Financing international trade is a complex process, involving many variables, ranging from corporate policy and marketing strategy to exchange risk and general borrowing conditions. The reason behind the complexity of financing international trade is that trade involves two countries with different currencies and jurisdictions. In addition, payments must be made at a distance and across time, so the exporter, the importer, or both need credit during part or all of the period form the initial manufacture of goods by the exporting firm to the time of the final sale and collection by the importer. The main objective of a good corporate export financing policy should be financing the greatest possible amount of sales with the greatest possible management simplicity and with minimal risk.
Following are among the important considerations in the choice of a strategy for trade financing:
- The nature of good in question. Capital goods usually require medium to long-term financing while consumer goods, perishable products, etc. require short term finance.
- A buyers’ market favors the importer and the exporter may have to offer longer credit terms, bear the currency risk and possibly some credit risk. A sellers’ market on the other hand, favors the exporter.
- The nature of the relationship between the exporter and the importer. For example, if both are members of the same corporate family (affiliated to the same MNC) or have had a long standing relation with each other, the exporter may agree to sell on open account credit while absence of confidence may require a letter of credit.
- The availability of various forms of financing, government regulations pertaining to the sale transaction, etc.
The crucial question is who will bear the credit risk? When an exporter sells on open account or consignment basis, the exporter bears the entire credit risk. On the other hand, in cases when the importer makes advance payment at the time of placing the order, he bears the credit risk. Most often, given the complexities in cross-border transactions and the absence of detailed knowledge regarding the financial status of the two parties, credit risk will be shifted to an intermediary who specializes in evaluating and undertaking such risks. This may be a government institution such as an EXIM bank or commercial banks, factors or others.
The nature of the relationship between the exporter and is critical for understanding the methods of import-export financing utilized. There will be usually three categories of relationships in an international trade:
- Unaffiliated unknown: Where a foreign importer with which the term has not previously conducted any business.
- Unaffiliated known: Where a foreign importer with which the firm has previously conducted business successfully.
- Affiliated: Where a foreign importer is a subsidiary business unit of the firm (intra-firm trade)
There are three basic elements for an import export transaction:
- Contracts: Where all contracts shall include the definition and specification for the quality, grade, quantity with reference to published prices/catalogs and associated descriptions/blueprints/diagrams and other technical detail aspects or characteristics.
- Prices: Prices should clearly indicate with reference to quantity, discounts, advance payment, extra charges in case of deferred payment, transportation charges, insurance fee, surcharge of any other fee levied by the relative country.
- Documentation: Documentation involves a variety of issues of particular importance from a financial management perspective; including shipping deadline, payment instructions (where various methods of payment are there), packing and marketing, warranties, guarantees and inspections. The methods of payment includes Open Account Credit, Consignment, Forfeiting, Factoring, Guaranteeing, Lines of Credit, Letter of Credit, Documentary Draft, Cross Border Leasing, Cash Down (CBD, COD), Buyers Credit, Suppliers Credit etc.