International Trade Operations - Essay Example

INTRODUCTION This report provides an insight into the payment risks involved in international trade activities. It evaluates and analyses the possibility of various risks associated with different kinds of payment procedures and puts forth the available remedies to curtail those risks. The report has been designed and formulated for ABC Ltd, which is a medium-sized company engaged in manufacturing electronic goods in UK and exporting them to both developed and developing countries. The company's major exporters are Malaysia, Canada, China and Algeria etc. As the company is engaged in operating internationally, providing the goods to international markets, the business involves several risks. The most critical of those risks is the risk associated with payment, which is to be received by the company from the importing countries. This issue has been chosen as the central objective of this report and therefore, assessing various payment risks underlying the operations of the company concerned in international markets, this report highlights the crucial steps that need to be taken by ABC Ltd to reduce these risks to the extent that can enable the company to minimize the probability of incurring loss in the course of international trade. PAYMENT RISKS IN EXPORT As an exporting country, the company confronts with two kinds of risks undermining the payment in consequence of international trade. These risks could be in two forms; either in the form of non-payment by the importer or in the form of late-payment due to a number of reasons. There are many factors that bring about the risk underlying payment in the international trade. As the business operations are carried out on the cross-border level, several international as well as domestic events taking place within both the exporting and importing countries may have their impact on the extent of risk associated with payment. RISK OF NON-PAYMENT This is the greatest risk underlying the export trade, which may cause substantial business loss to the exporter. ABC Ltd is providing electronic goods to both the developed as well as developing countries therefore, it comes across many cases in which it fails to receive export payments form the importers due to lack of credit worthiness, no or little information about importer, government policies and protection, lack of legal action and due to insecure payment modes. RISK OF LATE PAYMENT This is another risk underlying export payments, which may also cause irreparable loss to the company. The manufacture of electronic goods requires continued flow of capital that is ensured by secured payment from the buyers of the products. Late payments may entail innumerable problems for the business in terms of re-scheduling its manufacturing process. Information about buyers and their countries can play an important role in pre-determining the probability of late payments and potential problems that may arise due to it. ASSESSMENT OF PAYMENT RISKS Following are the most common risks that are involved in receiving the payment of goods exported to other countries: Commercial risks The commercial risks that are associated with the export payment are intimately related to the importers credit worthiness. These risks may turn into business loss if the buyer becomes bankrupt or insolvent rendering the exporter unable to receive the payment for goods exported. The commercial risks also include the non-acceptance of goods on the part of importer, showing his unwillingness to pay (Trade Facilitation and Electronic Commerce, accessed 02.01.2006). ABC Ltd also confronts the risk of default on payment by a buyer or importer at the end of the credit period. The company risks the payment against goods exported when the buyer is less credit-worthy. Risks Associated With Different Payment Methods The following are the common modes of payment used by ABC Ltd. in export trade. Some of them are highly insecure and involve risk potential. The risks associated with the different payment methods are assessed below: Cash in Advance This is the most desirable method for ABC Ltd., as it deals in the kind business and export the kind of products that need continued flow of capital in the company so as to complete the manufacturing process without any hassle. However, this method is not adapted by many importers as it causes high risks to them relating to the product quality and timely delivery. This method does not include a risk of non-payment, but may entail a possibility of decline in sales. Therefore, not most of the export transactions are carried out using this payment method by the company. Letter of Credit (L/C) This method can help the company to eliminate the risk of non-payment by the importer. A letter of credit is issued by the importer's bank as a guarantee that if the buyer fails to make payment for the goods purchased, the bank would be liable for the payment on presentation of relevant documents. The bank ensures the delivery of goods on time for importer and protects the right of payment for exporter (Guidance Notes for Overseas Purchases and Sales, accessed 02.01.06). Open Account This method of payment greatly involves the risk of non-payment by the importer. Under this method, the exporter sends the document containing payment request and conditions after the shipment of goods. After the goods are shipped, the payment depends entirely upon the buyer and his consent. For UK exporters, the importers usually ask for Open Account method of payment. Therefore, the exporter should go for this method only if he is confident about receiving the payment (Methods of Payment in International Trade, accessed 02.01.06). ABC Ltd. mostly confronts with the risks associated with this payment method. Documentary Drafts Under this method, the exporter in UK sends the documents to the importer's bank after the shipment of goods ordered. Those documents contain several conditions that buyer must comply with in order to take custody of the goods. The condition may be to release the goods only if the buyer