Operating on a global scale is much different than running your business domestically. When developing trading partners domestically, determining the creditworthiness of a buyer and their ability to pay is much easier as compared to assessing a foreign entity. Conversely, as an importer of goods, obtaining favorable payment terms from international sellers can be more difficult as compared to partnering with a company that operates in the same country as you.
For international importers and exporters, reaching and maintaining high growth levels will require some type of financing. Besides traditional lending, international factoring companies can provide avenues to improve cash flow, protect against payment default, and improve bottom-line growth.
Depending on your company’s needs, the following are the most common and readily available financing methods:
- Bank financing
- Export factoring
- Supply chain financing
Each approach to financing your operations has its own benefits and limitations. Determining which option is best will depend on the amount of capital you need, for how long, and under which terms. Understanding the different types of financing and the different methods of payment available will help your company choose the right solution for your financing need.
TYPE OF FINANCING
Three popular types of financing businesses use are bank financing, export factoring, and supply chain financing.
When either an importer or exporter begins to consider its financing options, visiting the bank often is thought of first. Banks can provide funding to increase inventory levels as a buyer or rebuild capital reserves after a large shipment for an exporter.
One advantage of bank financing is that the cost is relatively low compared to other financing methods. In addition, revolving credit lines may be made available for qualified trading companies.
However, bank financing does have a few downsides. Most banks require a personal guarantee or use of company properties as collateral. Either puts corporate assets at risk in the event of default. And, in almost all scenarios, a bank loan or line of credit will appear on the balance sheet as debt.
For small to mid-sized exporters, export factoring has become an integral part of successful growth. Unlike traditional methods of financing, export factoring can solve several challenges exporters face when negotiating with a buyer, like the buyer’s request to transact on open account. Although usually more expensive than bank financing, many exporters appreciate the benefits international factoring companies, or factors, provide.
Export factoring involves a factor who purchases a seller’s short-term account receivables at a discount. The factor, after evaluating a buyer’s creditworthiness and ascertaining the likelihood of payment, advances up to 90% of the value of the invoices upon shipping, on day 1, so the exporter doesn’t have to wait 30, 60, or 90 days to get paid. The factor also handles any collection issues. Entering a non-recourse factoring arrangement means that the factor purchases the receivables instead of loaning against them, transferring the risk of payment default entirely to the factor.
Supply Chain Financing
Export factoring solves the cash flow and default risk when shipping product. For importers, manufacturers, and distributors, there can be an entire supply chain suffocating an organization’s access to capital and limiting cash flow.
Supply chain financing can provide the capital necessary to keep a company’s flow of operations moving smoothly. Such financing can optimize the management of working capital and liquidity for a company’s full supply chain, including both its upstream and downstream partners. Using factoring, purchase order funding, inventory lending, letters of credit, structured guarantees, and other structured trade finance techniques, supply chain finance arrangements help align the needs of both buyers and sellers and minimize risk across the supply chain.
One of the benefits is that the importer can extend his payment terms and his suppliers benefit from an on-demand pool of liquidity, lower borrowing costs, faster funding and a higher advance rate.
After you’ve decided on what financing method works best for your company, you must agree on the appropriate payment terms with your trading partner.
More than 80% of global trade is conducted on open account terms, meaning that payment is due by the buyer 30, 60, 90 days or longer after goods are shipped. As an exporter, operating on open account terms internationally, though crucial to stay competitive in the global marketplace, exposes the company to delayed payment and default risk. Both exposures can be difficult to control as information regarding an overseas buyer may be challenging to obtain.
As an importer, open account terms are extremely favorable. What advanced cash payments are to exporters, open accounts are to importers. Open account terms provide zero-interest financing while you, as the buyer, have control of the product until sold.
Letters of Credit
Depending on your trading partner, a letter of credit may be used to guarantee payment. A letter of credit is a promise made by the buyer’s bank that the buyer will pay its seller on time in the right amount for the products it purchased. In the case that a buyer cannot pay its invoices, the bank is then obligated to make payment to the seller. When using letters of credit internationally, local banks usually will confirm a letter of credit presented by a foreign bank.
Obtaining a letter of credit will require the bank to secure a pledge of assets from the exporter to use as collateral. There is also a charge by any banks involved in issuing and confirming a letter of credit, although less than the cost of bank financing. Lastly, not all trading partners will accept a letter of credit or have access to a bank who can verify one.
For exporters, receiving payment up front is by far the most favorable method of generating cash flow for your business. Unfortunately, receiving full payment prior to delivery of your product typically only occurs on small orders. Larger customers will likely request more lenient and flexible payment terms.
As an importer, paying cash up front ties up valuable capital for your organization. Under the right terms, financing your purchase can allow a company to increase their purchasing power. Increased purchasing power equates to faster and more sustained growth. On the other hand, as the buyer, on-time delivery is more likely as the exporter has immediate use of the money.
FINANCING YOUR COMPANY’S GROWTH
Optimizing your organization’s working capital is the key to long-term growth year after year. Selecting the right method of financing as well as the right payment method for your company’s needs will go a long way in determining your company’s success. Whether working with your local bank or building a customized solution with an international factoring company such as Tradewind Finance, financing your international trading can become your competitive advantage.