In a global marketplace, exporters must walk a tightrope—balancing the need to offer competitive terms with the need to get paid in a timely manner.
Direct international produce sales are not protected under the U.S. Department of Agriculture (USDA) Perishable Agricultural Commodities Act (PACA). This article focuses on options available to reduce credit risk when selling produce overseas.
Methods of Payment
“Mitigating 100 percent of the risk is impossible,” says Tony Buak, vice president of export sales for Columbia Marketing International, Inc., which exports to 57 countries. His company secures transactions several ways, each carrying various levels of risk. Whether it is cash in advance, an open account with terms, documentary collection, or letter of credit depends on whether the client is new or an established customer, as well as the importing country’s political and economic climate. Direct sales represent 60 percent of Buak’s business; the balance is through U.S.-based exporters to ensure PACA protection.
Cash in Advance
From an exporter’s perspective, the most advantageous method of payment, of course, is to get paid in advance—particularly when dealing with a new or financially shaky customer. This type of transaction forces the buyer to bear all risk, and payment is usually made via wire transfer. Increasingly popular, however, are international automated clearing house (ACH) transactions, which are similar to wire transfers but less costly.
Where a wire transfer is processed in real time, ACH transfers are batch processed. Within the United States, ACH funds are available the next business day; international transactions may not be. “The challenge,” explains Tom Beube, director of international sales at Wintrust Financial Corporation, headquartered in Rosemont, IL, “is that you’re dealing with different jurisdictions and laws.” There is no common rule set or payment format, and settlement times and holiday schedules vary by country.
Los Angeles-based Autenrieth Company is an export brokerage firm with a high volume of trade with New Zealand, Australia, and Southeast Asia. Brian Autenreith, vice president, says company policy dictates upfront payment from international clients. While the practice certainly limits liability, he acknowledges it can also limit his customer base—but he would rather not take the risk. “We are a small family company and have developed long-term relationships with our customers,” Autenrieth says, adding the company’s reputation for delivering high quality produce has customers accepting terms to pay up front. Those that won’t are turned away.
Autenrieth also believes risk mitigation tools, like letters of credit (L/C) and credit insurance, drive up costs and “can make the difference between my customer buying from us, another competitor, or another country altogether.” He believes exporters should concentrate on the long run—not just the current year or a particular commodity. Bottom line, it’s quite simple: “If my customer isn’t making money, he won’t do business with me anymore.”
Open Account (Unsecured)
Many importers press for open account transactions with payment up to 30 to 60 days after delivery. In this scenario, all risk is borne by the seller. Open account transactions should be used only between parties where a solid relationship exists and there is no significant political or currency risk to the importing country.
In a global marketplace, exporters must walk a tightrope—balancing the need to offer competitive terms with the need to get paid in a timely manner.
Direct international produce sales are not protected under the U.S. Department of Agriculture (USDA) Perishable Agricultural Commodities Act (PACA). This article focuses on options available to reduce credit risk when selling produce overseas.
Methods of Payment
“Mitigating 100 percent of the risk is impossible,” says Tony Buak, vice president of export sales for Columbia Marketing International, Inc., which exports to 57 countries. His company secures transactions several ways, each carrying various levels of risk. Whether it is cash in advance, an open account with terms, documentary collection, or letter of credit depends on whether the client is new or an established customer, as well as the importing country’s political and economic climate. Direct sales represent 60 percent of Buak’s business; the balance is through U.S.-based exporters to ensure PACA protection.
Cash in Advance
From an exporter’s perspective, the most advantageous method of payment, of course, is to get paid in advance—particularly when dealing with a new or financially shaky customer. This type of transaction forces the buyer to bear all risk, and payment is usually made via wire transfer. Increasingly popular, however, are international automated clearing house (ACH) transactions, which are similar to wire transfers but less costly.
Where a wire transfer is processed in real time, ACH transfers are batch processed. Within the United States, ACH funds are available the next business day; international transactions may not be. “The challenge,” explains Tom Beube, director of international sales at Wintrust Financial Corporation, headquartered in Rosemont, IL, “is that you’re dealing with different jurisdictions and laws.” There is no common rule set or payment format, and settlement times and holiday schedules vary by country.
Los Angeles-based Autenrieth Company is an export brokerage firm with a high volume of trade with New Zealand, Australia, and Southeast Asia. Brian Autenreith, vice president, says company policy dictates upfront payment from international clients. While the practice certainly limits liability, he acknowledges it can also limit his customer base—but he would rather not take the risk. “We are a small family company and have developed long-term relationships with our customers,” Autenrieth says, adding the company’s reputation for delivering high quality produce has customers accepting terms to pay up front. Those that won’t are turned away.