makes immediate payment against it or an agreement that the buyer would pay at an agreed future date (Methods of Payment in International Trade, accessed 02.01.06). Therefore, this method can help the company to curtail the risks involved in foreign trade. Date Draft ABC Ltd. faces considerable risk of non-payment due to buyer default or insolvency under this method. It is sort of evidence that the importer would pay at an agreed future date, generally after the goods are delivered to the importer. The risk that is involved in this method is that the company may risk the payment for goods exported if the buyer dishonors the draft or fails to pay on the given date. Risk of Exchange Rate Fluctuation Fluctuation in the rate of foreign exchange in international markets is one of the greatest risks underlying export trade. ABC Ltd. is engaged in exporting goods to overseas markets, both the developed as well as developing countries. This increases the company's exposure to foreign currencies. The company usually agrees to receiving payment after the goods are produced and shipped, which offers great risks to company with respect to fluctuations in exchange rate. For example, when it exports goods to China, which is the main market for the company, the risk becomes much greater because of volatile nature of Chinese currency. This may result into unpredictable loss for company, if the importing country's currency devaluates before the payment is received. This can also happen in case of an international trade currency, for instance, US dollars. In this case, the company is likely to bear losses if the dollars devaluate, enabling the importers to spend less on the currency of transaction, while minimizing the profits for exporters. Risk of Currency Repatriation It is yet another risk faced by ABC Ltd. in the course of receiving payment against the goods exported. Most of the customers like the price of goods and agreement of sale to be in their domestic currency, which entails the risk of currency repatriation for the company. If the company agrees to carry out the export trade for a foreign currency and the payment is made after the goods' shipment, the company can incur loss in repatriating the currency in the company's domestic currency after receiving the payment. This may happen when the exporter's domestic currency devaluates before the repatriation of currency. In this case, the company will get less value in its currency for the money received in another currency. Country Risk The country to which the goods are being exported also holds considerable importance to the exporter. The political circumstances, natural sphere and economic state of a particular country may entail risks of non-payment or late payment (Getting Started in International Trade, accessed 04.01.06). ABC Ltd. exports goods to developing countries as well, and therefore, confronts with the risk of any uncertain and unstable situation in any of its importing countries. The major companies importing goods from ABC Ltd are from Malaysia, Canada, China and Algeria. The country or political risks faced by the company in any of these countries is discussed below: Malaysia is one of the important markets for the company's products. The political risk faced by businesses in this country is medium according to an estimate. The ethnic Malay community is affecting on the political condition of the country resting upon the difference between Islamic and secular school of thought. The country is facing succession problems ever since the country's former deputy Prime Minister Anwar Ibrahim left the authority (Asia risk, Malaysia, accessed 01.01.06). Therefore, the country's rising political uncertainty can cause various problems for businesses, especially ABC Ltd can risk its payment incase of any unpredictable situation. Algeria is another country in which the company has to confront with political risks. These risks are at the medium level with respect to the current situation according to an estimate. After the early period of 2003, the country suffered disastrous earthquakes and floods, which needed international community to extend their aids. Besides such political risks, the businesses need to protect their interest in the country because of its obsolete and orthodox banking system (Africa Risk, Algeria, accessed 01.01.06). Therefore, the company needs to protect its right of receiving payment from companies in Algeria with the help of various insurance options available. Apart from these two countries, the other importing countries to which the company exports goods have less risky political condition. MINIMIZATION OF PAYMENT RISKS Having learnt the major risks leading to late payment and non-payment faced by ABC Ltd., we will discuss the remedies that could take the company towards the minimization of payment risks in international export trade: Appropriate Payment Method The most efficient way to mitigate payment risks faced by ABC Ltd. is to choose appropriate payment method for its export transactions. There are many methods that can be used by an exporter to receive payment against the goods exported. Among all the payment methods mentioned above, the company should choose the safest way to ensure receiving the payment on time. Evidently, the most suitable method of payment that the company should use would be advance payment, but as this option is very risky for the importers, they may not agree on that very often. Therefore, the company should use another secure method such as a Letter of Credit, which involves the guarantee of importer's bank that incase if the importer fails to pay the exporter, the bank will make payment on the importer's behalf against some collateral. These two are the safest methods that should be used by the company in order to avoid late-payment and non-payment. However, if due to some reasons the company decides to go for the payment options other than advance payment and Letter of Credit, the company should ensure that the payment is insured against any payment risk. Exchange Risk Insurance The Exchange rate