Finance International Business - Research Paper Example

OUTLINE I. Introduction II. Consignment Purchases III. Cash-in-Advance IV. Down Payment V. Supplier’s Credit VI. Documentary Collection VII. Letter of Credit VIII. Counter Trade IX. Buyer’s Credit Introduction Business is almost as old as the civilization. It has evolved, however, with time. From the Barter system it has evolved into International Trade. The basic objective still remains the same- profit. The substantial change shave presented an entirely novel face of business. There are many options available to an importer to finance the purchases. Basically, finance in international business is broadly divided as Pre-shipment finance and Post-shipment finance. Pre-shipment finance As the name suggests Pre-shipment finance is the credit offered to the exporter before the shipment of goods. This includes manufacture ring, processing, buying, transportation, warehousing etc. Pre-shipment credit is also called as packaging credit in some countries. This is short term finance. Post-shipment finance. Post shipment finance is the credit offered to the importer in order to buy goods. Not all exporters are financially sound to extend credit to the importer. In order to encourage importers financial assistance is offered to them. This is done through financial institutions, commercial banks especially. Among all, the following are the basic trade financing instruments. Consignment Purchase Under the consignment terms of purchase the importer makes payment to the exporter only when the goods are sold to the end user and payment is received from them. This type of purchase poses high risk to the exporter as there could be indefinite delay in the sale of goods to the end user. It however favors the importer. This type of payment is observed in case of very high trust among the traders or if the exporting firm is financially capable enough to incur the loss, if there is any. Cash-In-Advance (Pre-Payment) The name clearly suggests the feature of this financing option. The importer has to pay in advance to receive the goods. In other words the payment is done before the shipment of the goods. Again, there are a few reasons for choosing this option. The importer is yet to establish a name in the market or the exporter has little faith in the financial status of the importer. The high demand of the product could be another reason for opting this mode of payment. The Cash-in-Advance type payment poses high risk to the importer. Down Payment This financial instrument poses equal amount of risk to both, the importer and the exporter. The importer has to pay a certain part of the payment in advance to initiate the trade. The down payment is paid at the time of signing the contract or shortly thereafter. The risk involved for the exporter is that the importer may not pay after receiving the goods. Similarly the exporter may not deliver the goods after receiving the down payment. Hence, the risks are equally divided among the exporter and the importer. Open Account The open account term of payment is similar to consignment purchase. The importer gets the goods on credit issuing a negotiable document that confirms his commitment to pay. The importer commits to make payment after a particular period of time. The Open Account option poses very high risk for the exporter. The exporter has very less evidence of the shipment of goods. The importer on the other hand has the liberty to make payment later on. The difference between the Consignment Purchase and Open Account is that the latter specifies a particular date of receiving payments. Whereas the former doesn’t specify any date, it assures payment after selling the goods to the end user which could take an indefinite amount of time. The Open Account is preferred in case of high level of mutual trust among the traders. The exporter, to reduce risk, can retain the title of goods unless the payment is made. Yet again this doesn’t help to bring down the risk significantly. In spite of all the shortcomings the Open Account term of payment is employed widely in international trade. The exporter resorts to this payment method in order to attract importers. This is also one of the most flexible modes of payment. Supplier’s Credit This is again a payment term that involves high degree of mutual trust among the traders, under the Supplier’s Credit the exporter allows the importer to make payment after the discharge of good according to his convenience. This credit is extended by the supplier or exporter, hence the name Supplier’s Credit. This term of payment is opted where the traders have been in long term relationship and the exporter is assured regarding the financial status of the importer. The terms of payment discussed have no or less role of banks regarding the financing of the trade. The following financial instruments of trade have a significant role played by banks. Documentary Collections Banks play a significant role in the transactions under Documentary Collection. The interest of the exporter and the importer are safeguarded under this financial instrument of payment. Neither the importer pays before the shipment nor does the exporter has to extend the credit. The transactions are carried out through banks. The banks charge an amount to carry out the transactions. This is expensive when compared to other financial