Step-by-Step Guide to Exporting - Paying Your Way: Planning Your Export Financing
"It's important to be diplomatic, especially when 'securing payment' for overseas sales. Demanding payment up front can be a terrible insult in some cultures." Exporter
Page Index
Understanding the risks of export financing
Imagine that you've just received your first international order for your product or service, and to your astonishment it's far, far larger than you expected. Suddenly you realize you're going to need more production capacity to fill it - but how are you going to finance the expansion you need? You can't do it from the export sale, because your buyer will likely want a 30-, 60-, 90-day, or even longer payment plan, and possibly will ask for financing assistance as well. And what if the company defaults or goes out of business before paying you?
Such risks mean that self-financing a growing export business can be very risky, especially for new or smaller exporters. Fortunately, however, financing options exist that can minimize your risks and even give you a competitive edge. For example, many new exporters may be able to offer their foreign customers competitive loans or financing terms through Export Development Canada (EDC).
A resource that will also help you here is TCI's Introduction to Export Finance. You can obtain it at exportsource.ca/finance.
Export Myth
I can't afford to export
Yes, you can! It's true that you'll need to market your product or service abroad and that you may have to expand capacity to fill foreign orders, but this won't necessarily demand large capital outlays and a lot of new staff. Sources such as TCI, EDC, BDC and the Canadian Trade Commissioner Service will be happy to furnish all kinds of inexpensive help, from market entry support to the provision of working capital.
Tip
Be prepared to meet increased demand from a successful foreign sale. Don't forget to plan how you'll adapt your product or service to the needs and tastes of your target market.
Planning your export finances
There are lots of stories about small firms finding overnight success in the export market. Most profitable export ventures, however, are built with sustained effort over relatively long periods of time.
Even though Canada is one of the least expensive countries in the world in which to do business, the costs of exporting can add up. Because of this, your export drive will need the financial stability and strength that comes from a reliable cash flow. You will also need a comprehensive financial plan for the export venture. If you don't have one, it will be very difficult to arrange the financing the venture may need.
The most important objective of your plan, however, is ensuring that your company always has sufficient cash or operating lines of credit. To do this, the plan must include:
- A cash budget - this highlights your financing requirements over the next two or three years, so you can determine the timing and amount of your cash expenditures.
- A capital budget - this is a longer-term cost-benefit assessment of your export objectives. It provides an overview of the funds you'll need to complete your export project and provides an operating plan against which you can measure actual expenditures and revenues. It also tells you when the project will start generating positive cash flows.
With respect to cash, you'll need to know the timing of both inflows and outflows. Cash flow planning can help you defend against such problems as:
- exchange rate fluctuations;
- transmission delays;
- exchange controls;
- political events; and
- slow collection of accounts receivable.
These segments of your financial plan relate mainly to your company's current financial situation, and accurate details are important to the overall effectiveness of your export plan.
Tip
Remember that international trade payments usually take longer to arrive than domestic ones, so allow for this in your cash flow planning.
Where to get financial help
There are two major sources of financial aid for exporters: Export Development Canada and the Business Development Bank of Canada.
Export Development Canada's working capital solutions
EDC's Pre-shipment Financing Program is designed to help you finance work-in-progress needs related to a product that will ultimately be exported. You may also be able to obtain additional working capital by applying for the Master Accounts Receivable Guarantee (MARG). MARG uses the security of an EDC guarantee to increase the availability of operating-line financing secured by foreign accounts receivable. If your foreign buyer needs financing, EDC may provide a direct loan for this purpose. Alternatively, EDC can arrange such financing through lines of credit or promissory note purchases.
Finally, if your buyer requires you to post a bond, EDC can help you obtain surety bonds or bank letters of guarantee, and can also insure you against the risk of wrongful call on the bond.
To find out more about these services, go to EDC's Small Business Services at www.edc.ca/smallbusiness. You'll also find EDC's online services useful; they're at www.edc.ca/online. Finally, for personalized help, you can call EDC at 1 866 260-4446.
