How to Manage Export Finance
Learn how to negotiate price and payment methods, how to choose the right finance and how to deal with foreign currencies
Exporting tends to be more financially demanding than selling in the UK as consignments are usually larger, lead times are longer and the risks are more difficult to control.
Negotiating an export sale involves balancing the risks and the costs to you and your customer. At the same time, you may need to take into account the problems of handling payment in foreign currencies.
This guide will explain how to negotiate the payment method, choose the right financing option and deal with foreign currency.
First steps to exporting
The terms of an export sale must satisfy both you and your customer. You should agree to the ‘terms of delivery’, covering the division of responsibility for transport costs and for the risk of loss or damage in transit (Standard international terms are set out in ‘Incoterms 2010′) and also ask potential customers what terms they prefer and what causes them problems. It’s also necessary to agree on the payment method – the customer’s creditworthiness will determine this – the currency used and what documentation will be provided.
The price you negotiate with overseas customers may include additional costs such as special packaging and labeling and the documentation may involve special costs beyond just the invoice – you must provide all the documentation required by the purchaser and by the payment method you are using.
Export invoices generally need more detail than those for UK sales including a full description of the goods including item price, net weight (in kilos), the country of origin and should be signed and dated – check with your freight forwarder or UK Trade & Investment for details. Goods for non-EU countries must be declared to HM Revenue & Customs before they are released for export, so export invoices must be prepared ahead of dispatch.
It’s your responsibility to insure the goods and the cost of any credit insurance you purchase must be taken into account. Financing and transaction costs should include the cost of financing the transaction until you receive payment, and any costs of foreign exchange, payment collection, and documentation.
Drawing up Bills of Exchange
Bills of Exchange are written documents in which ‘the drawer’ (you) requires ‘the drawee’ (the customer or their bank) to pay a specified amount.
The bill can specify immediate payment (‘at sight’ or ‘on demand’) or at a later date (‘the term’). If you’re a new exporter, the drawee’s bank may not initially be willing to provide term bills. Drawees become legally liable for payment once they agree or accept the bill.
‘Negotiable’ bills specify payment ‘to the order of’ the drawer, allowing you to negotiate the bill, i.e. to sell it to another party (usually your bank) to raise finance.
What payment method should you use?
The payment method you use has a significant effect on the financing you require and the level of risk to which you are exposed.
Open account payment is similar to offering credit to a UK customer. Typically, the credit term (e.g. 30 days) starts once you dispatch and invoice for the goods, in line with the terms of trade. In this scenario you bear all the risks of offering credit, just as for a sale in the UK and you need to arrange finance to fund the whole of the transaction – but there are no extra costs, other than those involved in any export transaction.
A documentary collection, where you draw up a bill of exchange, allows you to keep control of the goods and raise additional finance. An overseas bank, acting on your bank’s behalf, will only release the documents necessary for your customer to take possession of the goods once they formally accept the terms of the bill. There is a risk that the bill of exchange will not be accepted. You still have ownership and control of the goods but in your customer’s country. There is still a risk that you will not receive payment unless the bill has been guaranteed by the bank (‘avalised’). You will have a strong basis for pursuing legal action against the customer.
Other than payment in advance, documentary credits are the most secure method of payment. This involves your customer arranging a letter of credit with their bank which pays a correspondent bank in the UK once you’ve submitted all the necessary documentation. A letter of credit carries little credit risk and as long as you documents are accurate, the issuing bank guarantees to pay you within the stipulated time. By ‘confirming’ the letter of credit, your bank agrees to pay you if the issuing bank defaults. Your bank will charge a commission based on how creditworthy the issuing bank is. This letter specifies any credit period you are offering. A ‘term’ credit, where payment is made after a set term (e.g. 30 days) will require you to finance the gap between delivery and payment, but you use a valid, current letter of credit to raise additional finance in a similar way to using a bill of exchange. The customer is responsible for the cost of the letter of credit and will want to pass these costs on to you as part of the price negotiation.
You may also be able to negotiate payment in advance for all or part of the shipment, which means you have no risks and bear none of the financing costs.