instruments, but the risk involved is relatively low. Role of Banks Both the parties, exporter and importer, are represented by a bank. The bank representing the exporter is called Remitting Bank and the one representing the importer is called Collecting Bank. Both the banks do not finance the transactions. The role of banks here is to ensure the payment for transactions and they charge for this. The banks control and regulate the transactions through exchange of documents. They are however not responsible for the validity and accuracy of the documents. Process The exporter and the importer sign a contract governing the payment of trade. The payment is done in accordance to this contract. The goods are delivered by the exporter in return of the shipping documents that give details regarding the shipment. This acts as the proof of the delivery. The exporter then remits these documents to his bank. The Remitting Bank transfers these documents to the Collecting bank along with the instructions from the exporter. Next the importer has to pay the Collecting Bank in order to obtain the documents. Only through these documents can the Importer claim the rights to own the goods. The importer may also obtain the documents by submitting acceptance of draft6 from the buyer or distributor to the bank. When the Collecting Bank receives the payment from the importer it transfers it to the remitting bank which in turn credits the exporter’s account with the payment deducting its fee. Documents of Payments There are two types of payment terms that can be opted to tackle the payment issue among the traders. 1) Documents Against Payment: Under this the exporter holds the title to goods until the payment is done. The discharge of goods takes place only when the importer makes the payment to obtain title to the goods. Hence the documents to claim ownership are obtained against payment. 2) Documents Against Acceptance: This payment method is more liberal towards the importer. The importer under this contract has the luxury of making the payment later in the near future. He can claim the title to goods by depositing exporter’s draft to the exporter. The exporter’s draft is a document issued by the importer for the exporter committing to make payment on an agreed date. Both the parties are benefited under this contract. The importer is not required to pay in advance and exporter is assured of the payment. Under both the payment types there is a certain amount of risk involved. To bring this risk the exporter is supposed to get insurance cover. The remitting bank can finance the exporter by buying the documents from them. This is however, done under recourse contract. If by any means, say the importer fails to pay or files insolvency, the payment is not received from the collecting bank then the remitting bank is entitled to demand the payment legitimately from the exporter. This process through documents against acceptance and payment is less expensive when compared to the Letter of Credit. The reason being less risk coverage under these contracts. The banks do not buy the documents always. Hence, the exporter has to wait for the payment if it is governed by Documents Against Acceptance. In case of payment under Documents Against Payment if the shipment arrives at the destination an the importer refuses to pay then the exporter has only one option, either call back the shipment or negotiate deal with another buyer. In either of the cases the exporter is at loss. The importer also faces risk under this payment term. If the quality of goods delivered is not up to the standard then the importer cannot claim compensation from the exporter. Regardless of the contract it is advisable to strike deal with established traders and those that have the financial capability or back up to trade in international market. Letter of Credit One of the oldest and most trusted financial instrument is letter of credit. It is believed to be in existence for a couple of centuries. As in Documentary Collection the banks play a very important role in issuing Letter of Credit. In fact their role is of higher significance in their case, as only banks issue the letter of credit. “The Letter of Credit is a formal bank letter, issued for a bank’s customer, which authorizes an individual or company to draw drafts on the bank under certain conditions.” The banks are intermediaries assuring the payment and shipment. They however cannot be held responsible for substandard quality of goods. They are entitled to act according to the document governing the transaction. The Letter of Credit is issued by the issuing bank which represents the importer. The issuing bank ensures that the payment is done only when the goods are delivered. The advising bank represents the exporter. It assures the exporter the payment for the goods. Types of Letter of Credit 1) Revocable Letter of Credit: This type of Letter of Credit gives the liberty to the issuing bank of changing or cancelling the letter of credit. This could be done with or without informing the advising bank or exporter . Such a letter of credit is employed when there is less trust on the exporter. However, it is hardly in use in the present times. 