An open account transaction in international trade is a sale where the goods are shipped before payment is due, which is typically in 30, 60 or 90 days. Obviously, this option is advantageous to the importer in terms of cash flow and cost, but it is consequently a risky option for an exporter. Because of intense competition in export markets, foreign buyers often press exporters for open account terms, if possible, denominated in their local currency. In addition, the extension of credit by the seller to the buyer is more common abroad. Therefore, exporters who are reluctant to extend credit may lose sales to their competitors.
However, while open account terms will enhance export competitiveness, exporters should thoroughly examine the political, economic, and commercial risks as well as cultural influences to ensure that payment will be received in full and on time. Exporters can substantially mitigate the risk of non-payment associated with open account trade by using trade finance techniques such as export credit insurance, factoring and standby letters of credit. Exporters may need to obtain export working capital financing to reduce the burden on cash flow caused by granting extended terms.
Characteristics of an Open Account Transaction
Applicability: 8BRecommended for use (a) in low-risk trading relationships or markets and (b) in competitive markets to win customers with the use of one or more appropriate trade finance techniques.
Risk: Substantial risk to the exporter because the buyer could obtain the goods and default on payment.
Pros: (1) Boosts competitiveness in global markets; (2) Helps establish and develop successful trade relationships.
Cons: (1) Significant exposure to the risk of non-payment; (2) Additional costs associated with risk mitigation measures and financing.
Key Points
• The goods, along with the necessary documents, are shipped directly to the importer who has agreed to pay the exporter’s invoice at a specified date, which is usually in 30, 60 or 90 days.
• The exporter should be confident that the importer will accept shipment and pay at the agreed time and that the importing country is commercially and politically secure.
• Open account terms may help win customers in competitive global markets with the use of one or more of the following trade finance techniques: (a) export working capital financing, (b) export credit insurance, (c) export factoring, and (d) standby letters of credit.
• Open account terms may also be offered to importers who demand to pay in their local currency with the use of a proper foreign exchange risk hedging technique, such as forward contracts.
Export Working Capital Financing
Exporters who lack sufficient funds to extend open account terms in global markets need export working capital (EWC) financing that covers the entire cash cycle, from the purchase of raw materials through the ultimate collection of the sales proceeds. EWC financing can be structured to support export sales in the form of a loan or a revolving line of credit. Due to the repayment risk associated with export sales, EWC financing for U.S. small and medium-sized enterprises (SMEs) is generally only available through commercial lenders participating in the EWC Guarantee Programs administered by the U.S. Small Business Administration and the Export-Import Bank of the United States.
Export Credit Insurance
Export credit insurance (ECI) provides protection against commercial losses (such as default, insolvency, bankruptcy) and political losses (such as war, nationalization, and currency inconvertibility). ECI allows exporters to increase sales by offering more liberal open account terms to new and existing customers while providing security for banks that are providing working capital and are financing exports. ECI can also be used for sales using documentary collections and even as an alternative to confirmation for sales using letters of credit, but exporters will not likely be allowed to choose to insure only individual transactions—insurance companies normally require “whole turnover” of export sales on a year-to-year basis.
Export Factoring
Factoring in international trade is the discounting of short-term receivables. The exporter transfers title to their short-term foreign accounts receivable to a factoring house, or a “factor,” for cash at a discount from the face value. Factoring allows an exporter to ship on open account as the factor assumes the financial liability of the importer to pay and handles collections on the receivables. Factoring houses most commonly work with exports of consumer goods.
Standby Letters of Credit
A standby letter of credit (SBLC) acts as an insurance policy issued by the importer’s bank in favor of the exporter in a trade transaction, assuring that payment will be made if the importer fails to pay as agreed. The SBLC is suitable once a regular trade relationship is established between an exporter and importer. Using an SBLC, as a condition for trading on open account terms, greatly improves cash flow for the importer while mitigating the risk of non-payment for the exporter. An exporter can also consider selling on open account terms to an unknown importer with an SBLC issued by a reputable bank in a stable country, which is generally seen as a sign of the importer’s good faith as well as a proof of their credit quality and ability to make payment.
Forward Contract
Exporters can use a forward contract to offer open account terms to foreign buyers who demand to pay in their local currency. A forward contract enables the exporter to sell a set amount of foreign currency at a pre-agreed exchange rate with a delivery date in the future (typically three days to one year) to their foreign exchange service provider. This ensures that the U.S. exporter will receive a predetermined payment in U.S. dollars at a future date regardless of fluctuating exchange rates upon receiving payment in foreign currency from the importer. A forward contract does not provide protection against the risk of currency inconvertibility.
Trade Finance Technique Unavailable for Open Account Terms: Forfaiting
Forfaiting is a method of trade financing that allows the exporter to sell their medium and long-term receivables to a forfaiter at a discount, in exchange for cash. The forfaiter assumes all the risks, thereby enabling the exporter to offer extended credit terms and to incorporate the discount into the selling price. Forfaiters usually work with exports of capital goods, commodities, and large projects. Forfaiting was developed in Switzerland in the 1950s to fill the gap between the exporter of capital goods, who would not or could not deal on open account, and the importer, who desired to defer payment until the capital equipment could begin to pay for itself.
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