Consignment Purchase Overview
Consignment Purchase is one of the three most basic methods of trade finance, along with Open Account and Cash In Advance. Before the advent of institutionalized trade finance, which opened up a range of trade finance options for importers and exporters, Open Accounts, Cash In Advance and Consignment Purchase were the entirety of trade finance options.
Open Accounts favor importers, who do not have to pay for an order of goods until the order is shipped by the exporter. Exporters, who bear virtually all of the risk with Open Account transactions, try to avoid them and will typically accept Open Account transactions if they have an existing relationship with the importer.
Cash In Advance favors exporters, who receive payment in full for a shipment of goods before they are shipped and perhaps before they are even produced, depending on the nature of the goods. Importers, who bear all of the risk in Cash In Advance transactions are very seldom willing to pay for an order of goods in advance.
Consignment Purchase is the most favorable import financing for the importer. With Consignment Purchase transactions the importer places an order for goods from the exporter. The parties agree on a price for the goods, but payment for the goods isn’t due to the exporter until the exporter produces and ships the goods, the importer receives the goods, and the importer sells the goods to his customer.
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Import Finance Using Consignment Purchase
For importers, a consignment purchase is the lowest-risk method of payment for cross-border trade. With a consignment purchase, the importer does not pay the exporter for the transaction until the imported goods have been sold to the importer’s end customer.
Not surprisingly, exporters are extremely reluctant to extend consignment terms to importers. In fact, exporters almost never enter into consignment purchase transactions because it delays payment for the goods and significantly increases the possibility of not receiving full payment at all. In short, consignment purchase transactions are considered highly risky by exporters and are, therefore, rare.
The other end of the risk spectrum in methods of payment are cash-in-advance. Cash in advance is the riskiest import financing option for importers because the importer commits all of the funds up front, with no reliable guarantee that the goods will be delivered when promised and in good condition.
Exporters prefer cash in advance, especially if they too are intermediaries who have to pay for goods in advance of receiving payment for their export. It is very common for exporters to offer discounts to importers if they will pay cash in advance. It is, nonetheless rare for importers to agree to cash in advance terms.
Consignment purchases leave all the risk with the exporter, while cash in advance terms leave all the risk with the importer. Sometimes a compromise can be struck between the two extremes to make a deal. A reasonable compromise, in this case, might be a down payment, where the importer pays a non-refundable deposit up-front and the exporter ships the goods on the strength of that deposit. The importer then pays the remainder of the cost when the goods are received in good condition.
However, much more likely is the solution employed almost 90% of the time which is that the parties rely on trade finance solutions provided by third-party trade finance providers.
Trade Finance Learning Center
With more than 80% of the world’s trade depending on trade finance it is an essential segment of the financial services sector. It is also one of the least understood of the financial services. One of the things that undermine people’s understanding of trade finance is the absence of a single vocabulary. Do a search for the definition of import financing, for instance, and the top 20 results will provide 20 different definitions. We are creating a learning center with content that will help improve understanding of trade finance and its various component segments. Each of the below tabs provides the factual information you need to make good business decisions, beginning with important trade finance definitions.
Accounts Receivable is money owed to a company by a customer for products and /or services sold. Accounts receivable is considered a current asset on a balance sheet once an invoice has been sent to the customer.
Accounts Receivable Factoring
Accounts Receivable Factoring is a method of Trade Financing where a company sells their accounts receivable in exchange for working capital. The purchaser of the receivables relies on the creditworthiness of the customers who owe the invoices, not the subject company.
Advance Against Documents
Advances Against Documents are loans made solely based on the security of the documents covering the shipment.
Asset Based Lending
Asset Based Lending is a method of Trade Financing that allows a business to leverage company assets as collateral for a loan. Asset-based loans are an alternative to more traditional lending which is generally characterized as a higher risk which requires higher interest rates.
Cash Against Documents
Cash Against Documents is the payment for goods in which a commission house or other intermediary transfers title documents to the buyer upon payment in cash.
Cash in Advance
Payment for goods in which the price is paid in full before shipment is made. This method is usually used only for small purchases or when the goods are built to order.
Cash with Order
Cash with Order is the payment for goods whereby the buyer pays when ordering and in which the transaction is binding on both parties.
