For exporters, any sale is a gift until payment is received. For importers, any payment is a donation until the goods are received. Successful exporters and importers recognize this conundrum and are able to negotiate payment terms that recognize the inherent risk and yet meet the needs of both parties.
There are five primary methods of payment in international trade that range from most to least secure. Of course, the most secure method for the exporter is the least secure method for the importer and vice versa. The key is striking the right balance for both sides. This article focuses on open account.
The Advantages of an Open Account
An open account transaction in international trade is a sale where the goods are shipped and delivered before payment is due, which is typically in 30, 60 or 90 days. Obviously, this option is advantageous to the importer in terms of cash flow and cost, but it is a risky option for an exporter.
Because of intense competition in export markets, foreign buyers often press exporters for open account terms. In addition, the extension of credit by the seller to the buyer is more common abroad. Therefore, exporters who are reluctant to extend credit may lose a sale to their competitors.
Though open account terms will definitely enhance export competitiveness, exporters should thoroughly examine the political, economic and commercial risks as well as cultural influences to ensure that payment will be received in full and on time.
It is possible to substantially mitigate the risk of non-payment associated with open account trade by using trade finance techniques such as export credit insurance and factoring. Exporters may also seek export working capital financing to ensure that they have access to financing for production and credit while waiting for programs.
The Keys to Using an Open Account
Under an open account, the goods, along with all the necessary export documents, are shipped directly to the importer who has agreed to pay the exporter’s invoice at a specified date, which is usually in 30, 60 or 90 days.
The exporter should be absolutely confident that the importer will accept the shipment and pay at the agreed time and that the importing country is commercially and politically secure.
Open account terms may help win customers in competitive markets and may be used with one or more of the appropriate trade finance techniques that mitigate the risk of non-payment. These techniques include export working capital financing, government-guaranteed export working capital program, export credit insurance, export factoring, and standby letters of credit.
Open accounts may also be offered to importers who demand to pay in their local currency using a proper foreign exchange risk hedging technique such as forwarding contracts.
Export Working Capital Financing
Exporters who lack sufficient funds to extend open accounts to potential international customers need export working capital financing that covers the entire cash cycle, from the purchase of raw materials through the ultimate collection of the sales proceeds.
Export working capital facilities, which are generally secured by personal guarantees, assets or receivables, can be structured to support export sales in the form of a loan or a revolving line of credit. Due to the repayment risk associated with export sales, this type of financing is generally only available through government guarantee programs.
Government-Guaranteed Export Working Capital Programs
The U.S. Small Business Administration and the U.S. Export-Import Bank offer programs that guarantee export working capital funds granted by participating lenders to U.S. exporters. With those programs, U.S. exporters can obtain needed funds from commercial lenders when financing is otherwise not available or when their borrowing capacity needs to be increased.
Export Credit Insurance
Export credit insurance provides protection against commercial losses (such as default, insolvency or bankruptcy) and political losses (such as war, nationalization or non-convertible currency). Insurance also provides security for banks that are providing working capital and financing exports.
Export Factoring
Factoring in international trade is the discounting of short-term receivables up to 180 days. The exporter transfers title to their short-term foreign accounts receivable to a factoring house for cash at a discount from the face value. It allows an exporter to ship on open account as the factoring house assumes the financial liability of the importer to pay and handles collections on the receivables.
Factoring houses most commonly work with exports of consumer goods.
Standby Letters of Credit
A standby letter of credit acts as an insurance policy issued by the importer’s bank in favor of the exporter assuring that payment will be made if the importer fails to pay as agreed. Using this type of letter of credit as a condition for selling on an open account greatly improves cash flow for the importer while mitigating the risk of non-payment for the exporter.
Forward Contract
Exporters can use a forward contract to offer open account terms to foreign buyers who demand to pay in their local currency. A forward contract enables the exporter to sell a set amount of foreign currency at a pre-agreed exchange rate with a delivery date in the future to their foreign exchange service provider. This ensures that the U.S. exporter will receive a predetermined payment in U.S. dollars at a future date regardless of fluctuating exchange rates upon receiving payment in foreign currency from the importer.
Summary
At first glance, selling to international customers under an open account may seem too risky to even consider. There are enough potential advantages, however, that using this payment term under the right circumstances may make sense. It can make an exporter’s products more competitive and may even allow them to charge more for their goods.
The keys to selling under an open account are a high level of confidence that the buyer will pay, a good understanding of external forces like a country’s economic situation or government won’t cause payment problems or extended delays, and using proven trade financing techniques that mitigate risks of non-payment.
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This article is taken in large part from the Trade Finance Guide: A Quick Reference for U.S. Exporters, which you can download for free by clicking the link below.