Open Account Transaction Overview
An open account transaction is a trade finance solution used in cross-border trade where the goods are shipped by the exporter and received by the importer before payment is due for the transaction. Payment by the importer for the transaction is then typically due within 90 days. While 90 days is certainly not long-term import financing, it may well be a sufficient amount of time for the importer to receive and resell the shipment without ever having come out of pocket.
Open Account transactions are, in many respects, similar to Consignment Purchases, at least insofar as the importer’s payment for the shipment to the exporter is not due and payable until after the shipment has been received by the importer or, in many cases, payment is not due until after the importer has sold the goods to his customers.
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Financing Imports With Open Account
An open account transaction in cross-border trade is the simplest form of trade finance. In open account transactions, the exporter extends credit terms directly to the importer without the involvement of a third-party trade finance provider. More specifically, in an Open Account transaction the goods are produced and shipped by the exporter and received by the importer before payment for the transaction is made or becomes due. Generally, payment by the importer is payable to the exporter within 90 days.
An Open Account transaction disproportionately favors the importer over the exporter in terms of cash flow and risk mitigation. This is one of the safest import financing methods for importers, who face very little transaction risk because they receive the goods they are purchasing before paying for them.
Because the structure favors the importer, Open Account transactions have a correspondingly greater risk for the exporter, who is essentially bearing all of the payment default risks in the transaction with very few structural or transactional protections against default. Ordinarily, exporters are not willing to extend Open Account credit terms to importers unless it is an importer with whom they have previously done a great deal of business and with whom they are comfortable.
While that is ordinarily the case, at present, there are market factors at work which are altering that paradigm. The global shortage of trade finance is contributing to an intense competition in export markets. This is especially the case is less developed markets. Because many importers cannot arrange import financing sufficient to book purchases, exporters are unable to find enough importers to purchase their goods. Exporters are compelled to offer Open Account terms or even Consignment terms to importers or lose sales to their competitors.
Faced with offering credit terms to importers or reducing production, credit terms are winning out. Foreign importers are perfectly willing to press this advantage and are, for the time being, able to extract Open Account import finance terms from exporters.
Beyond the present imbalance in world markets that are compelling exporters to advance credit terms in order to generate sales, even under ordinary, balanced market conditions, the extension of credit by exporters to importers is more common abroad than it is in the United States.
Because it is presently a fiercely competitive export market, exporters who are unwilling to provide trade financing by extending Open Account credit terms to importers are likely to lose sales to other exporters who are willing to extend Open Account or even Consignment Purchases import financing terms.
While exporters certainly remain more competitive by extending Open Account credit terms to importers, they must do so with full awareness that the financial risks in the transaction have shifted in favor of importers. As a result, exporters should examine the political, economic, and commercial risks involved in the transaction in order to assure themselves that they will be paid in full and on-time for the transaction.
It is also possible to mitigate the payment default risk which is associated with Open Account terms by using trade finance techniques such as export credit insurance and invoice factoring to mitigate risk. Exporters may also strengthen their financial position and free up liquidity with pre-export working capital financing or some other form of export financing so they will have the capital they need to produce and ship the goods while waiting for payment under the Open Account credit terms.
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
Open Account Financing Key Takeaways
- Open Account import financing terms may be offered in highly competitive export markets by exporters who are competing for the sale. The importer and the exporter may well benefit in the intermediate and long-term from having created a new trading partnership.
- Both the goods and the transaction documents are shipped straight to the importer who has contractually agreed to make date certain, amount certain payments to the exporter, usually within 90 days.
- As a method of import financing, Open Account transactions offer tremendous advantageous terms to importers, but they do so at the expense of the exporter who must then bear significant risk exposure. The exporter must also bear the additional costs associated with risk mitigation tools the exporter must employ.
- Exporters who do extend Open Account terms frequently add other trade finance facilities to the equation from the export side of the transaction, most notably export working capital financing, government-guaranteed export finance programs, export credit insurance, and export factoring.
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