- Understand the Risks: Cross-border commerce can open your business to substantial commercial, political and foreign exchange risks. Be sure to understand the risks and rewards, and how you can choose the best strategies depending on your role in the transaction.
- Use Proven Tools to Protect Your Business: Working with an experienced and trusted banking partner, you can expand cross-border relationships using letter of credit instruments and other financing tools to help you maximize growth opportunities.
Today, innovation companies understand that expanding into global markets can deliver a competitive advantage and be a significant catalyst for growth. Like any sound financial planning, expanding your ability to succeed in cross-border business requires developing a strategy that intelligently manages the risk.
Assessing the risk is the first step. Here are a few questions the seller/exporter should ask before moving ahead:
- What's our leverage with the buyer to secure fast and full payment?
- Have we conducted the appropriate risk/reward analysis around extending credit to make a deal vs. loss of value/risk of default?
- Do we have protections in place in case of default?
Here are some typical scenarios to help evaluate payment and financing guarantee mechanisms to increase your opportunity for cross-border success. Letters of credit carry fees and interest costs, so it's important to compare options when consulting with your banker.
|Trade Finance Tools and Tips ||Your Role in the Transaction |
Cash in Advance
Exporters who insist on payment in advance as their sole method of doing business may find themselves losing out to competitors who may be willing to offer more attractive payment terms.
Wire transfers and credit cards are the most common cash-in-advance options.
- Seller/Exporter: Most secure
The exporter can avoid credit risk, since payment is received prior to the transfer of the goods.
- Buyer/Importer: Least secure
Requiring payment in advance is the least attractive option for the importer, raising concerns that the goods may not be sent if payment is made in advance.
Exporters who are reluctant to extend credit may lose the sale to competitors. Credit insurance can provide protection that will allow the exporter to offer more competitive account terms while reducing the risk of non-payment.
- Seller/Exporter: Least secure
An open account transaction means that the goods are delivered before payment is due, usually within a prescribed time period. This is the highest risk option for an exporter.
- Buyer/Importer: Most secure
Foreign buyers often press exporters for open account terms since the extension of credit by the seller to the buyer is more advantageous to them.
Commercial Letter of Credit
A letter of credit (LC) is an excellent risk-mitigation tool and a secure instrument since the issuing bank's credit replaces the buyer's credit. Exporter has a greater assurance of payment provided all terms and conditions are met, generally eliminating foreign bank or country risk, if confirmed by a reputable bank.
An LC can be detailed and complex, increasing the potential for discrepancies, so it should be prepared by well-trained documenters.
- Seller/Exporter: More secure
An LC is recommended for use in new or less established trade relationships when the buyer's creditworthiness is hard to substantiate, but the seller is satisfied with the creditworthiness of the buyer's bank.
An LC protects the seller against order cancellation. LCs with deferred payment terms provide the seller with an LC discounting option to receive payment earlier. This allows the exporter to close out the receivable resulting in improved DSOs and cash flow.
- Buyer/Importer: More secure
An LC protects the buyer since no payment occurs until the documents proving that the goods have been shipped or delivered as promised are presented. Extended payment terms may be available under an LC, allowing payment at a later date.
Standby Letter of Credit
A standby letter of credit is not used as a means for primary payment. It serves as a "secondary" guarantee in case the primary payment system does not work.
The letter of credit should be drawn only if the buyer/seller fails to fulfill the obligation of the underlying contract.
- Seller/Exporter: More secure
Common uses include guaranteeing credit limits for suppliers and office/equipment leases.
- Buyer/Importer: More secure
Common uses include guaranteeing advance payments and bid and performance bonds.
Guide to Foreign Exchange Policy: The guide helps you create a formal policy for managing foreign exchange (FX) exposure. This process will help you examine accounting and cash flow implications, in context of your risk tolerance and corporate goals.
Guide to Trade Finance: Silicon Valley Bank's Trade Finance Guide explains the common techniques for managing risk as you expand your company's global presence.
Have questions on how to set up accounts for your overseas business? We are here to help. Contact your Silicon Valley Bank Relationship Manager or Global Treasury and Payments Advisor to start a conversation. Visit SVB.com for additional information and best practices for global expansion.
The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decisions. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.
Foreign exchange transactions can be highly risky, and losses may occur in short periods of time if there is an adverse movement of exchange rates. Exchange rates can be highly volatile and are impacted by numerous economic, political and social factors, as well as supply and demand and governmental intervention, control and adjustments. Investments in financial instruments carry significant risk, including the possible loss of the principal amount invested. Before entering any foreign exchange transaction, you should obtain advice from your own tax, financial, legal and other advisors, and only make investment decisions on the basis of your own objectives, experience and resources. Opinions expressed are our opinions as of the date of this content only. The material is based upon information which we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied upon as such.