By Ray Pereira
The viable financing alternative.
As the global economy has become increasingly competitive, companies are finding that they must be more flexible with customers to maintain and grow sales. Being able to offer international customers better financing terms is now an important part of any sales package. Since payment from companies in other countries involves elements of uncertainty that are unlike those faced with domestic companies, credit risk becomes more of an obstacle. Selling on open account, which may be best from a marketing and sales standpoint, is fraught with danger. In particular, you may not be able to discover or understand the customer's financial situation and the economic situation of the country in which the customer is located. Also, collecting from foreign accounts is every bit as difficult as you imagine it to be. Cash-in-advance terms are more often placing you at a competitive disadvantage, as open account terms with extended dating are becoming more common despite the dangers.
Other challenges emerge as customers prefer to trade in local currencies. In addition, most domestic banks will not provide the necessary financing on export receivables. This remains a critical issue as these receivables are now utilized as a financing tool in international trade programs.
However, there is an attractive alternative: international factoring. Many exporters have added factoring companies to their list of financial partners in an attempt to incorporate international sales and financing into their objectives.
International Factoring Comes Into Its Own
International factoring may be defined as the sale of assignments of short-term (generally 120 days or less) accounts receivable arising from an international sale of goods or services. There are four parties involved in a transaction: the exporter (seller), the US factor (export factor), the foreign factor (import factor) and the customer (buyer). Transactions are somewhat more complex than traditional domestic factoring since there are a number of parties, depending on how many countries there are in which the seller conducts business.
Although international factoring has become more visible in recent years, it is not new. Factoring has been used in one form or another since the fifteenth century when merchandise█such as fish, fur and timber█was exported to England with agents from London making loans and advances to these sellers to help provide working capital.
The nineteenth century was a period of resurgence for factoring, but it was centered more in the US rather than Europe. Beginning in the 1970s, a number of countries began enacting legislation to open the doors to opportunity for cross-border trade activities, and once again the factoring industry was revived as an alternative financing tool. In 1995, $23 billion in international trade was covered by factors, up 17 percent from a year earlier. Two of the top US factors with specialty units for international factoring are Bank of America Commercial Finance/Factoring and CIT Group/Commercial Services. Some of the major factors are making export business a priority. As only one example, Bank of America Commercial Finance/Factoring was awarded the President's ¤EË Award in 1994 for its excellence in export service, and it continues to expand internationally by opening offices in Hong Kong and London.
A Worldwide Factoring Network
The international factoring business involves networks similar to the use of correspondents in the banking industry. Factors Chain International is the largest of these global networks of factoring organizations. About half the worldwide factoring transactions are through the member companies.
Global networks enable the export factor to give the seller a working financial partner to engage in factoring in another country. The member companies in each country speak the local language, keep current on who is creditworthy, and are ready to act with the export factor as the seller's overseas financial representative. This means that the seller can do business abroad as if it were next door to the customer.
The export factor will work directly with the import factor to represent the seller. Under the supervision of the export factor, the import factor will manage the seller's collections and cover the credit risk.
There are basically three elements of service offered by international factoring companies:
- Managing the receivable, where an accounts receivable manager handles collections and provides reporting and bookkeeping services. Typically, the seller "assigns" orders to the factor and the buyer pays the import factor. The export factor guarantees the payment for the order (minus charge-backs, defects, and other things that may go wrong that are beyond the factor's control).
- Furnishing credit protection on the receivable and establishing credit lines. Usually, if the order is not approved for factoring, the seller can still sell to the buyer, but collection is no longer guaranteed by the export factor. For approved orders, the factor collects the payment for the order and then pays the seller, minus the factor's fees, which can include an annual fee plus a commission on each sale.
- Lending against receivables. Interest rates vary and the most common loan is no greater than 90% of the value of the receivables. The seller must usually have a minimum of working capital and other qualifying criteria.
How It Works
The seller will sign a factoring agreement with the US factor (export factor). Under this agreement, the seller's accounts receivable are assigned to the US factor and the seller is covered against credit losses, up to 100 percent of the approved credit. The export factor selects an appropriate import factor to act on the seller's behalf overseas with the export factor's supervision. In the meantime, the import factor overseas investigates the credit standing of any local customer to whom the seller wishes to sell goods.
When approved, credit lines are established so the seller's foreign customer can place orders for goods on open account trading terms. Once authorized sales take place, the seller becomes eligible for funding. The import factor handles the local collection and payment of the accounts receivable.
During all stages of the transaction, records are kept for the seller and reports are made to give the seller important, timely information on such details as delayed deliveries, the wrong merchandise sent to the wrong place, or any other discrepancy causing delays in payment.
Typical US sellers who factor are manufacturers, distributors, wholesalers or service companies with sales ranging from $5 million to $200 million. Usually the export sales minimum is $5 million. International factoring is also becoming a financing tool for larger corporations, such as Fortune 1000 companies, who utilize factoring to manage their balance sheets.
International factoring is coming of age among US exporters and there are enormous opportunities to capitalize on the economic changes. This alternative financial tool allows the exporter to compete and increase global sales without increasing global risk.
Pereira is the International Factoring Manager for Bank of America Commercial Finance in Atlanta, and can be reached via e-mail at email@example.com