The Role of Trade Finance in Working Capitalcounterparty bank. This applies particularly
when exporting to a new market where
the local banks are not well known to the
exporter. One solution is for the exporter to
ask its bank to confirm the letter of credit
issued by the importer’s bank, although
this will be at additional cost. This further
mitigation of risk effectively removes bank
and country risk in the importer’s country.
Finally, even if the terms of the letter of
credit are well negotiated, it may be that
the exporter may not have access to all
the required documentation to meet those
terms. In these circumstances it is usually
possible to work through the two banks to
seek resolution. This is on the basis that both
parties want the transaction to be completed
(the reason they both entered into the
contractual relationship in the first place).
However, if a disputed letter of credit is
pursued through the local courts, then any
discrepancies may make it difficult for the
exporter to receive payment. See page 99
for more details on the use of documentary
credits, including the use of the International
Chamber of Commerce Uniform Customs and
Practice for Documentary Credits (UCP 600).
Payment in advance
Payment in advance is the most secure
term of payment for the exporter, and the
least secure method for the importer. Under
payment in advance the exporter will only
ship the goods after it has received the funds.
In many cases an exporter is able to request
part-payment in advance, perhaps on the
signing of the contract.
Risks and advantages for buyers/importers
This is the riskiest term of payment for
an importer. In effect, the importer risks
making payment to the exporter but
receiving nothing in return. In this event
recourse is usually via the legal system
in the exporter’s home country, although
this will not protect the importer against
insolvency of the exporter. To pursue such
a claim it will be important for the importer
to ensure an appropriate contract is in place
before payment is sent, as otherwise it will
be difficult to prove a claim. It may also be
difficult to seek redress in the event that the
goods are damaged in transit. To protect
against this, the importer should ensure that
adequate insurance is in place.
There are cash flow disadvantages
for the importer with this term of payment
too, as the importer would be financing
the exporter for a period of days or even
weeks, depending on the nature of the
transaction and the shipping time. However,
for a cash-rich company, extending credit to
its suppliers may be an appropriate way to
utilise surplus cash effectively and negotiate
preferential buying arrangements.Risks and advantages for sellers/exporters
From the perspective of the exporter,
payment in advance offers the greatest level
of security. Risks are low for the exporter, as
the funds will already have been received
before the goods are shipped.
From a cash flow perspective, the exporter
benefits, as the importer is effectively funding
the exporter’s working capital.Companies don’t work in isolation
The assumption behind the payment
risk ladder is that both participants view
themselves in isolation. In reality, both the
exporter and the importer are reliant on each
other. The exporter needs to receive cash from
the importer to recycle back into its business.
The importer wants a streamlined procurement
process to facilitate an efficient production
process or, if the importer is a retailer, to allow
goods to meet customer demand.
As a result, it is not always in a company’s
best interests to require its counterparty to
accept severe payment terms. Making a
supplier wait for payment will mean that it will
need to find alternative sources of funds to
purchase its own inputs. If these funds are
more expensive (likely, if the supplier is a
weaker credit, or if its local funding sources
are limited), this will result in the supplier
being forced to increase its prices in due
course. On the other hand, if the supplier
cannot raise the funds, it may be forced to
reduce production or cease trading, putting
the importer’s physical supply chain at risk.
It works the other way, too. If a supplier
tries to force a customer to pay earlier,
this will put pressure on the customer’s