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International Trade Finance

Need for Finance | Methods Of Trading | Other Short Term Finance Schemes | Other Forms Of Financing

International business is no different to domestic trading provided due care and diligence is observed. The international trade cycle utilises the same investment funds, overdrafts or working capital to purchase raw materials, which are turned into saleable items, these are in turn sold on. The resultant profit and original funds, purchase more raw material.

However companies trading internationally often rely on and have to give longer credit periods. Importers prefer to pay for the goods when they arrive in their home port and like wise exporters are required to give longer credit. The normal credit period in Europe is between 30 and 60 days, which can have a significant impact on cash flow.

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The Need for Financing

Case Study:

Zinzam Manufacturing Ltd was selling into Australia and was required to give 60 days credit.  Gross profit on the transaction was 40% . The buyers were seeking to purchase £100,000 worth of goods per month.

The Cash flow forecast shows the effect of increased trade into one market expanding business into other markets will have a multiplier affect on the company's working capital requirements which needs to be financed as positive cash flow is often eroded by this increase in business volume. This chapter will explain some of the solutions available to companies who require additional working capital.

Working Capital

Many companies sell on open account terms. 85% of sales in to Europe are funded from working capital. This working capital is often provided by an overdraft facility, therefore, any undue delays of obtaining payment will impact on cash flow and increase the cost of borrowing with your bank.

The company was selling on 60 day terms but an additional 31 days credit has been taken by the buyer.

Zinzam Ltd are funding this extra 31 days at a cost of £9,555 per annum or £27 per day, based upon an interest rate of 9% per annum.

Many companies are not aware of this financing cost, which is often lost in the overall interest charge levied quarterly by their banks.

Exporters should use this formula on their overseas sales, to ensure that profit margins are not being eroded.

Many payments are delayed in reaching the beneficiaries due to the lack of information that exporters provide their buyers. German companies often quote several bank details on their invoices, the bank details include SWIFT address, sorting code and bank account details.

What is the SWIFT address of your bank?

This is an unique address of banks world-wide, who are members of the Society for World-wide Financial Telecommunications (SWIFT). In effect, this is an electronic messaging system for use between member banks which simplifies the transmission of payment instructions.

£120 million is held in the suspense accounts of British banks because overseas remitters have failed to provide sufficient details to allow the British banks to pay funds away.

Exporters should inform their overseas customers of the SWIFT address and telex numbers of your bank. It is also wise to include the banks sorting code and account number to ensure that payments in your favour, find their way into your account in the shortest time possible.

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Methods of Trading

Open Account Trading | Bills For Collection | Export Finance Scheme

Smaller Export Schemes | Larger Export Schemes

Financing against Open Account

Open account trading relies on clean payments being remitted to your account and this is where delays can occur which has a negative impact on cash flow. Various financing schemes are available but documentation is required by any lender to ensure shipments have been actioned against firm orders. The various schemes will be detailed latter in this section.

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Financing against Bills for Collection

The above diagram shows the manner in which Bills for Collection are handled from the time documents are lodged at the sellers bank until payment is received in their bank account.

The diagram shows that the seller does not receive payment for the goods until the buyer pays his bank, i.e., the collecting bank is collecting payment on behalf of the seller through the banking system.

Finance can be arranged on presentation of the documents at the remitting bank (sellers bank). The sellers bank will negotiate (finance) up to 100% of the invoice amount on a "recourse basis", i.e., if the collection is not paid by the buyer the financing bank will debit the sellers account with the amount of the finance plus accrued interest.  This is called Bill for negotiation.

Exporters will be required to arrange a negotiation facility with their bankers before availing themselves of this facility. The bank will mark the advance as a "Contingent liability" which demonstrates that they have a potential claim against their customer should the collection remain unpaid. The full amount of the advance is marked as a contingent liability.

Many exporters maintain credit insurance policies to protect themselves from potential bad debts. The credit insurance policies can be assigned to the lending banks to support any advances made under the bill for negotiation facility.  Many banks will reduce the level of contingent liability if credit insurance policies are assigned.

 

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Export Finance Schemes

There was a preponderance of export finance schemes a few years ago but these have steadily declined over the years.  However, the credit insurers have sought to reestablish this market with schemes designed for the smaller exporters and managed by a third party, enabling banks to provide the finance against approved debts.

One of the reasons for the demise of these schemes, which still has not been resolved, was the competition between branch and international divisions for the lending. 90% of all exports are financed through the exporter's overdraft facility and, therefore, many domestic bankers were reluctant to introduce these schemes to their customers. Furthermore, many exporters felt that these schemes may have been more expensive than the traditional overdrafts.

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Most banks currently in the market offer two main schemes:

Smaller Exporter Scheme

The smaller exporters scheme is designed for exporters whose turnover is below £1 million per annum. Some banks have increased this threshold to £2 million. The scheme provides the exporter with credit insurance, which is provided under the banks own credit insurance policy.

The banks will finance up to 90% of the invoice value to approved buyers. The financing banks will provide the exporter with a total facility and then undertake credit checks on each overseas buyer providing credit limits to each.