Business Development Bank of Canada (BDC)
BDC can help you meet your working capital needs through long-term financing and flexible repayment options. Call a representative at 1 877 232-2269 or visit them at www.bdc.ca.
Tip
When you're researching your export financing, don't forget to investigate TCI's ExportSource Web portal at exportsource.ca. It has links to international, federal and provincial bodies that offer financial information and assistance to both new and experienced exporters.
Finally, it's payday
There are several common ways for customers to pay an invoice in international trade: cash in advance, letter of credit, documentary credit, documentary collection, and open account. We'll examine them in order of increasing risk to your company.
Cash in advance
Cash in advance is your most secure option, since it eliminates all risk of non-payment and adds to working capital. Unfortunately, few foreign buyers are willing to pay cash in advance, although some will pay a portion when goods or services are specially ordered. For services, a retainer might be paid upon signing a contract, after which progress payments are matched to deliverables.
Letter of credit
Letters of credit (LCs) provide some security to both the importer and exporter because they rely on banks to receive and check shipping documents, and to guarantee payment. An LC can allow the costs of financing a transaction to be borne by either the exporter or importer. Both sight and term payment provisions can be arranged.
Letters of credit can be confirmed or unconfirmed. For example, a Canadian bank can confirm an LC issued by a foreign bank, thus guaranteeing that the Canadian bank will pay the exporter even if the foreign bank doesn't. This kind of LC is obviously much better for you than the unconfirmed one.
LCs can also be irrevocable. This means it can't be cancelled or amended without your approval. The most secure form of an LC is one that is both confirmed and irrevocable.
However, letters of credit aren't foolproof - you should examine them carefully before accepting one. Check them as follows:
- Are the names of the applicant (buyer) and the beneficiary (exporter) complete and spelled correctly?
- Is the LC irrevocable?
- Is the LC confirmed by a reputable Canadian bank?
- Are the amount and currency of the LC acceptable?
- Are the shipping and expiry dates acceptable, and is the time period for presentation of documents sufficient?
- Can the shipping instructions be met?
- Are the goods or services to be provided accurately described?
- Are the insurance specifications acceptable?
Source: Adapted with permission from the Atlantic Canada Opportunities Agency, The Atlantic Canada Opportunities Agency Trade Tool Kit.
Documentary credit
Exporters can also use sight and term documentary credits, as follows:
- A documentary credit calling for a sight draft means that the exporter is entitled to receive payment on sight, i.e. upon presentation of the draft to the bank.
- A term documentary credit, in contrast, may allow for payments to be made over terms of 30, 60, or 90 days, or at some specified future date.
Documentary collection
In a collection, you ship goods to an importer (your customer) and forward the shipping documents to a collecting bank. Next, the customer pays the collecting bank in exchange for the documents. You then obtain the money from the bank.
With a collection, you're exposed to the credit risks associated with the importer until you actually get the money. In other words, no bank has guaranteed that you'll get paid, and you're required to finance the shipment until your customer receives the goods and pays through a sight or term draft.
Open account
Open accounts require you to ship goods and pass title to the customer before payment is made. In these cases, you're fully exposed to any credit risk associated with the customer until payment is received. In addition, because open account terms usually allow 30, 60, 90 days (or even longer) before payment is due, you effectively finance the transaction.
Pitfall
Low priority - the exporter uses foreign markets as a backup to the domestic market and abandons exporting when the local economy booms.
Insuring against non-payment
Imagine this: you assumed your foreign purchaser was reliable, but something has gone seriously wrong at his end and now he can't, or won't, pay. If the future of your company hangs on the deal, this is a nightmare scenario. Even if it wasn't, the impact of non-payment can be severe and lasting.
You can protect your company from such a disaster through Export Development Canada's Accounts Receivable Insurance. It covers up to 90 per cent of the value of a sale when the customer doesn't pay. For details on this, and also for information about insurance against political risks, go to www.edc.ca/insurance.
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