risk is the greatest risk faced by the company dealing in international markets being exposed to different foreign currencies. But the company can alleviate this risk with the help of any of the following measures: Forward Currency Contract: The forward currency contract refers to buying or selling a certain quantity of foreign exchange at a specific date or before or after a date. This assures the exporter of the exact amount he would receive after selling the foreign exchange received from the importer, regardless of the fluctuations in exchange rates (Overseas Trade, accessed 05.01.06). This kind of protection against exchange rate fluctuations will minimize the payment risk faced by ABC Ltd especially in case of Chinese currency because of the volatile nature of its currency. Foreign Currency Account in UK: This is yet another method to combat the impact of exchange rate fluctuations on payment value and minimize the risk incurred. Under this method, the company can have a bank account and reserve it for foreign currency received in payment from the importers. This will require the company to keep the foreign exchange reserves until the exchange rate comes to a level that is favorable to the company (Overseas Trade, accessed 05.01.06). Such a method will require ABC Ltd. to hold its reserves may be for a long period depending upon the exchange rate of a particular currency. However, this can be done in the case when an increase in the currency's exchange rate is expected by the company. Foreign Account This method holds for opening a bank account in the importing countries. The exporter can hold the foreign currency in the overseas bank account for as long as it comes to a level that is favorable to the exporter. Opening a bank account in the importing country will also provide convenience to the importers as they would be dealing with their local banks (Overseas Trade, accessed 05.01.06). Opening an account in a foreign country where major exports are made can be considered by ABC Ltd. to curtail the payment risk involved in dealing with foreign currency because of exchange rate volatility of some particular currencies such as Chinese Yuan. Overseas Investment Insurance The Overseas Investment Insurance is provided by the Export Credits Guarantee Department (ECGD) to the companies in UK investing abroad especially in some of the world's poorest countries. This insurance provides protection to the companies incase of non-payment due to political risks or country risks in the countries where the investment is being made (Overseas Investment, accessed 09.01.06). In order to ensure full payment from the importer's side on time, ABC Ltd. can also consider this method of coverage to insure against any payment risks. It will cover the country and political risks faced by the company in developing markets such as Algeria where political conditions are uncertain giving rise to payment risks in particular situations resulting into non-payment or delayed-payment to the company. Performance Bond Coverage The Performance Bond Coverage is issued by either a bank or an insurance company on the behalf of selling company as a security that all the terms and condition on the contract would be met by the other party (Willsher, glossary, accessed 09.01.06). This coverage can act as a guarantee for a company engaged in export trade like ABC Ltd. and help it recover the payment for goods exported incase of any non-payment or delayed payment by the importer. Credit Insurance This type of insurance is necessary for exporters to avoid any risks associated with payments. The exporters, who need to confront with political risks as well as the risk of delayed payment due to extended credit terms granted to importers, should make use of this method of insuring their payments. The credit insurance protects the rights of exporter in case of non-payment by the importer within 6 months of the payment due date. It also provides coverage against non-payment arising due to some political risks such as war, problems in currency repatriation, withdrawal of export and import licenses etc (Guidance Notes for Overseas Purchases and Sales, accessed 02.01.06). Therefore, ABC Ltd can avail this this insurance facility when dealing with politically risky countries like Malaysia and Algeria as well as the importers who are less credit worthy in order to ensure that export payments are received full on time. Lines of Credit A letter of credit acts as a line of credit for a particular import transaction. It also provides as an undertaking for the exporter that the payment will be made on the due date. It becomes an irrevocable undertaking by the importer's bank that the bank would become liable to pay the due amount if the importer fails to pay the amount, after all the conditions for opening an L/C have been fulfilled and the goods are shipped to the destination on the date mentioned on the Letter of Credit (Glossary of Terms, accessed 07.01.06). As stated above, it is the safest way to receive export payment from the importer on the due date for ABC Ltd. Short-Term Post-Shipment Insurance The short-term post-shipment insurance is a kind of security provided to the exporter after the goods are shipped to the importing country. ABC Ltd. can take up this option in the situations where it is not sure of an importer to make the payment on time or fears non-payment due to any reason i.e., a lack of importer's creditworthiness or any uncertain condition prevailing in the importing country. This will help to minimize the payment risk borne by the company. Therefore, after discussing all the major risks faced by ABC Ltd. within its specified markets and the methods to alleviate those risks in this report, it becomes evident that the company confronts with major risks due to the reason that it operates in international market as a small and medium enterprise. However, if the company follows the measures stated above, it will help the company to mitigate the risks involved in international export trade. 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