Most bank schemes provide "non-recourse" finance relying upon their credit insurance to repay them for any advances that remain unpaid. In the event that the credit insurer refuses any claim made under the policy, the financing bank will debit the customer, therefore, there can be a recourse element attached to the policy.

The remaining 10% of the invoice is paid when the documents have been paid.

These schemes are not restricted to exports transacted on a bill for collection as many banks will finance open account business provided the following documentation is submitted at the time of shipment:

• Copy of the order submitted by the buyer.
• Evidence of shipment or if the shipment is by road evidence of delivery ( if possible).

Copy of invoice submitted to the buyer.

 

These schemes are designed for the smaller exporters with turnovers below £1m.  When the export turnover of companies is above £1m a larger exporter scheme is often recommended.

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Larger Export Schemes

These schemes have been designed for the larger exporters who maintain their own credit insurance policy. This policy is either assigned to the bank or, alternatively, the bank become joint insurers with the exporter, giving the bank the right to step into the exporters place to run the policy should the export default.

Most banks run two types of larger export schemes, which enables either the bank to manage the whole scheme, providing returns to the credit insurer and paying the premiums on behalf of the exporter. Naturally, this type of scheme can be very costly.

Alternatively, the bank may leave the management of the scheme to the exporter, who will continue to deal directly with the credit insurer, paying the premiums etc.  The bank will simply finance all the approved debts up to a pre-set figure.

There is a similarity between the banks' schemes and those of the factoring houses and this is a further reason why the banks' schemes have been reduced in number.

 

 

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Other Short Term Finance Schemes

Factoring | Invoice Discounting | Confidential Invoice Discounting

Factoring

Factoring of overseas debts is increasing, due to the increase in credit insurance premiums, the world-wide recession and the demise of clearing bank export finance schemes.

The factor agrees to buy all the trade debts of a client . The factor undertakes the sales accounting functions of the company, monitoring the sales ledgers, sending out statements of the account and exercising credit control.

The factor becomes the only sales debtor and releases working capital, which is locked up in a company's outstanding invoices. This enables the company to obtain up to 85% of the value of the invoices at the time the export is dispatched, the remaining 15% is released after the invoice has been paid by the buyer.

However, exporters need to consider the type of factoring service they require:

Recourse factoring provides the factor with the right to debit the exporter for any overseas debts, which are unpaid.

Non-recourse factoring provides recourse to the factor in the event that an overseas buyer defaults, i.e. the factor pays. The cost for this type of factoring may be higher and the factor will probably set strict credit limits. Furthermore, it may be prudent to reduce the cost of finance to take out credit insurance on your buyers.

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Invoice Discounting

The factor agrees to purchase the overseas debts of an exporter either on a with or without recourse basis. However with Invoice discounting the exporter instructs the buyer to settle the debt with the factor through the home factors affiliate in the buyers country.

Management of the debtor ledger is the responsibility of the seller and chasing of debts.

 

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Confidential Invoice Discounting

This service provides financing against book debts but without the sales ledger accounting service and, therefore, the exporter's customers are not aware that a factoring service is being used by the exporter.

The cost of factoring is based upon turnover and volume of invoices and can vary from 3/4% to 2½% of the debts purchased plus an interest rate of up to 4% over base rate.

The exporter will trade normally with the buyer and settlement will be made directly to the seller, who will reimburse the factor for the financing that they receive at the time of shipment.

Fees for this service are often more expensive than the standard factoring facility and larger exporters are normally attracted to this type of factoring facility. Many factors seek additional security in the form of credit insurance. The assignment of a credit insurance policy should enable exporters to negotiate finer interest rates and service charges from the factor.

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Other Forms of Financing

Pre-Shipment Finance | Finance Against Letters of Credit | Avalised Bills of Exchange

Pre-shipment Finance

Pre- shipment finance is a much sought after export finance product but seldom available from many main stream banks. Specialist Trade finance banks or trade finance consultants can often structure trade finance solutions with a certain percentage of finance available against confirmed orders.

Case Study

Freckles Manufacturing Ltd was a very successful family run company, with an order book of £10 million. The company designed and manufactured capital machinery which took between 4 to 6 months to complete. Gross profit was 40%.

The Company had a working capital facility of £1m secured by the companies’ assets and was unable to increase its working capital to meet the increased volume of orders.

Most sales were to Blue chip buyers in Europe and against Letters of credit for sales into any other country.

The company required a facility of £2.5m to meet its order book and pay its suppliers on time. The Bank Relationship Consultancy advised the company and structured a pre-shipment facility with a trade finance bank which allowed the company to borrow to meet its growing order book.

The facility was geared to the order book enabling the company to borrow against a large order book which reduced as the order book decreased.

 

Pre-shipment finance facilities need to be carefully structured to minimise risk and to make the finance attractive to banks.

Credit insurance is often required if shipments are made on open account terms and pre-shipment cover is also recommended. Pre- shipment cover protects both the exporter and the bank in the event the order is cancelled mid way through the production period. The insurer will reimburse the exporter or the bank if the policy is assigned the cost of the partly finished project less the re-sale or scrap value of the capital equipment.