2) Irrevocable Letter of Credit: This directs the parties involved to change or cancel it only by mutual consent. Any action to be taken on the letter of credit will be taken only by mutual agreement. This type of letter of credit doesn’t offer any special privilege to either party. It is impartial in nature. A letter of credit is considered an irrevocable letter of credit unless specified explicitly in it. 3) Confirmed Letter of Credit: The exporter can request the letter of credit to be confirmed. A confirmed letter of credit directs advising bank to credit the exporter’s account with the agreed amount even if the payment is not done by the importer. This presents very low risk to the exporter. Such a letter of credit is employed when the exporter is skeptical regarding receiving the payment from the importer. The political and economic atmosphere of the importer’s country could be unstable. Under these circumstances the probability of receiving the payment is low. Hence the exporter resorts to confirmed letter of credit in order to save members from incurring loss. The bank has to credit the exporter’s account even if there is any delay in the payment. 4) Unconfirmed Letter of Credit: Under this the bank acts as an intermediary alone. The exporter is not entitled to receive credit from the bank in case of no or late payment. They are to bear the loss in case of any mishap. The risk involved is higher. Such a letter of credit is generally employed when the exporter is confident about receiving the payment for the goods delivered. Unless stated, the letter of credit is considered unconfirmed letter of credit. 5) Transferable Letter of Credit: As the name suggests this letter of credit can be transferred from a beneficiary to another. Consider a situation wherein the exporter is not the manufacturer and has got goods from the manufacturer on credit. So instead of receiving the payment from the issuing bank and paying the manufacturer, the beneficiary can request the bank to transfer the whole or part of the payment to another individual or company. This new beneficiary is regarded as second beneficiary and the advisory bank is regarded as the Transferring bank. The first beneficiary can request the Issuing or Advising or Confirming bank to change the beneficiary. The bank need not consult the importer regarding the change to be made in the beneficiary status. Unless stated a letter of credit is considered to be non-transferable. The beneficiary has the right to assign the proceeds of a letter of credit without revealing the second beneficiary to the importer. Under this the exporter or beneficiary need not request the importer for a transferable letter of credit. 6) Revolving Letter of Credit: If there are two parties (exporter and importer) that are in business for quite sometime and intend to continue the same, they may chose Revolving letter of credit of applying for a new letter of credit every time they have a transaction to make. The revolving letter of credit is subjected to certain conditions like, quantity and quality of goods, time period, etc. The revolving letter of credit expires once its validity gets over. If before the expiring of the letter of credit any conflict arises between the two parties, then, there is no guarantee of the recourse for both the parties. It is used very rarely, as parties involved in business for a long term hardly require letter of credit. 7) Standby Letter of Credit: A standby letter of credit is a sort of back up letter of credit. It comes into effect in case the importer fails to make payment. The transaction is governed by the standby letter of credit if the exporter meets all its demands as agreed upon while signing the contract. This type is also rarely used. Countertrade The developing countries may not have enough foreign exchange holdings to finance their importers or exporters. To tackle this lack of finance such countries resort to Countertrade. Under Countertrade in return of goods and services the payment is done partially or wholly with goods or other obligations, apart from cash. The payment for the goods import is done by goods again. There are three basic types of Countertrade. 1) Barter: This is the earliest form of business wherein goods are exchanged for goods. There is no monetary advantage under this system. Goods of equal monetary value are exchanged. 2) Counter purchase: This form of trade is little complex than the barter. The exporter agrees to buy goods from the importer or an entity representing the importer or agrees to arrange a third party to purchase. 3) Buy-Back: The exporter sells machines or other heavy equipments to the importer and in return agrees to take the finished products manufactured using these machines. Such a type of countertrade is called Buy-Back. 4) Compensation Deal: This is a mix of Barter system and the Contemporary Trade system. Under Compensation Deal the payment for goods bought is done partially by cash and partially by goods. Buyer’s Credit This is a financial instrument employed by financially stable countries to promote their exports. There are entities in developing countries who fail to import due to lack of financial support. To encourage such importers the exporting nation agrees to finance the importers directly or indirectly through some financial institutions. This type of finance is called Buyer’s Credit. This helps both countries to boost their economy. BIBLIOGRAPHY n.d Retrieved from http://www.tradeport.org/how_to_import/import_finance.html Read More