International Payment Risk: What Are the Best Ways to Ensure That an Importer in a Territory New to Your Firm Will Honour Its Debts? Anthony Boczko Explores the Alternative Methods

By Boczko, Anthony | Financial Management (UK), March 2005 | Go to article overview

International Payment Risk: What Are the Best Ways to Ensure That an Importer in a Territory New to Your Firm Will Honour Its Debts? Anthony Boczko Explores the Alternative Methods


Boczko, Anthony, Financial Management (UK)


Imagine the scene: you're a newly appointed finance manager at a UK manufacturing plc. Product quality is high, but profits are down. Its market share in the UK is at an all-time low and a recent decline in stock price has led to speculation about its future. But all is not lost: although it has little experience of trading outside western Europe, internal marketing reports suggest that the company is well placed to win a number of big contracts in Africa, Asia, South America and eastern Europe.

This scenario is all too familiar for finance managers in many UK firms struggling to find a foothold in an unpredictable global market, where the search for profits, market share and shareholder value is rarely risk free.

The sources of risk in international trade can be divided into four categories:

* Country risk (see Technical matters, February), which relates to the acts of a nation's government.

* Credit/commercial risk, which relates to the possibility that the buyer will default on payment.

* Foreign exchange risk, which relates to movements in currency markets. This is often grouped with credit risk.

* Property risk, which relates to the possibility of loss or damage to goods in transit.

Country risk influences levels of risk in the other three categories and so affects the number of payment strategies you can use to limit your firm's credit risk. Although a range of methods exist (see panel, opposite page), their selection and use--while partly dependent on negotiation between the trading partners--is influenced largely by the levels of regulatory control and socio-economic uncertainty in the destination country. Such factors range from restrictions on the transferability of funds to currency devaluations as a result of a nationwide economic slowdown.

A firm seeking to establish a global presence must clearly exercise caution and use appropriate payment strategies, especially when trading with companies in high-risk destination countries. For example, the use of payment in advance would ensure that funds are cleared before the goods are exported and so minimise the risk of financial loss.

There may be instances where firms adopt payment strategies in higher-risk countries that are normally used only in low-risk countries, but such cases are rare. Even so, it's important to recognise that generalisations about countries can be dangerous. Even in well developed and politically stable nations, payment strategies may need to vary according to factors such as market sector differences, volume differences and certainly in larger countries such as China regional cultural variations as expressed in the form of local bureaucratic structures.

So which payment methods are typically used in which countries? Let's take a brief and highly selective tour.

Africa

In Kenya all the common forms of arranging payment are used. In South Africa most established importers use documentary collections varying from 60 to 120 days alter acceptance, but they also use confirmed irrevocable letters of credit. In Zimbabwe some payments are made on an open account, but it's becoming more usual to use bills of exchange and confirmed irrevocable letters of credit, as is the case in many other African countries.

Asia

In Hong Kong and Singapore most of the customary payment methods are used, while in Taiwan the general practice is to insist on confirmed irrevocable letters of credit, with more favourable terms available only after a number of successful transactions. The usual method in China is also confirmed irrevocable letter of credit against presentation of shipping documents. In Malaysia, India and Pakistan payment against an invoice is usual.

South America

In Argentina confirmed irrevocable letters of credit are the norm, although they have become hard to obtain as a result of the country's financial crisis. …

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