information on how to hedge risks of importing in order for your banker to facilitate the financing of the transaction.
ow to finance your International Trade with no money down. A practical guide.
- by Shaun Beecham - © Shaun Beecham All Rights reserved - (thedlcadvantage@msn.co.za)
The reason for writing this article is to explain the process on how a trader or agent is able to finance their business of buying goods from a supplier and then selling these goods to a buyer without using any of their own capital. There are many ways to achieve this but this article will deal with one particular method namely using Documentary Letters of Credits to finance transactions.
In order to explain the concept fully, we will need to analyze the following case study:
A trading company known as World Wide Traders CC won a contract to supply stationery to a stationary company in Angola. World Wide Traders CC concluded the sales contract for an initial order of USD250 000,00 delivered on a DDU basis at the buyers warehouse in Angola and subject to the Incoterms 2000. World Wide Traders CC requested a Documentary Letter of Credit confirmed by a first class South African Bank payable at sight of documents. World Wide Traders CC source the goods from a supplier in China for USD185 000,00 based upon a CPT Lobito Port Angola Incoterms 2000 price. The supplier would like a Documentary Letter of Credit payable at sight for payment of the goods. World Wide Traders CC approached their bankers to finance the transaction due to their balance sheet not being strong enough to issue a Documentary Letter of Credit for USD185 000,00.
Their bankers agreed to finance the transaction provided the transaction meets the following criteria :
1) The bank can confirm the letter of credit issued by the buyer in Angola. 2) The bank can co appoint the freight forwarding company. 3) The bank can co appoint the insurance company. 4) The transaction will not require any value adding. 5) The transaction is self liquidating. 6) The transaction is profitable. 7) The transaction complies with the South Africa Reserve Bank regulations.
Let us explain the seven points above in some detail and discuss the reason why the bank is insisting on these conditions.
The bank is able to confirm the letter of credit issued by the buyer in Angola. In short this means that the bank will be able to rely on the instrument issued. The bank will know that it is able to get paid provided that it complies with the terms and conditions of the Documentary Letter of Credit. The bank by financing this transaction must also know that it can fulfill these terms and conditions of the Documentary Letter of Credit. For example in the case study above the buyer requested that the goods be supplied on a DDU basis. This means that the seller will deliver the goods to the buyer's warehouse in Angola. The seller will need to prove this by the issuance of a delivery note that is a conditional for payment under the Documentary Letter of Credit.. When the bank issues the out going Documentary Letter of Credit payment will made against a Commercial Invoice and a Bill of Lading. In other words once the supplier provides these two documents the supplier will receive payment under the Documentary Letter of Credit issued in their favour. Clearly the bank will not able to secure payment under the incoming instrument as the bank will require a delivery note and not a bill of lading. It is for this reason that the bank insists on co appointing the freight forwarder. By co appointing the freight forwarder the bank ensures that the transaction can be completed as the freight forwarder will deliver the goods and will control the issuance of the delivery note. The delivery note is handed to the bank for presentation under the Documentary Letter of Credit. Usually the bank and the freight forwarder enter into an agreement for the above arrangement.
Why does the bank insist in co appointing the insurance company? In the above case study, the risk of loss of the goods passed from the seller in China to the buyer at the port of loading in China. The seller can now present their documents for payment under the Documentary Letter of Credit. However the bank can only get paid against presentation of a delivery note in Lobito. The Bank will ensure that it's interest have been noted in the transaction in order that it may liquidate the transaction. The bank will prefer to know that the goods are adequately insured for the correct landed costs value.
Why does the bank not allow any value adding? By value adding the bank means that certain modifications are needed to the goods. For example the pens need a name of a certain company printed on them. The bank prefers to be in control of the transaction and the goods at all times. If for some reason the value adding did not take place the bank will not be able to liquidate the incoming Documentary Letter of Credit and therefore receive payment. The bank will always prefer to finance pure source and supply type transactions as it is easier to keep control. The bank will also insist on a costing being done for the transaction to ensure that it is profitable. It is of no use if the goods will cost more to import, custom clear and delivery and insure than the amount that the goods are being sold for. Again this forms part of the self liquidating condition and will need to be satisfied. The final condition being South African Reserve Bank regulations being complied with is of vital importance. The bank will not be able to facilitate any type of transaction that does not comply to the South African Reserve Bank regulations.
Financing of International Trade is usually the last area of concern on the traders or agents agenda. It should be the second area of concern, directly after securing the order and placing the order. My advice to all traders and agents who need to finance their International Trade to approach their bank's International banking department and speak to someone who understands the above risks. By doing so you will save yourself time, energy and frustration and ensure that you are in a position to deliver your products to your buyers quicker than your competitors.
resource Shaun Beecham For more information please contact the author at thedlcadvantage@msn.co.za
About the Author
Specialist in trade finance advising compnaies on how to hedge the risks associated with the financing of imports or exports.