Autenrieth also believes risk mitigation tools, like letters of credit (L/C) and credit insurance, drive up costs and “can make the difference between my customer buying from us, another competitor, or another country altogether.” He believes exporters should concentrate on the long run—not just the current year or a particular commodity. Bottom line, it’s quite simple: “If my customer isn’t making money, he won’t do business with me anymore.”
Open Account (Unsecured)
Many importers press for open account transactions with payment up to 30 to 60 days after delivery. In this scenario, all risk is borne by the seller. Open account transactions should be used only between parties where a solid relationship exists and there is no significant political or currency risk to the importing country.
Regarding the latter, Howard McCourt, senior manager of National Bank of Canada’s supply chain financing solutions, warns Canadian exporters about the danger of currency fluctuations if they accept currency other than Canadian dollars. “If the currency depreciates while the seller is waiting for payment, the seller has lost money.”
McCourt suggests a hedging strategy to ensure profit margins, noting that any convertible currency can be hedged through all schedule A and B banks in Canada. Additionally, National Bank of Canada offers factoring services. “We are the only Canadian bank that is a member of Factors Chain International,” he states, referring to a global network that was created to facilitate international trade.
Factors Chain International currently has 277 factoring companies in 76 countries, including 10 in the United States. The factor purchases the exporter’s accounts receivable on a non-recourse basis which prevents devaluation during currency fluctuations. “We advance the money upfront, so exporters have no risk as long as they deliver the product as contracted,” McCourt explains.
Documentary Collection
Open account risk can also be minimized with documentary collection (D/C), as the exporter retains title of the produce until documents are accepted by the importer’s bank (collecting bank). The exporter ships the produce and provides documentation to its bank (remitting bank), which then sends the documents and a draft (bill of exchange) to the collecting bank. The documents specify requirements for transfer of title; the draft specifies how payment will be made. “Document against payment,” as its name implies, requires the importer to pay when documents are presented. “Document against acceptance” allows payment on a specified future date.
A D/C is less expensive than a letter of credit; however, exporters beware as there is no safety net. Banks serve as facilitators only; there is no guarantee of payment. “The exporter sends shipping documents to us and we would prepare our cover letter to the foreign bank,” states Beube. “The only thing the buyer’s bank does is to examine the documents to see if they match the cover letter.” They do not verify if terms of the agreement have been met, he notes.
Letters of Credit (Secured)
A letter of credit (L/C) guarantees payment by a buyer’s bank based on the buyer’s ability to pay. Risk is balanced between the parties and sellers must comply with all L/C terms and conditions to receive payment. Because an L/C is labor intensive, it is relatively expensive for both parties. It also puts a hold on the buyer’s credit, which can be a disadvantage.
Chuck Olsen, president of Chuck Olsen Company, Inc., a grower-shipper that exports citrus and grapes to Pacific Rim countries, has found that many customers are refusing to provide L/Cs or to pay up front. For over a decade, his company has been exporting product through various licensed American exporters. “The exporter takes title,” he says, “and as a result, we have coverage under PACA.”
Nevertheless, L/Cs are the most common way to secure payment in international trade. The exporter’s bank can advise sellers on payment terms, verify the authenticity of the issuing bank’s L/C, and prepare presentation instructions. However, Beube noted, “Every country has different import rules when shipping food products. The importer needs to know what Customs requires to have the product released from the port.” If this type of documentation is not included with the L/C terms, he says “the buyer has made a big mistake” as the shipment may be detained, preventing the buyer from making delivery. This does not, Beube confirms, “affect the exporter, as the bank would still pay.”
Additional Terms
Under the International Chamber of Commerce’s Uniform Customs and Practice for Documentary Credits (UCP 600) rules, L/Cs are irrevocable; they cannot be canceled or modified by the issuer without the consent of all parties. However, an importer can request a revocable L/C from the bank, which enables the issuer to modify terms without consent of the seller. To ensure an agreement is binding, exporters should require an irrevocable L/C subject to UCP 600.
Exporters can further reduce risk by requesting a confirmed L/C, particularly when trading with countries subject to political upheaval, foreign currency shortages, unfavorable exchange regulations, and economic collapse. The importer’s bank authorizes a U.S. bank to add its guarantee should the issuing bank be unable to pay. Use of an unconfirmed L/C exposes the exporter to all these risks.