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Financing against Letters of Credit

The letter of credit flow chart detailed above shows the movement of both goods and documents. The diagram assumes that payment is made when documents are presented in accordance with the letter of credit at the counters of the advising bank. This is called payment at sight enabling the exporter to receive payment immediately. The reimbursement instructions found in the letter of credit determine the payment procedure.

There are several reimbursement instructions each instructs the advising bank how it must pay the exporter should the documents presented to the bank comply with terms of the letter of credit.

REIMBURSEMENT TERMS

Payment

The advising bank will be authorised to debit the issuing banks account in their books and pay the beneficiary, providing documents are presented in accordance with the terms and conditions of the letter of credit. This enables the exporter to be paid immediately

Negotiation

The negotiation bank, often the advising bank, purchases the bill of exchange, drawn under the letter of credit from the exporter. When the confirming bank negotiates bills of exchange, the negotiation is undertaken "without recourse".

However, if the letter of credit is unconfirmed, the negotiation is "with" recourse, i.e. the negotiating bank will seek to recover the amount of the negotiation from the exporter in the event that the issuing bank fails to reimburse the negotiating bank.

The exporter will be charged interest on the advance from the date the negotiation takes place until the date the negotiating bank is reimbursed by the issuing bank.

Many companies many not have been charged interest because most issuing bank maintain cash deposits with the advising bank, who are instructed to debit the issuing banks account in settlement.

Acceptance

An acceptance of the bill of exchange can be made, either by the advising bank or the issuing bank, depending on the instructions in the letter of credit. Normally, the acceptance is given by the advising bank in the sellers country.

A bill of exchange accepted by a bank can be discounted, i.e. purchased at a fine interest rate, possibly about ½% above current lending rate. This rate demonstrates the high quality of the acceptor.

The discounter buys the bill of exchange " without recourse", the discount rate will depend on the quality of the acceptor.

Exporters with bills of exchange that have been accepted by a first class bank are advised, in the first instance, to offer the bill to the acceptor who should be prepared to purchase the bill a very fine rates.

Deferred Payment

Some letters of credit are issued with a undertaking by the advising bank that payment will be affected at a pre-determined date after presentation of documents. This undertaking does not constitute a bill of exchange and in theory, cannot be discounted. However, the bank who issued the undertaking, will often provide finance, charging interest from the date of the advance to the date cleared funds are received.

Collection

Many letters of credit, particularly those credits issued by banks in China, will only effect payment against documents, when these are received at the counters of the issuing bank.

Exporters need to consider this reimbursement instruction carefully because they will lose control of their documents and rely upon the integrity of the issuing bank, to effect prompt reimbursement.

The normal delay in receiving payment from overseas is about 21 to 28 days after release of the documents. This delay needs to be built into your cash flow.

Exporters can seldom obtain payment under these letters of credit and wait until payment is received by the bank who remitted the documents. A waiting period of over 21 days has been known.

This delay can have a significant impact on cash flow. The documents relating to the transaction will be in the buyers country and control over the documents and goods will be lost.

Some banks who have developed an expedited collection system and guarantee payment under letters of credit within 10 days, this system aids exporters in speeding the processing of documents presented under these type of letters of credit.

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Avalised Bills of Exchange

Letters of credit are used to provide payment security to sellers, however, increasing use is now made of avalised bills of exchange.

• Avalised bills are bills of exchange drawn on the buyer with payment guaranteed by the buyers bank. Therefore in the event that the buyer defaults the avalising bank will make payment.
• Avalised bills will allow sellers to agree longer credit terms with payments made annually or semi-annually. The bills once avalised can be discounted in the market.
• Avalised bills transfer the non-payment risk from the buyer to the avalising bank allowing the seller to obtain finer discounting rates if the avaliser is a recognised bank.

If the avalising bank is located in the developing markets some Western banks may counter guarantee payment although this will significantly increasing the financing costs.

Forfait

The forfait market has developed considerably over the last 20 years and is subject to constant change with bank forfaiting teams moving to competitors. The forfait market is very specialised and a secondary market exists to allow banks to buy and sell bank guaranteed bills.

Exporters will sell the avalised bill to a recognised bank which will purchase the bill at an agreed rate. The bank who purchased this debt may not wish to hold the risks of the avalising bank or country risk and will sell this bill to another bank, this paper may be retained for weeks and then sold to another bank who will possibly hold the paper until its maturity.

Alternative forfait pricing:

The cost of selling avalised bills into the secondary market can increase the export financing costs and reduced the contracts profitability. An independent company based in London called The Bank Relationship Consultancy assists exporters to minimise the cost of financing exports by obtaining reduced confirmation fees and discount rates for avalised bills by placing letters of credit and avalised bills with banks providing the lowest confirmation fees and discounting rates.

A recent example: A company was selling capital equipment to a Turkish buyer,with repayments over 3 years. The seller was in competition with Italian and German competitors, who were quoting cheaper financing costs. The U.K. buyer obtained the following quotations:

Forfaiting company who wished to sell the bills into the secondary market. 18% per annum

Direct placement of the avalised bills 12 % per annum.

This direct placement of avalised bills to prime buyer reduced the financing costs by 6% per annum and made to UK exporter more competitive.

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