Funding Solutions For Importers
Import Finance or Trade Finance for Imports are specialized Trade Funding methods used primarily to finance the purchase of goods which are being exported from one country for the purpose of being imported into another country. Unless the importer or purchaser is prepared to pay cash in advance for the goods, which is rare, the importer will rely on Import Finance to finance the transaction. For importers, using Import Finance makes more sense than paying cash in advance for the goods. That holds true even if the importer has ample cash on hand to pay for the purchase. Even though there are costs for using Import Financing, the costs are far less significant than are the benefits you get from using Import Trade Financing because it solves the problems faced whenever sending money internationally.
Just like domestic purchase and sale transactions where the buyer and seller have different interests in the transaction, in international trade deals, the interests of the importer and exporter are to some degree opposed. Importers want to wait until they receive the merchandise in good condition before paying for them. Better still, importers would like to be able to sell the goods to customers before having to pay for them. Conversely, exporters want to be paid in full for goods before shipping them, which eliminates the risk of importers who default in the payment. Import Finance, combined with related trade credit bridge the diverging needs of importers and exporters so that goods and money keep flowing to everyone’s benefit.
Import Finance Using Consignment Purchase
For importers, a consignment purchase is the lowest-risk import trade finance option. With a consignment purchase, the importer does not pay the exporter for the goods until the goods are sold to the importer’s end customer. Not surprisingly, exporters are almost always reluctant and almost never enter into a consignment purchase deal because it likely means delaying payment for the goods or not getting paid in full for the goods at all. Consignment purchase transactions are considered highly risky by exporters and are, therefore, rare.
At the other end of the spectrum, cash-in-advance is the riskiest Import Finance option for importers because the importer commits all of the funds up front, with no reliable guarantee that the goods will be delivered. 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. Many exporters offer importers discounts 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. Somewhere between the two, it is likely that a compromise can be struck to make the deal. A reasonable compromise 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.
Import Finance Using Open Accounts
Many exporters offer Open Account purchase terms to get a deal done. With Open Account transactions, the importer initially purchases the goods on account, then makes a series of payments to pay the remainder of what is due. With Open Account transactions, it is entirely likely that the exporter will charge interest on the outstanding balance. Open Account transactions help importers manage cash flow more efficiently. However, the exporter must still bear payment default risk, because the importer may not make the payments as agreed. In Open Account transactions, the exporter has no security or collateral for any outstanding balance that’s owed because title ownership of the goods passes from the exporter to the importer when the goods are delivered, and the importer can sell the goods on to customers before making the final payment to the exporter. If the importer defaults on the payment, the exporter is unlikely to recover the goods.
Because of this, exporters will usually only enter into Open Account transactions if the importer is someone with whom the exporter has an established relationship. However, with the growing availability of credit insurance in Import Trade Finance, open account transactions are being more widely used. These alternatives are all forms of trade credit. But for many importers, particularly small businesses, trade credit is likely very restrictive, very expensive or not available at all. So, many importers need to use some kind of Import Trade Finance to fund their international purchases.
Import Finance Methods
Letters of credit are the most widely used form of Import Finance worldwide. Letters of Credit are letters issued by an importer’s bank that authorize the exporter to withdraw funds from the bank under certain conditions. Letters of credit are issued in favor of a named beneficiary (the exporter), for a stated amount, and with a hard expiration date. Letters of credit specify the terms and conditions under which payment will be made. In order to draw payment from the importer’s bank, the exporter has to provide documentary evidence that the goods have been supplied in accordance with the terms and conditions which are specified in the letter of credit. The documents required typically include an invoice or receipt for the goods and a bill of lading confirming that the goods have been shipped; insurance documents, inspection reports, and other export documents may be needed as well.
When an exporter presents correct documentation along with a demand to draw to the importer’s bank, the bank is obliged to pay, whether or not the importer has provided the funds to do so. Depending on the terms specified in the letter of credit, payment can be in the form of either a funds transfer known as a sight draft or a promise to pay which is known as a term draft. A promise to pay often takes the form of a bill of exchange, which is a non-interest bearing note requiring the issuer to make payment at a specified time in the future. Bills of exchange can themselves be used as a means of payment since they can be endorsed over to another beneficiary. They can, therefore, help to ease cash flow pressures for exporters.
Sometimes, a trusted third party – usually a major international bank – acts as guarantor for a letter of credit to protect the exporter in the event the issuing bank defaults on payment. These are known as confirmed letters of credit. Letters of credit eliminate the obligation of the importer to pay for goods prior to shipping, since the importer’s bank in effect guarantees that payment will be made when documentary evidence that the goods have been shipped is received by the bank. Letters of credit eliminate much of the risk inherent in international trade but can be expensive, and if too tightly specified they can be difficult to enforce, which is likely to result in expensive legal battles.
A less expensive but slightly riskier form of trade finance for imports are Documentary Collections. In documentary collections, the sale of goods is settled by banks through the exchange of documents. The exporter provides documentary evidence to his bank that the goods have been shipped, usually in the form of a bill of lading. The exporter’s bank forwards the bill of lading to the importer’s bank and, in return, receives payment in settlement of the invoice. Settlement can be a funds transfer or a promise to pay, such as a bill of exchange. In documentary collection transactions the importer’s bank does not guarantee payment. If the importer does not accept the goods, the bank won’t pay. In documentary collections, title to the goods does not pass to the importer until payment has been made, so the exporter can recover the goods. However, recovering goods from locations in foreign countries can be difficult and expensive.
Import Finance Key Takeaways
For many international import trade transactions, some form of Import Trade Credit will be sufficient, especially one which creates a reasonable balance between the needs of exporters and importers. 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 Import Finance solution for both exporter and importer is a matter for negotiation as part of the trade deal.
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