This article is taken from the latest newsletter from Ray Stannard at International Trade Financial Solutions http://www.inttradefinsolns.co.uk.
Tomorrow, Ray begins a glossary of terms which are apt to confound and confuse importers and exporters!
The Risk Ladder is one way to demonstrate some of the ways in which overseas trade can be financed. It focuses on the relative advantages and disadvantages, mainly from a cashflow point of view and clearly shows that, usually, what’s best for one party will be the least favoured for the other. Such is the way with most trade. There is always the over-riding aspect of how you get on with your counter party, plus the fact that, in many instances, one party will hold the upper hand in terms of negotiating. For example, if you have to buy your stock from 1 supplier only, you have a much more limited bargaining hand. Nevertheless, the Risk Ladder is still a useful tool insofar as it explains the effect of various types of payment/settlement.
From this, you can assess the impact on your cashflow. This, in turn, helps with finance planning and, if necessary, gives you longer advance notice of any pinch points in your cashflow.
OK, so what is it? It takes the most common forms of payment options and their appeal [or otherwise] to both an importer and exporter. Looking at an importer first, your preference is to pay as late as possible – ideally well after you have received the goods and sold them. However, for the exporter, he wants money up front. The following payment methods are in
descending order of preference for an importer and ascending order of importance for an exporter.
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Open Account. Pay after receipt of goods
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Acceptance Collections. Payment made by the acceptance of a future dated bill of exchange with all accompanying transport and commercial documents being processed through a bank. The longer the acceptance term, the more beneficial for the importer, as he has longer to pay.
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Payment collections. As above, except that there is no period of grace to pay. The buyer [importer] can only obtain the documents once he has paid for the underlying goods.
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Unconfirmed Letter of Credit. More costly to set up; the importer usually has to put some collateral aside for his bank to agree to issue.
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Confirmed Letter of Credit. Even more expensive, but the seller [exporter] has the added benefit that a local bank [in his Country] has added their name to the payment.
[Note that with Letters of Credit, it is the documents and not the goods that determine whether or not payment is forthcoming].
Advance Payment. Exporter is paid before he parts with goods.
With all of these, ITFS can help with more explanation, indication of likely costs and all other aspects of their respective uses and benefits.