Commercial Finance is defined as the offering of loans to businesses by a bank or other lender. Commercial loans are either secured by business assets, accounts receivable, etc., or unsecured, in which case the lender relies on the borrower’s cash flow to repay the loan.
Confirmed Letter of Credit
A Confirmed Letter of Credit is a Letter of Credit issued by a foreign bank, which has been confirmed as valid by a domestic bank. An exporter whose form of payment is a Confirmed Letter of Credit is assured of payment by the domestic bank who confirmed the Letter of Credit even if the foreign buyer or the foreign bank defaults.
Consignment is a delivery of merchandise from an exporter (the consignor) to an agent (the consignee) subject to an agreement by the agent that the agent will sell the merchandise for the benefit of the exporter, subject to certain limitations, like a minimum price. The exporter (consignor) retains ownership of and title to the goods until the agent (consignee) has sold them. Upon the sale of the goods, the agent typically retains a commission and remits the remaining net proceeds to the exporter.
A Cross-Border Sale refers to any sale that is made between a firm in one country and a firm located in a different country.
Factoring is the selling of a company’s invoices and accounts receivable at a discount. The lender assumes the credit risk of the debtor and receives the cash when the debtor settles the account.
Invoice Discounting is a type of loan that is drawn against a company’s outstanding invoices but does not require that the company give up administrative control of those invoices.
Invoice Factoring is one of the most common methods of trade financing. Your company sells their invoices to a factor in exchange for immediate liquidity. The factor who purchases the invoices relies on the creditworthiness of the customers who owe the invoices, not the subject company.
Irrevocable Letter of Credit
Irrevocable Letter of Credit is a Letter of Credit in which the specified payment is guaranteed by the bank if all terms and conditions are met by the drawee.
Letter of Credit
Letter of Credit or LC is the most common trade finance solution in the world. A Letter of Credit is a document issued by a bank for the benefit of a seller or exporter, which authorizes the seller to draw a specified amount of money, under specified terms, usually the receipt by the issuing bank of certain documents within a given time.
Open Account is a trade arrangement in which goods are shipped to a foreign buyer without guarantee of payment. The obvious risk this method poses to the supplier makes it essential that the buyer’s integrity be unquestionable.
Pro forma Invoice
Pro forma Invoice is an invoice provided by a supplier prior to the shipment of merchandise, which informs the buyer of the kinds, nature and quantities of goods to be shipped along with their value, and other important specifications such as weight and size.
Receivable Management involves processing activities related to managing a company’s accounts receivable including collections, credit policies and minimizing any risk that threatens a firm from collecting receivables.
Revocable Letter of Credit
Revocable Letter of Credit is a Letter of Credit that can be canceled or altered by a buyer after it has been issued by the buyer’s bank.
Structured Trade Finance
Structured Trade Finance is cross-border trade finance in emerging markets where the intention is that the loan gets repaid by the liquidation of a flow of commodities.
Trade Credit Insurance
Trade Credit Insurance is a risk management product offered to business entities wishing to protect their balance sheet assets from loss due to credit risks such as protracted default, insolvency, and bankruptcy. Trade Credit Insurance often includes a component of political risk insurance, which ensures the risk of non-payment by foreign buyers due to currency issues, political unrest, expropriation, etc.
Global Reserve Currency May No Longer Be US DollarThe issue of when a global reserve currency begins or ends is not an exact science. There are no press releases
Consignment Purchase Key Takeaways
For importers, there is no better way to finance international trade transactions than by consignment purchase. For exporters, a consignment purchase is the riskiest. Unlike most trade finance solutions that, to a certain extent, at least attempt to balance risk in cross-border trade between the importer and exporter, a consignment purchase shifts all of the risk to the exporter. For this reason, it is extremely rare to find an exporter who is willing to extend consignment purchase credit terms to an importer, unless it is to an established customer with whom the exporter is very comfortable.
But when exporters and importers are still early in a relationship, without having yet established a relationship of trust, using trusted intermediaries can mitigate cash flow and credit risks for both sides. Identifying the best trade finance solution for both exporter and importer is a matter for negotiation as part of the trade deal.
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