Repatriate the money from export trade – use the versatile tools in our toolbox
When talking with SMEs that export goods and services, it sometimes turns out that exporters have anything but a clear idea of the various risks and hedging options related to payment transactions and the financing of export trade. Therefore, we made a summary of a few tips for managing the risks in export trade. Do not forget to scroll down for a small challenge that helps to illustrate the solutions offered by Finnvera!
The first step of risk management and the selection of the most suitable financing solution is an evaluation of the overall situation. To assist the evaluation, you can draw a timeline describing the lifecycle of the export trade transaction. This helps in determining the risks involved in each phase of the transaction and the cause of the risks identified.
Risks can be classified into several different categories:
- They can be short- or long-term risks and relate to the period before, during or after delivery.
- When financing foreign trade, commercial risks, i.e. credit risks, and political risks, i.e. country risks, are often mentioned.
- Risks also vary according to the degree of customisation of the exported products.
- Examples of other types of risk include exchange risk caused by the use of different currencies and risk to the profit margin caused by the fluctuating prices of raw materials.
- The legislation of the buyer’s country often involves its own requirements for the product and the sales contract.
- Because some risks are created even before the sales contract is concluded, it is a good idea to perform the risk analysis in time to include potential hedging costs in the sales price.
Once the timeline has been drawn and risks have been identified, the company’s own risk policy needs to be checked. The risk policy helps to determine the company’s risk appetite, limits of tolerance and the decision-making powers. It is a guideline for employees. If your company does not yet have a written risk policy, now is the time to prepare it.
Concrete ways to manage risks include the introduction of client and country limits, the use of standardized sales contract clauses and recommendations for the use of payment methods and hedging instruments.
Only one third of export companies use a hedging mechanism to avoid credit loss.Companies do not think that guarantees are necessary, because the client has a clear payment history or the buyer is a large company. On the other hand, SMEs do not recognise the opportunities to protect their sales receivables. Do not forget that even one credit loss can cause major damage to company finances.
Choose the right product for the right situation – test how well you know export trade!
In this export trade challenge, we identify the link between hedging against risks and the financing needs in export trade. The estimated value of each deal in the examples is below EUR 2 million.
Can you find the right pairs by matching the situations 1–4 with the most appropriate tool A–D? Find the right answers at the end of this article.
1. Export of a production line to China. The line has been highly customised according to the specific needs of the buyer.
If the buyer cancels the deal, it is difficult to sell the product to anybody else. The buyer is a new client. The exporter wants to hedge against the risk that the deal is cancelled and ensure that the sales price is received at the time of delivery.
2. Export of secondary timber products to Russia.
The buyer is an established trading partner of the exporter and purchases products constantly. The buyer has a payment period of 3 months. The exporter’s liquidity is excellent, because it receives a part of the sales price in advance.
3. Export of machinery to a dealer in South America.
The machines are mobile and resellable. Cooperation with the dealer has continued for years. The exporter sells several machines every year, and the annual sales to this dealer amount to between EUR 1 and 2 million. The buyer requires a payment period of five months, but the exporter would like to have the cash in hand immediately after delivery.
4. A single delivery of devices worth EUR 2 million to a hospital in Brazil.
The devices are the core products of the exporter and can be sold to another buyer if the deal is cancelled. The buyer requires a payment period of 3 years. The exporter wishes that the bank would finance the payment period and the exporter would be paid on delivery.
A. With credit insurance, the exporter can insure its sales receivables and ensure that the sales price is paid.
Because it is a simple insurance product, it is suitable for situations where the exporter has enough liquidity to finance the payment period of the buyer. The credit insurance has the most competitive price.
By using credit insurance, the exporter can transfer risks related to the buyer’s liquidity and willingness to pay, as well as those related to the buyer’s country, to Finnvera. Credit insurance is generally employed in insuring post-delivery receivables, but it is also suitable for covering incurred costs of manufacturing if the deal is cancelled before delivery.
B. Receivables purchase guarantee provides the exporter with similar coverage as credit insurance once the delivery has taken place and the exporter sells the accounts receivable incurred on the basis of the sales contract to its bank.
The bank finances the payment period of the buyer and the exporter receives the price as cash after the delivery at the time of selling the receivables.
Finnvera’s guarantee provides the bank that purchased the accounts receivable extensive coverage in case the buyer does not pay its invoice on the due date. Like credit insurance, a receivables purchase guarantee is typically suitable for cases where deliveries are repeatedly made to one buyer and the payment period is less than six months.
C. Using a bill of exchange guarantee, the exporter can grant the buyer a payment period of up to five years and receive the purchase price as cash as soon as the delivery has been made and the exporter takes the bill of exchange approved by the buyer to its bank.
The bill of exchange is separate from the sales contract and consists of a transferrable debt instrument between the exporter and the buyer. The bill of exchange is suitable for a number of countries. The exporter transfers the credit risk involved in the bill of exchange to its bank by selling the bill.
The bill of exchange guarantee protects the bank that bought the bill of exchange against credit risks. It is suitable for both short and long payment periods.
D. Aletter of credit guarantee protects the bank that confirms the documentary credit. With a confirmed documentary credit, the exporter can eliminate risks related to the buyer and the buyer’s country.
The exporter receives the sales price covered by the documentary credit from its own bank as soon as the exporter meets the conditions agreed on the documentary credit and submits the required documents to its bank.
A letter of credit guarantee is an excellent solution if the trading partners do not know each other, because the documentary credit protects both parties. It provides protection even before delivery.
If the buyer needs a certain payment period, it is possible to agree on the use of documentary credit with a payment period, in which case the exporter’s bank can discount the sales price for the exporter.
The correct pairs are: 1–D, 2–A, 3–B, 4–C.
Finnvera’s financial advice: Tel. +358 29 460 2582 weekdays 9 a.m.–4:15 p.m.