Chapter 6

Financing International Trade

Trade Finance Methods
Accounts receivable financing
Factoring
Letters of credit (L/Cs)
Banker’s acceptances
Working capital financing
Medium-term capital goods financing (forfaiting)
Countertrade

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 Trade Finance Methods
Accounts Receivable Financing
• Could take the form of an open account shipment or a time draft. Prior to shipment,
the exporter should have conducted its own credit check on the importer to
determine creditworthiness. If the exporter is willing to wait for payment, it will
extend credit to the buyer.
• If the exporter needs funds immediately, it may require financing from a bank. The
bank will provide a loan to the exporter secured by an assignment of the account
receivable.
• If the buyer fails to pay the exporter for whatever reason, the exporter is still
responsible for repaying the bank.

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 Trade Finance Methods
Factoring

• Factoring represents the sale of outstanding receivables related to export of goods by the
exporter to overseas buyers. The seller of the receivables thus transfers the risk of default
on contractual obligations arising from non-payment by the buyer to a third party (is called
a factor).

• The factors may be independent or subsidiaries of major banks and financial institutions

• The seller of the receivables is paid discounted value of the receivables. Factoring is
possible with recourse or without recourse.

• The advantages enjoyed by an exporter due to such financing are immediate payment after
export. The exporter can enjoy financial benefit, in the case of without recourse, at no risks
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arising from the deal after factoring.
 Trade Finance Methods
Factoring Mechanism

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 Trade Finance Methods
Factoring Mechanism

1. Seller issues an invoice to buyer, with instructions to pay the factor directly

2. Seller sends a copy of the invoice to the factor

3. The factor pays an agreed percentage of the invoice amount to the seller

4. The factor operates credit control procedures. The factor sends a statement of account to
the buyer on behalf of the seller

5. The buyer makes payment of the full amount of the invoice to the factor as per agreed
terms.

When an invoice is not paid on the due date, the liability will depend on the type of
agreement,
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for example whether it is with recourse or without recourse to the seller.
 Trade Finance Methods
Benefits of Factoring to the exporter:

- By selling accounts receivable, exporter does not have to worry about the administrative
duties involved in maintaining and monitoring an accounts receivable accounting ledger.

- The factor assumes the credit exposure to the buyer, so the exporter does not have to
maintain personnel to assess the creditworthiness of foreign buyers.

- The exporter receives immediate payment and improves its cash flow.

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 Trade Finance Methods
Factoring for International Trade:

- Since it is the importer who must be creditworthy from a factor’s point of view, creoss
border factoring is often used.

- This involves a network of factors in various countries that assess credit risk. The
exporter’s factor contacts a correspondent factor in the buyer’s country to assess the
importer’s creditworthiness and handle the collection of the receivable.

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Trade Finance Methods
Banker’s Acceptance

 Bill of exchange, or time draft, drawn on and accepted by a bank. It is the accepting
bank’s obligation to pay the holder of the draft at maturity.

 If the exporter does not want to wait until the specified date to receive payment, it
can request that the banker’s acceptance be sold in the money market. By doing so,
the exporter will receive less funds from the sale of the banker’s accountance than
if it had waited to receive payment. This discount reflects the time value of money.

 A money market investor may be willing to buy the banker’s acceptance at a

discount and hold it until payment is due.
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Banker’s Acceptance
Trade Finance Methods
Banker’s Acceptance

??? WHAT IS THE DIFFERENCE BETWEEN BANKER’S ACCEPTANCE AND ACCOUNTS

RECEIVABLE FINANCING ???

??? WHAT ARE THE BENEFITS OF BANKER’S ACCEPTANCE FOR EXPORTER, IMPORTER
AND ISSUING BANK ???

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 Trade Finance Methods
Medium-Term Capital Goods Financing (Forfaiting)

 Because capital goods are often quite expensive, an importer may not be able to make payment on
the goods within a short time period. Thus, longer-term financing may be required here.

 Forfaiting refers to the purchase of financial obligations such as bills of exchange or promissory
notes, without recourse to the original holder, usually the exporter.

 In a forfaiting transaction, the importer issues a promissory note to pay the exporter for the
imported goods over a period (from 3 to 7 years). The exporter then sells the notes, without
recourse, to the forfaiting bank.

 Similar to factoring in that the forfaiter (or factor) assumes responsibility for the collection of
payment from the buyer, the underlying credit risk, and the risk pertaining to the countries involved.

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 Multi choices question
1. Which of the following is a reason why commercial banks can facilitate international trade?
a. The exporter may not wish to accept credit risk of the importer
b. The government may impose exchange contracts that prevent payment by the importer to
the exporter
c. The exporter may need financing until payment for the goods is received
d. All of the above

2. Consider an exporter that sells its accounts receivables off to another firm that becomes
responsible for obtaining cash from the various importers. This reflects:
a. accounts receivable financing
b. forfaiting
c. factoring
d. a letter of credit
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 Multi choices question
3. Consider a bank that acknowledges that it will make payments on behalf of a computer
importer after the computers are delivered to the importer. This reflects:
a. accounts receivable financing
b. forfaiting
c. factoring
d. a letter of credit

4. Consider an importer that issues a promissory note to pay for the imported capital goods
over a period of five years. The notes are extended to an exporter who sells them at a discount
to a bank. This reflects:
a. accounts receivable financing
b. forfaiting
c. factoring
d. a 14letter of credit
 Multi choices question
5. Consider an exporter that is willing to send goods to the importer without a guaranteed
payment by the bank. The bank provides a loan to the exporter that is backed by the value of
the exported goods. This reflects:
a. accounts receivable financing
b. forfaiting
c. factoring
d. a letter of credit

6. MNCs can use ____ to sell their existing accounts receivable as a means of obtaining cash
a. accounts receivable financing
b. forfaiting
c. factoring
d. a letter of credit
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