The Role of Trade Finance in Working CapitalUnder open account trading, an exporter
will ship goods to the importer and, at the
same time, send a request for payment by
the date agreed in the contract. The agreed
time might be immediately, or within 30
days or 90 days, the timing usually being
determined by standard practice either in the
industry or in the importer’s home country.
The exporter often has to accept payment
according to the normal payment terms in
the importer’s home country, especially if no
specific agreement has been reached.
In most markets, the buyer will have a
choice of suppliers. This gives the buyer
the ability to demand a credit period prior
to payment. In these circumstances, any
supplier wanting payment on delivery would
be at a competitive disadvantage to those
prepared to offer credit.
Risks and advantages for buyers/importers
A central benefit for the importer is that they
control the timing of the payment for the
goods. Although the importer should pay
within the agreed term, the importer will have
some flexibility in chosing the precise date of
payment. This suits companies with weekly,
fortnightly or even monthly disbursement
cycles for non-urgent payments.
Where the importer pays on open
account it is likely that the importer will have
at least some use of the goods before having
to pay. From a working capital management
perspective, this effectively means the
exporter is funding the importer. In this
context the importer will need to consider
whether this is appropriate, a decision
which will depend on the creditworthiness
of the exporter and the importance of the
exporter as a supplier to the importer. When
negotiating terms, the importer will want
to consider both its own interests and the
financial strength of the exporter. If the
exporter’s cash flow is under pressure, it
may be prudent for the importer to reduce
the payment term, or use another trade
finance technique, to accelerate cash flow to
the exporter.
Risks and advantages for sellers/exporters
Under open account trading the exporter
has to accept the risk that the importer
may not pay. In the event of a counterparty
failure the importer will have control of the
goods, making it difficult for the exporter to
obtain cash.
Open account trading is most commonly
used when exporting to customers located
in jurisdictions where the exporter has
confidence in the legal system, as for
instance between parties located in both
the Western European and North American
markets. Confidence in the legal system is
important in the event that the exporter has to
seek adjudication in a dispute.
In some cases exporters may be forced
either by accepted market practice or the
threat of competition to trade on open
account terms.
On the positive side, where there is a
clear record of the importer paying promptly,
the exporter may be able to arrange working
capital finance on presentation of the
invoices, whether via an invoice discounter or
a supply chain financing structure. For more
on these techniques, see page 117.
More generally, open account trading does
not rely on documentation to the same extent
as documentary collections or documentary
credits. As a result, it remains a relatively
cheap way for both parties to transact.Documentary collection
A documentary collection offers more security
to the exporter than trading on open account.
Under a documentary collection both
parties use their banks as intermediaries to
the transaction. Although the exporter will still
ship the goods before receiving payment,
this will be to an agent or shipping line in
the importer’s country. At the same time,
the exporter will send a collection order to
its bank that will include the appropriate
transport document as well as details of the
terms and conditions of the transaction.
The exporter’s bank (known as the
remitting bank) will then forward the collection
order to its correspondent bank in the
importer’s country (known as the collecting
bank), which will collect payment from
the importer (or the importer’s bank). The
collecting bank will not release the shipping
documents until receipt of payment or
acceptance of payment.