Financing of International trade | Management Optional Notes for UPSC PDF Download

Introduction

A significant global initiative undertaken by a domestic company involves the exchange of goods and services through imports and exports. Trade financing exhibits several shared characteristics with the conventional value chain operations conducted by businesses universally. Every company is obligated to identify suppliers for the myriad goods and services essential as inputs for their internal processes related to goods production or service delivery.

Principles of international trade financing:

1. Maximize Profit and Sales:

   • In any business deal, the main goal is to increase sales and profits.

2. Manage Risk:

   • At the same time, it's crucial to handle and control any potential risks that might come up.

Risks in International Trade Finance:

1. Non-payment Risk:

   • There's a risk that the other party may not pay as promised.

2. Incorrect or Insufficient Goods:

   • Sometimes, the products received might not be what was expected or may not be enough.

3. Currency Issues:

   • Dealing with different currencies can be tricky and might pose a risk in international trade.

Sources of International Trade Financing

Private Banks and Thrift Institutions

• Services Provided:
  • Private banks and thrift institutions offer financial services such as Letters of Credit (LC), financing options, and wire transfers to their customers.
  • LC facilitates secure transactions, financing aids in monetary support, and wire transfers ensure swift movement of funds.

Private Equity Firms and Individuals

• Financial Support Services:
  • Private equity firms and individual investors provide financial support through services like loans, trade finance, and Purchase Order (PO) finance.
  • Loans offer capital, trade finance supports international transactions, and PO finance helps fund the procurement of specific orders.

Public and International Institutions

• Specialization in Financing:
  • Public and international institutions specialize in financing solutions, particularly for trade and Purchase Orders (POs).
  • These entities play a crucial role in facilitating financial transactions on a larger, often global, scale.

Success in Global Marketplace

1. Key Success Factor:

   • Studies emphasize a crucial factor for success in the global market: exporters must provide customers with appealing sales terms.

2. Ultimate Business Goal:

   • The primary goal in every export sale is to receive full and timely payment for the products or services.

3. Payment Method Importance:

   • Choosing the right payment method is vital, balancing the need to minimize payment risks while meeting the buyer's requirements.
   • This careful selection contributes significantly to successful global business operations.

There are five primary methods of payment for international transactions (Baker, 2003)

Cash-in-Advance

1. Payment Process:

   • In cash-in-advance, the exporter receives payment before transferring ownership of the goods to the buyer.
   • Common methods include wire transfers and credit cards, with the emergence of online escrow services for smaller transactions.

2. Buyer Considerations:

   • This approach is less favorable for buyers due to the impact on cash flow.
   • Buyers may be concerned about making payment upfront without assurance of goods delivery.

3. Competitive Dynamics:

   • Businesses relying solely on this method risk losing to competitors offering more attractive payment terms.

Letters of Credit (LCs)

1. Security in Transactions:

   • LCs are a secure mechanism ensuring payment in international trade.
   • The buyer's bank commits to pay the exporter once specified conditions in the LC are met.

2. Buyer Protection:

   • LCs protect buyers as there's no payment obligation until goods are shipped according to the agreed-upon terms.
   • Especially useful when reliable credit information about the foreign buyer is challenging to obtain.

Documentary Collections (D/C)

1. Payment Collection Process:

   • In a documentary collection, the exporter's bank collects payment through the importer's bank.
   • It involves sending necessary documents to release goods upon payment.

2. Cost-Effectiveness:

   • Generally more cost-effective than LCs, but it lacks a thorough verification process.
   • Limited recourse for non-payment issues.

Open Account

1. Deferred Payment Structure:

   • In an open account, goods are shipped and delivered before payment is due, often within 30, 60, or 90 days.
   • Presents a high risk for exporters, but it's advantageous for importers in terms of cash flow.

2. Risk Mitigation Techniques:

   • Exporters can use trade finance techniques, such as export credit insurance, to reduce the risk of non-payment.

Consignment

1. Payment Upon Sale:

   • In consignment, payment is made to the exporter after the goods are sold by the foreign distributor to the end customer.
   • It involves a contractual arrangement where the exporter retains title to the goods until they are sold.

2. Risk and Benefits:

   • High-risk strategy for exporters, as payment is not guaranteed.
   • Offers advantages like better availability, faster delivery, and reduced inventory costs.

3. Success Factors:

   • Success in consignment relies on partnering with reputable foreign distributors and having proper insurance coverage.

International Trade and Finance

1. Definition:

   • International trade involves the exchange of capital, goods, and services across borders.
   • Trade finance, often facilitated through banks, encompasses both traditional methods like letters of credit and non-traditional methods such as structured financing.

2. Methods Overview:

   • Various payment methods cater to different needs and risks in international trade, offering flexibility and options for both exporters and importers.

In essence, these detailed explanations cover the intricacies of different international trade financing methods, shedding light on their processes, considerations, and competitive dynamics. Each method comes with its advantages and challenges, providing businesses with options based on their preferences and risk tolerance.