Africa, Business, Business process, Cash-in-Advance, Documentary Collections, Export & Agency Finance, Factoring, Forfaiting, ghana, Letter of credit, Open Account, Trade finance, United States, World Trade Organization, WTO
Reflex Eco Group – Africa news
by Paul Frimpong (Ghanaian Economist)
To release the potential of Africa, there is the need to develop means to facilitate trade financing across the borders. This means major financing opportunities in trading on the continent. Despite claiming regional trade as a strategic objective, African countries have yet to reach their trade potential particularly when it comes to raising funds to trade with each other. In the post independence period, trade has being a core element of the development strategy of African countries. The importance that African countries attach to regional trade has been reflected in the high number of trade schemes and policies on the continent. The trade agenda is geared towards empowering Africa to take its rightful position in the global economy.
Although some progress has been achieved on the process of Africa’s trade integration, the objective of African market integration is far from being realized. Serious efforts must be made to help Africa develop a culture where eventually, Africa will be borderless particularly in terms of doing business. However, most often than not, it is very difficult to achieve this objective because of financing constraints.
Trade financing, which is the method that importers and exporters of commodities and goods use to finance their businesses, is a major block to doing business in Africa. International trade, the cross-border exchange of goods and services is now widely acknowledged as an important engine of growth in most developing and transition economies. As Africa trades, more and more goods and commodities are bought and sold, and therefore, more and more banks and financing institutions are needed to lend money to finance the purchase and sale of these goods and commodities, right across the global supply chain. Therefore the absence of an adequate trade finance infrastructure is, in effect, equivalent to a barrier to trade. Limited access to financing, high costs, and lack of insurance or guarantees are likely to hinder the trade and export potential of an economy, and particularly that of small and medium sized enterprises.
One of the most important challenges for traders involved in a transaction is to secure financing so that the transaction may actually take place. The faster and easier the process of financing an international transaction is, the more trade will be facilitated. Trade finance therefore provides companies with the necessary capital and liquidity and helps them to better manage their cash flow, allowing them to expand and grow.
In one form, it is quite a precise science managing the capital required for international trade to flow. Yet within this science, there are a wide range of tools at the financiers’ disposal, all of which determine how cash, credit, investments and other assets can be utilized for trade. Among the trade financing tools available are discussed below:
This is when an importer must pay the exporter in cash before a transaction is made. Thus, prior to receiving a shipment of a product from an overseas vendor, importers are required to send cash in advance. With this payment method, the exporter can avoid credit risk, since payment is received prior to the transfer of ownership of the goods. Wire transfers and credit cards are the most commonly used cash-in-advance options available to exporters. However, requiring payment in advance is the least attractive option for the buyer, as this method creates cash flow problems. Foreign buyers are also concerned that the goods may not be sent if payment is made in advance. Thus, exporters that insist on this method of payment as their sole method of doing business may find themselves losing out to competitors who may be willing to offer more attractive payment terms. With the cash-in-advance payment method, the exporter can avoid credit risk or the risk of nonpayment, since payment is received prior to the transfer of ownership of the goods.
Letters of Credit
Letters of credit (LCs) are among the most secure instruments available to international traders. An LC is a commitment by a bank on behalf of the buyer that payment will be made to the exporter provided that the terms and conditions have been met, as verified through the presentation of all required documents. The buyer pays its bank to render this service. An LC is useful when reliable credit information about a foreign buyer is difficult to obtain, but you are satisfied with the creditworthiness of your buyer’s foreign bank. An LC also protects the buyer since no payment obligation arises until the goods have been shipped or delivered as promised.
A documentary collection is a transaction whereby the exporter entrusts the collection of a payment to the remitting bank (exporter’s bank), which sends documents to a collecting bank (importer’s bank), along with instructions for payment. Funds are received from the importer and remitted to the exporter through the banks involved in the collection in exchange for those documents. Documentary collections involve the use of a draft that requires the importer to pay the face amount either on sight (document against payment—D/P) or on a specified date in the future (document against acceptance—D/A). The draft lists instructions that specify the documents required for the transfer of title to the goods. Although banks do act as facilitators for their clients under collections, documentary collections offer no verification process and limited recourse in the event of nonpayment. Drafts are generally less expensive than letters of credit.
An open account transaction means that the goods are shipped and delivered before payment is due, usually in 30 to 90 days. It is now estimated that over 80% of global trade is conducted on an open account basis. Obviously, this is the most advantageous option to the importer in cash flow and cost terms, but it is consequently the highest risk option for an exporter. Due to the intense competition for export markets, foreign buyers often press exporters for open account terms since the extension of credit by the seller to the buyer is more common abroad. Therefore, exporters who are reluctant to extend credit may face the possibility of the loss of the sale to their competitors. However, with the use of one or more of the appropriate trade finance techniques, such as export credit insurance, the exporter can offer open competitive account terms in the global market while substantially mitigating the risk of nonpayment by the foreign buyer.
Factoring, or invoice discounting, receivables factoring or debtor financing, is where a company buys a debt or invoice from another company. In this purchase, accounts receivable are discounted in order to allow the buyer to make a profit upon the settlement of the debt. Essentially factoring transfers the ownership of accounts to another party that then chases up the debt.
This refers to the purchase of an exporter’s receivables thus the amount importers owe the exporter at a discount by paying cash. The purchaser of the receivables, or forfaiter, must now be paid by the importer to settle the debt. As the receivables are usually guaranteed by the importer’s bank, the forfaiter frees the exporter from the risk of non-payment by the importer. The receivables have then become a form of debt instrument that can be sold on the secondary market as bills of exchange or promissory note.
Export & Agency Finance:
This part of Trade Finance’s remit covers the roles of the export credit agencies, the development banks and the multilateralagencies. Their traditional role is complement lending by commercial banks at interest by guaranteeing payment. These agencies have once again become of vital importance to the trade finance market due to the role that they play in facilitatingtrade, insuring transactions, promoting exports, creating jobs, and increasingly through direct lending. All are important in the current global downturn.
The structure of trade finance is a simple business even though the structures used in trade finance in more complex business transaction requires a lot of work for all parties involved. This is why the total loan amount of a structured trade finance loans must be high enough to warrant the involvement of highly-paid bankers, lawyers and other advisers. But what do all these trade financing matter to Africa going forward? A question that we all need to answer as Africans.
WTO Publications© World Trade Organization 1999
ABOUT THE AUTHOR
Paul Frimpong is an Associate Chartered Economic Policy Analyst (ACCE-Global), who writes on the macroeconomy, emerging markets and global affairs.
He is also an African Affairs Analyst
Tel: +233 -241 229 548
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