Sources of finance for foreign trade
either in sterling or in the overseas currency.
Bills of exchange
a negotiable instrument drafted by the exporter (the drawer), accepted by the importer (the drawee) who thereby agrees to pay for the goods/services either immediately or more commonly after a specified period of credit.
If the importer accepts the bill it is known as a “trade bill”, whereas if the importer arranges for its bank to accept the bill, it becomes a less risky “bank bill”.
Where payment will be made after the specified period of credit, the exporter can sell the bill at a discount to its face value and receive the cash immediately.
If the bill is dishonoured the exporter can seek legal remedies in the country of the importer.
similar, but less common than bills of exchange, since they cannot usually be discounted prior to maturity.
Documentary letters of credit
the importer obtains a Letter of Credit from its bank, which guarantees payment to the exporter via a trade bill. Though slow to arrange, this method is virtually risk free provided the exporter presents specified error free documents (eg shipping documents, certificates of origin and a fully detailed invoice) within a specified time period.
The high bank fees for this procedure are normally borne by the importer, and the DLC is normally reserved for expensive goods only.
the factoring company (often the subsidiary of a bank) assumes the responsibility for collecting the trade debts of another – in this case an exporter.
The factor may provide a range of services (eg providing advances, administering the sales ledger, credit insurance etc) for an additional fee. Widely regarded as a useful means of obtaining trade finance and collecting of debts for small or medium sized exporters.
However the exporter must always bear in mind the eventual consequences of dispensing with the services of the factor and undertaking the running of the sales ledger and cash collection activities itself.
a medium term source of finance whereby a domestic bank will discount a series of medium term bills of exchange, which have normally been guaranteed by the importers bank. The forfaiting bank normally forgoes the right of recourse to the exporter if the bill is dishonoured.
The exporter obtains the benefit of immediate funds, but the bank charges are expensive. Forfaiting is normally used for the export of capital goods, where the importer pays in a series of instalments over a period of years.
Leasing and hire purchase
the exporter sells capital goods to a lessor, which in turn enters into a leasing agreement with the exporter’s overseas customer.
Alternatively the equipment can be sold to a hire purchase company which resells to the importer under a HP agreement.
a large reputable exporter can arrange for its bank to accept bills of exchange (which are related to its export activities) on a continuing basis.
These bills can then be discounted at an effective cost, which is lower than the bank overdraft interest rate.
where an importer acquires commodities for the purpose of immediate resale, it can raise a loan from its bank, which takes custody of the goods until the importer is able to sell them.
Thereafter the principal sum, interest and storage costs are repaid to the bank out of the proceeds of the sale.
Requesting payment in advance from the importer
if this were possible it would avoid all of the above complications.