For many companies, a jump to international sales can open up exciting growth opportunities. But it can also be much trickier to balance risks and rewards in foreign markets compared to domestic markets. Credit risks in payments are a case in point. This blog post examines the risks of typical international payment structures as well as five critical questions and considerations for optimizing risks versus rewards for your business.
Your risks are only one part of the equation
Recently, we provided CFO consulting services to a client who sells high-end computer equipment. The client was struggling with a payment balancing act. His company had a great sales opportunity in a developing nation, and he called looking for ideas to minimize transaction risks in the payment process. In a perfect world for an exporter, the answer to the question would be easy: get a letter of credit or cash in advance. Both methods are secure and essentially payment guarantees. But both options also ignore the risks to customers and the fact that your customers may have other reasonable or good options with better terms. So how do you strike the right balance between the needs of your business and your customers?
Understanding the payments “continuum”
Before exploring essential questions to ask regarding payment structures for international transactions, let’s review the primary payment options for exporters. The International Trade Administration provides a handy Trade Finance Guide that highlights four standard international payment methods on a continuum. Here is a summary of each, as well as one additional option, in the order of least secure to most secure.1
Open account—Your customer has a predefined timeframe (typically 30 to 90 days) to pay for goods, once they arrive. In competitive marketplaces, many customers may expect these favorable terms, which often present considerable non-payment risks (you may be able to offset risks with insurance).
Partial deposit—This self-explanatory method is not listed in the Trade Finance Guide. It can be a good option for offsetting risks to your business without overburdening your customer. In the end, however, it provides no guarantee that you will be paid.
Documentary collections—With documentary collections, you rely on banks to complete a transaction. Your bank provides your customers with transaction requirements, documentation and payment instructions and then collects signed documents and any payment your customers send through their bank. While the bank’s assistance can be helpful, and the cost of documentary collection is lower than the following options, there is no guarantee of payment from your bank.
Letters of credit—With a letter of credit, your customer pays its bank to commit to paying you once you have met all transaction terms and conditions. When you are confident in the credit worthiness of your customer’s bank, this method minimizes non-payment risks to your business while also protecting your customer’s interests. However, potential customers may be wary of paying for letters of credit when they have other options available to them.
Cash-in-advance—With cash-in-advance, there is no promise of delivery until payment is made via wire transfer or credit card, or other options. This method is virtually risk free to you, but usually unattractive to your customers because they assume all of the risk that you will actually deliver the goods and meet quality expectations. Prepayment is also disruptive from a cash flow perspective.
Five critical questions to consider
When it comes to deciding which payment method to use for an international deal, the following questions can quickly tell you how much risk your business can tolerate and whether or not international transactions make sense.
- What percentage of annual profit will be impacted if a deal goes bad?
- What percentage of sales is the potential deal to the company?
- What are key competitors doing from a price, quality and payments standpoint?
- Based on the risks of the payment terms customers are likely to accept, is the risk to the company worth the reward?
- Would additional support, such as export credit insurance, change the equation?
The last question brings up an important point about exporting. Many business leaders who are new to exporting are unaware that the Export-Import Bank of the United States provides all kinds of products and programs to help U.S. businesses succeed abroad, including insurance and loans. Purchasing an export credit insurance policy can help you protect your business while better meeting customer expectations on payment terms.2
Getting to win-win
After carefully weighing the payment options against business goals/realities and competitive considerations, our computer equipment reseller client decided to ask for partial deposits when making sales abroad. Since they are competing against a deep field of resellers, letters of credit or cash advances are usually out of the question. Partial deposits provide a way to show the customer goodwill and provide reasonably flexible payment terms while covering the cost of the equipment and only putting the margins on the equipment in jeopardy.
It should come as no surprise that getting to a win-win scenario is usually more difficult with international versus domestic sales, but that’s absolutely no reason to shy away from exploring the opportunities. If experience is a concern, you can always rely on CFO services from virtual CFO (vcfo) for help with finding the right balance. After all, with the right approach, your business could dramatically increase growth opportunities for a very reasonable cost and risk.
1 The Trade Finance Guide: A Quick Reference for U.S. Exporters, The International Trade Administration, April, 2007.
2 Protect Against Buyer Nonpayment, Export-Import Bank of the United States.
Bill Schwartz is a Consulting CFO for vcfo Austin. As a top financial consulting and HR consulting firm, vcfo provides contract CFO and CFO Consulting services, HR outsourcing and interim HR services. Additionally, vcfo provides technology strategies consulting and cost-effective recruiting solutions. Whether you seek part-time, interim, project-based or full-time support, vcfo’s customizable engagement model will fit your specific business needs.