Financial Issues In International Trade

FINANCIAL ISSUES IN INTERNATIONAL TRADE

When begin by considering the problems associated with financing international trade. In any business transaction, the buyer and the seller must negotiate and reach agreement on such basic issues as price, quantity, and delivery date. However, when the transaction involves a buyer and a seller form two countries, several other issues arise:

1)      Which currency to use for the transaction

2)      When and how to check credit

3)      Which form of payment to use

4)      How to arrange financing

Choice of currency

One problem unique to international business is choosing the currency to use to settle a transaction. Exporters and importers usually have clear and confliction preferences as to which currency to use. The exporters typically prefer payment in its home currency so it can know the exact amount it will receive form the importer. The importer generally prefers to pay in its home currency so it can know the exact amount it must pay the exporter. Sometimes an exporter and an importer may elect to use a third currency. For example, if both parties are based in countries with relatively weak or volatile local currencies, they may prefer to deal in a more stable currency such as the Japanese yen or U.S. dollar. By some estimates, more than 70 percent of the exports of less developed countries and 85 percent of the exports of Latin American countries are invoiced using the U.S. dollar, while the exports of many of the new entrants into the European Union favor the euro.

Credit Checking

Another critical financial issue in international trade concerns the reliability and trustworthiness of the buyer. If an importer is a financially healthy and reliable company and one with whom an exporter has had previous satisfactory business relations, the exporter may choose to simplify the payment process by extending credit to the importer. However, if the importer is financially troubled or known to be a poor credit risk, the exporter may demand a form of payment that reduces its risk.  In commercial transactions it is wise to check customer’s credit ratings. For most domestic business transactions firms have simple and inexpensive mechanisms for doing this. In North America, for instance, firms may ask for credit reference or contact established sources of credit information such as Dun & Bradstreet or Moody’s.  Similar sources are available in other countries; however, many first-time exporters are unaware of the. Fortunately, an exporter’s domestic banker often can obtain credit information on foreign customer through the bank’s foreign banking operations or through its correspondent bank in a customer’s country. Most national government agencies in charge of export promotion also offer credit-checking services.

Method of Payment

1)      Payment in Advance

-          Payment in advance is the safest method of payment from the exporter’s perspective. The exporter receives the importer’s money prior to shipping the goods. But, from the importer’s perspective, payment in advance is very undesirable. The importer must give up the use of its cash prior to its receipt of the goods and bears the risk that the exporter will fail to deliver the goods in accordance with the sales contract.

2)      Open Account

-          From the importer’s perspective the safest form of payment is the open account, whereby goods are shipped by the exporter and received by the importer prior to payment. But, from the exporter’s perspective, an open account may be undesirable for several reasons.

3)      Documentary Collection

-          To get around the cash flow and risk problems caused by the use of payment in advance and open accounts, international businesses and banks have developed several other methods to finance transactions. One is documentary collection, whereby commercial banks serve as agents to facilitate the payment process. There are two major forms of drafts: a sight draft & a time draft

4)      Letter of Credit

-          To avoid such difficulties, exporters often request payment using a letter of credit, a document that is issued by a bank and contains its promise to pay the exporter on receiving proof that the exporter has fulfilled all requirements specified in the document. Depending on the product involved, the importer’s bank may demand additional documentation before funding the letter, such as the following:

a)      Export licenses

b)      Certificates of product origin

c)       Inspection certificates

5)      Credit card

-          For small international transactions, particularly those between international merchants and foreign retail customers, credit cards such as American Express, VISA, and MasterCard may be used. A firm may tap into the well-established credit card network to facilitate international transactions, subject to the normal limitations of these cards. The credit card companies collect transaction fees form the merchant and in return assume the costs of collecting the funds form the customer and any risks of nonpayment. The companies typically charge an additional 1 to 3 percent for converting currencies. However, the offer exporters and importers none of the help banks do in dealing with the paperwork and documentation requirements of international trade.

6)      Countertrade

-          This method occurs when a firm accepts something other than money as payment for its goods or services. Forms of countertrade include barter, counter purchase, buy-back, and offset purchase.

Financing trade

Financing terms are often important in closing an international sale. In most industries standard financing arrangements exist, and an international firm must be ready to offer those terms to tis foreign customers. Depending on the product, industry practice may be to offer the buyer 30 to 180 days to pay after receipt of an invoice. For the sale of complex products such as commercial aircraft, which will be delivered several years in the future, the payment terms may be much more complicated. They may include down payments, penalty payments for cancellation or late delivery, inflation clauses, and concessionary interest rates for long-term financing.