Magazine article Business Credit

Exporters Can Choose Different Terms of Sale

Magazine article Business Credit

Exporters Can Choose Different Terms of Sale

Article excerpt

About 95 percent of the world's population lives outside of the United States. Because of this, many American companies are exporting their products to reach these potential customers.

As a percent of the gross domestic product (GDP), U.S. merchandise trade exports rose from 5 percent in 1986 to 7 percent in 1991. Entering overseas markets can benefit exporters in many ways, including extended product life cycles; increased sales and profits; tax advantages; and a larger, more diversified customer base.

Export credit management presents a unique set of problems and challenges to the credit manager. Those challenges include:

* "political risk";

* risk related to foreign currency exchange rate fluctuations;

* applicable laws in other countries;

* difficulties in obtaining accurate credit information about international customers;

* interpretation of foreign financial statements which use different accounting methods than in the U.S.;

* and, setting appropriate credit terms.

This article discusses the last of these challenges: negotiating and setting appropriate terms of sale (methods of payment) with export accounts.

Term options include cash in advance, documentary letter of credit, standby letter of credit, sight draft, time draft, and open account.

Cash in Advance Means the Highest Risk to the Importer

Reliable credit information about foreign companies is sometimes difficult and expensive to obtain. Because of the concerns credit managers have about doing business in foreign countries where business practices and laws are different than in the U.S., some require cash in advance payment terms from their foreign customers.

Receiving cash in advance represents the lowest risk to the seller (the exporter). Importers, on the other hand, are often unwilling or unable to pay this way for the following reasons:

* This represents the highest risk to the importer since the buyer has only the seller's word that the product will be shipped as agreed.

* Cash in advance terms offer the importer the least flexibility.

* Cash in advance may adversely impact the importers cash flows since the exporter requires payment even before making the shipment. This, in turn, results in a lower profit margin to the importer based on the time value of money.

* The laws in some nations forbid importers from paying on cash in advance terms. In fact, in some cases, the government specifies to importers the minimum number of days they may accept before payment becomes due.

For all these reasons, requiring cash in advance tends to limit the amount of export business for a company. However, if an exporter decides to require cash in advance, it is probably faster and safer to instruct the customer to wire transfer the money to the exporter's bank, rather than having a check mailed to the company.

Letters of Credit Can Be Restrictive

Credit managers often require foreign customers to provide them with a letter of credit (L/C) covering shipments the exporter makes. An L/C is a contract between the issuing bank and an importer (the buyer) for which the exporter is the beneficiary. The L/C contains a promise by the issuing bank to pay an agreed upon amount at a specified time to the beneficiary if the beneficiary provides to the bank specific documents in compliance with stipulated terms and conditions and within a specific time frame.

L/Cs issued by foreign banks can normally be "advised and confirmed" by a U.S. bank. A confirmation obligates the bank to pay the company if the foreign bank defaults on payment. Requiring a confirmed L/C eliminates most of the political risk of doing business with a bank in a foreign country.

Some credit managers are willing to accept an L/C from a foreign issuing bank without requiring a U.S. bank to confirm it. These credit managers normally require the L/C to be advised through their bank or another U. …

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