Letters of credit can be structured to pay upon presentation of documents and verification the seller has complied with the terms, called a ‘sight’ L/C; alternatively, a ‘time’ or ‘usance’ L/C provides a grace period. Once documents are presented and verified, payment is made on a specified future date.
When dealing with multiple purchases over a period of time, an exporter may request a revolving L/C. It eliminates the need to issue a new L/C for each purchase. The issuing bank guarantees the amount of credit will be available again, usually under the same terms.
A bank may also recommend other types of L/Cs, such as when an exporter is unable to pay suppliers before receiving an importer’s payment. In this case, the exporter’s bank issues a back-to-back L/C in favor of the supplier. The strength of the L/C is based on the guarantee of payment from the importer’s bank.
Letters of credit can also serve as performance bonds, since many parties play a role in getting produce from point A to point B in international trade. A standby L/C in favor of an importer guarantees the exporter will meet its contractual obligations to pay third parties involved in the deal.
Credit Insurance
The increasing desire for open account terms has spurred growth in trade credit insurance. Purchased by the exporter, credit insurance covers nonpayment due to factors such as insolvency, political risk, and exchange rate fluctuations.
“Credit insurance eliminates the need for a letter of credit, which ties up the buyer’s credit,” explains Ben Clumeck, West Coast regional manager at Atradius Trade Credit Insurance.
Based on an extensive analysis, the insurer will advise an exporter on the amount of credit that should be offered to a specific buyer. Atradius monitors companies in more than 120 countries. “If we can’t cover a buyer, we tell our clients to sell on cash-in-advance terms only,” said Clumeck.
Policies can be structured based on a portfolio of accounts or only the largest buyers (key accounts). Premiums are based on country risk, business volume, loss history, and a risk analysis of an exporter’s buyer mix. “One of the biggest misconceptions is that insurance is expensive,” Clumeck commented. “Cost generally runs 0.10 percent on the insurable sale to 0.5 percent. For high risk or low volume, it could go to 0.75 percent.” Policies typically cover up to 90 percent of a contract’s value. Claims for nonpayment are usually paid within 15 days of nonpayment, according to Clumeck.
Companies in the both the United States and Canada can get trade credit and political risk insurance from the government; Canadian exporters go through Export Development Canada, and U.S. firms can turn to the Export-Import Bank of the United States. Though coverage is generally limited to established exporters, there are ways new or smaller businesses can earn eligibility to qualify for coverage (see sidebar).
FOR EXPORTERS TOO SMALL TO QUALIFY FOR CREDIT INSURANCE
Some export businesses do not qualify for traditional credit insurance, so John Keevan-Lynch, president of Provident Traders, Inc., based in Philo, CA, recommends visiting the Export-Import Bank of the United States website (www.ExIm.gov) to make use of its free credit-decision guidelines. Here’s what to look for:
1) Country Limitation Schedule – lists countries considered safe enough to insure open account credit terms. For example, Ex-Im Bank will insure open account terms to private sector buyers in Mexico, but not in Indonesia, where insurance will typically be limited to bank letters of credit.
2) Special Buyer Credit Limit Application – lists Ex-Im Bank’s minimum credit requirements for insuring open account terms; a credit limit of $50,000 requires at least one ‘favorable’ credit agency report or one ‘favorable’ trade reference.
3) Trade Reference Form – includes questions to ask a reference about a buyer’s credit and payment history; the form is set up so you can easily fill in the appropriate information while interviewing a trade reference.
4) Short Term Credit Standards – this manual defines the criteria used to evaluate a buyer’s credit information; for example, page 19 outlines what the Ex-Im Bank considers a ‘favorable’ trade reference.
John Keevan-Lynch is president of Provident Traders, Inc., a Northern California export finance consultancy and licensed credit insurance broker, and has more than 32 years experience with Ex-Im Bank. Further information can be found at www.providenttraders.com.
Lastly, in addition to common ways to mitigate risk, Columbia Marketing International uses insurance in a rather unusual way: “We have [life] insurance policies on some clients,” Buak asserts. The company is the beneficiary and pays the premiums for policies on major individual customers. “If they die, we will get paid.”
Conclusion
Overseas markets are potential profit centers for produce sellers but exporting can be fraught with peril. Using appropriate credit tools to ensure payment can help mitigate risks and prevent a host of problems along the way.
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