment instrument, allowing exporters to raise the guarantee of payment while also protecting the buyer’s interests as well as their own. This is accomplished by substituting the creditworthiness of the buyer for that of the issuing bank, as long as the terms and conditions of the LOC are met.
With an unconfirmed LOC, a buyer contracts with a foreign bank to facilitate payment once a set of conditions have been met, such as the on-time receipt of goods. This type of agreement makes it possible for exporters to offer open account terms while mitigating many of the associated risks with the buyer. In the case of forfeiture, the bank pays the seller and issues a loan to the buyer for the cost of the payment.
Exporters may also choose to improve the security of a LOC by having their LOC confirmed.. A confirmed LOC requires the buyer to provide a guarantee from a second bank, typically in the exporter’s country. In the event that the first bank is unable to honor its agreement to pay, the second bank is then responsible to pay the seller. A confirmed LOC is especially helpful when initiating trade with foreign buyers where the political or economic environment is uncertain as it improves the odds of a receiving payment should the first bank fail.
When it comes to selecting the option that’s best for your business, take stock of your needs and your risk tolerance. While demanding cash in advance provides the most security for your company, it could limit your ability to compete in a global market. When that is the case, your financial institution can help you find a solution using one of the payment instruments available.
About the Author
Matt has been in commercial banking since 2006. His experience in the Global Banking Group and Commercial Credit Analysis has given him a wide depth of knowledge in assisting clients reach their financial goals. As a member of the Global Banking team, Matt has an extensive knowledge of the foreign exchange markets, international payment options, international trade products and letters of credit.