What financing options are there?
Exporting may require additional financing unless you have negotiated in advance. You can use a standard loan or overdraft facility but other options can be more cost effective and provide access to greater amounts of working capital.
You can arrange a foreign currency loan or overdraft to borrow the amount of foreign currency you expect to be paid. You may be able to use proof of the export sale as security for the borrowing but your bank may only accept this form of security if it has approved the customer, or if you purchase credit insurance. This is repaid with the payment you receive from your customer, but If the customer fails to pay, you will be exposed to the additional risk that the exchange rate has moved against you.
Another option is to sell a negotiable bill of exchange that has been accepted by the drawee which the bank buys from you for a discounted value. The amount the bank pays depends on the currency, amount and term of the bill and the creditworthiness of the drawee. The bill will have to be endorsed by a third-party If the drawee is not known to your bank as creditworthy. The effective interest rate your bank charges on the financing will include a margin over interbank interest rates for that term in that currency – typically, the margin for a bill that has been accepted by a high quality drawee (eg a major bank) will be 1 to 3%. The amount you sell the bill for will be paid to you in the currency the bill is denominated in and you can then convert the proceeds.
The bill can be used to arrange for additional borrowing as it acts as security for a bank loan or overdraft facility. This financing can be arranged on a ‘recourse’ basis, where you have to repay your bank if the customer does not make the payment required by the bill, or a ‘non-recourse’ basis, where financing is only available if the bill has been accepted or guaranteed by an institution that is acceptable to your bank.
Forfaiting, usually used to finance high-value goods like construction projects, is another option that enables you to raise money on major transactions where you will be paid in stages over a longer period. In this, you draw up a series of bills of exchange with different terms and can then negotiate them all at once.
An export factor, specialising in collecting payments from overseas, can usually lend you more against an invoice than a bank, providing up to 80% of the value of each invoice once you issue it. It’s generally only available for sales to countries where your annual exports are at least £100,000 and the cost is usually 1 to 3% above a standard rate for an overdraft.
Dealing with foreign currencies
Many customers prefer you to quote and invoice them in their local currencies, rather than pounds. Unless you are prepared to do so, they may choose alternative suppliers. However, invoicing in a foreign currency exposes you to additional risks and costs.
You have a foreign exchange risk for any amounts you hold or expect to receive in a foreign currency, but you are particularly at risk if the foreign currency is volatile or chronically weak, for example, in some middle Eastern or African currencies. To do this you will need a foreign currency bank account to hold the funds until you convert them to pounds.
There will be an extra transaction cost delay for converting any foreign currency into pounds, but this should be included in the rate you are quoted. For example, a £100,000 transaction in a widely traded currency (e.g. US dollars), the effective cost might be 0.1 to 0.5% . A ‘spot’ transaction usually takes effect two days after you agree the transaction price.
You can hedge against the risk of adverse exchange rate movements by using a forward foreign exchange contract, where you agree to sell the bank the foreign currency at a fixed future date for a price that is set now. The difference between this and a spot exchange rate will reflect relative interest rates between the two currencies. The effective transaction cost of a forward contract is typically 0.2 to 0.6%, but you must fulfil the forward contract, even if your customer does not pay you.
You can buy an option to sell the foreign currency, which gives you the right, but not the obligation, to sell the foreign currency at an agreed rate on the specified date – if exchange rates move against you, you use the option; if they move in your favour, you allow the option to lapse. You pay a premium for the option, which depends on the volatility of the currencies involved, relative interest rates and how far into the future the option covers you. A three-month option on a specific forward exchange rate might typically cost you 2 to 5%.
However, It may be more convenient to maintain foreign currency accounts if you frequently issue foreign currency invoices. You will receive interest on the balance in each foreign currency account, but for amounts less than the equivalent of £100,000, the interest rate is likely to be substantially below the interbank rate. You can convert foreign balances into pounds sterling when you choose, though remember that fewer, larger transactions will be cheaper and involve less administration than converting every payment received. It can be useful to have a foreign currency account for any payments you need to make in that currency.