Managing Finance & Risk Protection

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A number of payment methods are available for conducting international transactions. However, it is crucial to note that what is usually financially risky for exporters, will often be least risky for foreign buyers and vice-versa. In order to compromise, you may decide to offer attractive sales terms accompanied with appropriate payment method to win sales against foreign competitors.

By choosing the most appropriate and least risky payment method, you may be able to reduce potential payment risk while also accommodating the needs of the foreign buyers.A Documentary Letter of Credit or L/C is usually considered the most popular payment option in international trade settlement. It is a document issued mostly by financial institutions which usually provides irrevovable payment undertaking to a beneficiary against complying documents as stated in the L/C. L/Cs can also be confirmed, transferable, back-to-back, revolving or “Red Clause”.

These payment instruments are subject to the International Chamber of Commerce publication, the Uniform Customs & Practice (UCP) for Documentary Credits, version 600. You should contact your bank for a copy if you intend to trade using Documentary L/C’s.

Managing Credit and Payment Risk:

Assess creditworthiness of foreign buyers

Low- risk buyer

High- risk buyer
  • No issue
  • May apply a less costly transaction structure
  • Design risk management strategies
  • Obtain insurance 
  • Obtain secure payment options
  • Choose not to pursue business

 

A brief comparison of the payment methods for exporters (taken from Export Development Canada):

Payment options

Complexity

Risk

Trade Relationship

Features

Cost

Payment in Advance

Minimal

Low

Higher-risk relationships or export markets

Various options as to timing and proportion of prepayment

Low

Letter of Credit (L/C)

High

Low

Applicable to all levels and types of relationships, may be a necessity in certain markets irrespective of the trade relationship

Wide range of payment, financial and risk mitigation options

High

Documentary Collection

Medium

Medium

Recommended for use in established and secure trade relationships and in stable export markets

Limited flexibility and features; opportunity for financing

Moderate

Open Account

Low

High

Recommended for use in the most secure trading relationships and markets only

Payment vehicles and timing may vary widely

Minim

 

Managing Foreign Exchange Risk:

Some common techniques used to minimise foreign currency exchange risks include:

  • Forward contracts: are contracts that allow the exporter to sell a fixed amount of foreign currency at a fixed price at a mutually agreed future date by entering into contract with commercial banks. Such contracts eliminate the uncertainty associated with FX fluctuations.
  • Exposure netting: relates to the practice of matching foreign currency inflows with outflows in the same currency to eliminate or "net out" the exposure. This is best handled by opening a foreign currency account with you bank.
  • Currency options: are contracts that grant the right (but not the obligation) to buy or sell foreign currency at a specified price, within a defined time period. Option contracts offer the possibility for exporters to benefit from favourable fluctuations in FX rates.

It should be emphasised that obtaining a secure payment option such as irrevocable L/C or confirmed L/C may greatly increase the protection your company will have from payment default. Banks will be able to provide you with advice on other payment options including their advantages and disadvantages, as well as how you can protect yourself against fluctuation in foreign exchange rates. Export Finance and Insurance Corporation (EFIC) can also provide competitive finance and insurance facilities to assist Australian firms exporting and investing overseas.