Export sales bring several types of risk such as trade risk, production risk, exchange rate risk, country risk and judiciary risk.
Trade risk is the probability not to get paid because the buyer fails to comply.
Here I will address how to control and limit it.
First of all we have to recognize that every step of the selling process must be considered under this perspective: from customer selection to negotiation of delivery terms, payment terms and possible credit insurance.
Customer Evaluation: Credit Limit – It is impossible to make profit dealing with unreliable clients.
Therefore before any transaction we need to collect information regarding the credit standing of the counterpart. The 5 Cs of credit are useful guidelines: character, capacity, capital, collateral, conditions.
How formal and in depth will be the analysis depends on the magnitude of the transaction.
An useful and sinthetic source of information is the quotation of the credit premium insurance.
The final result of this exercise is the definition of a credit limit
Delivery Terms – If we use a documentary payment – Documents against Payment or Documents against Acceptance – or Cash against Documents, for the exporter it is safer to negotiate delivery terms implying he pays the freight costs: this increases the control on the freight company, which is in charge to deliver the goods after the payment has been secured.
Payment Terms – In order of increasing risk for the exporter and decreasing for the importer:
1. Advance Payment.
The importer pays at order, usually with bank draft or bank money transfer. It is the safest for the exporter, but it result in a constraint to his growth potential.
2. Documentary Credit : Letter of Credit (L/C).
On importer’s request, a bank (issuing or confirming) guarantees the exporter the payment of the purchased goods upon handing in the documents listed in the L/C.
In principle the bank guarantee is attractive for the exporter; in practice the utmost formalism of bank control over documents handed in is demanding and requires specialized staff. The Discrepancies raised by the bank cause the suspension of the guarantees and the payment is finalized if the client fulfill his commitment.
3. Documentary Payment: Documents against Payment (D/P) or Documents against Acceptance (D/A).
In this case the bank doesn’t guarantee the payment, but releases the documents to the client once he has paid or has signed the Acceptance to pay at a future date.
4. Cash on Delivery (COD).
In this case the carrier releases goods and documents in exchange of the payment (cash, checks or other titles) or the bank receipt of the money transfer.
It is in the best interest of the exporter to pay the freight costs to have direct control over the carrier.
5. Direct Remittance or Open Account
The exporter delivers the goods and related documents against the importer’s agreement to pay at due date, counting on his good faith and credit reputation.
6. Consignment Goods
The exporter delivers the goods with the agreement to be paid when the importer sell them.
In this case the there is neither a formal guarantee nor a due date for the payment.
Insurance of the credit – An alternative to Advance Payment and to Letter of Credit is the insurance of the trade credit. It allows the exporter to agree a deferred payment, covering the risk at a reasonable cost. In particular for SMEs this option compared with the L/C has the advantage not to require specialised staff to avoid the Discrepancies, often raised by the banks in a very formalistic perspective that twarth their guarantees.
The cost of the insurance is affordable. For instance SACE BT insures the credit towards a client located in Turkey and with a deferred payment up to 6 months with a policy of 1,5% on the invoices value. In case the client doesn’t pay the insurance covers 80% of the amount.
In addition the insured credit can be easily discounted to banks and therefore transformed in liquidity.
Other companies offering export credit insurance are Coface, Euler Hermes, OeKB.
It is always necessary to scrutinise, with patience and persistence, timing and costs of claim settlement. For these matters the reps of the insurance companies tend to refer you to policy clauses, which are rarely clear at first glance. I usually ask for foolproof explanations with numerical examples.
Research Material
Confindustria di Bergamo: Il credito documentario e la sua gestione operativa (di A. Di Maio) [IT]
Camera di Commercio di Lodi: I pagamenti internazionali in un’ottica legale e contrattuale [IT]
US Department of Trade: Trade Finance Guide [EN]
B2B Bank : The 5 Cs of Credit Analysis [EN]