Archived: The basics of export financing

5. The basics of export financing

It may not be possible for you to finance an export initiative entirely from your company's resources. For example, you might need additional capital to cover production and operating costs until the goods are finished, shipped and paid for. In such cases, you will need to know what financing might be available and where you can obtain it on the best terms.

The guide Grants and Financing, which you will find at
www.canadabusiness.ca/eng/page/2868, provides a detailed overview of how Canadian exporters can finance their U.S. initiatives. The essentials are fairly straightforward and we will examine them in the next sections.

5.1. Types of financial assistance

There are several types of basic financial assistance for export ventures: pre-shipment financing, post-shipment financing, medium-term financing and project financing.

• Pre-shipment export financing

  You may require additional financing to produce the goods or services your buyer wants. To persuade a lender to help you, you will need a firm export sale and a contract that is acceptable to the lender in terms of repayment risk, payment terms, production timeframes and recourse conditions.

• Post-shipment export financing

  This covers your financial needs during the time between shipping the goods and receiving payment for them.

• Medium-term export financing

  This is often used with capital goods exports.You can usually obtain such assistance for terms of 180 days to two years, and possibly for terms of as long as five years.

• Project financing

  This usually applies to large undertakings such as major capital projects. This is a less common export field for small- to medium-size Canadian businesses, since such projects tend to be long-term, complex and demanding. If you are considering becoming involved in one, be sure to obtain help from project-financing experts from the very beginning.

5.2. Obtaining financial assistance

There are three chief sources for the financial help you may need: banks, government assistance programs and venture capital. In brief:

• Banks

  As with domestic business operations, bank lines of credit or loans are commonly used to help fund export operations.

• Government assistance

  Several government agencies and programs exist specifically to help Canadian exporters do business abroad. Among them are:

  • The Business Development Bank of Canada (BDC) provides flexible financing for the development of international markets, R&D, product modifications and new production equipment or technology. Refer to www.bdc.ca for more information.
  • Export Development Canada (EDC) offers innovative commercial solutions to help Canadian exporters and investors expand their international business. EDC's knowledge and partnerships are used by 6,400 Canadian companies and their global customers in up to 200 markets worldwide each year. Refer to www.edc.ca for more information.
  • Industry Canada's "Finding Financing" web page at
    www.ic.gc.ca/eic/site/ic1.nsf/eng/h_00073.html may help you identify other private or public sources of financing.
• Assistance from regional agencies

  Various regional development agencies offer financial assistance to exporters. Refer to the Canada Business Network at www.canadabusiness.ca to find out what financing programs may be available, or call 1-888-576-4444.

5.3. U.S. buyer financing

Suppose you have a potential U.S. buyer who does not, for legitimate reasons, have the immediate financial resources to purchase your goods. You may be able to arrange financing for such a buyer through Export Development Canada, which can offer flexible financing and payment options to companies wanting to buy Canadian goods and services. Better yet, you can enjoy peace of mind knowing that you can secure a cash sale while EDC assumes the risk if your customer does not pay. To find out more, refer to EDC's Financing page at www.edc.ca/financing.

5.4 Payment methods

Canadian businesses exporting to the United States should be prepared to give credit terms to their buyers. The most common payment method is by open account, with a 30- to 90-day credit period. "Open account" means that you agree to ship the goods, or provide the services, before getting paid. This is simple and involves less paperwork than other payment methods, but it has one huge drawback. You are fully exposed to your buyer's credit risks and if the buyer refuses to pay, for whatever reason, you may not get your money.

You can insure yourself against such risks, but another option is to seek more favourable payment terms from your customer, at least until you develop a relationship. These include:

• Cash in advance

  Your buyer pays you in full, or provides a deposit, before you ship the goods or provide the services. This is obviously the best option for you. However, U.S. buyers may refuse to purchase from you if you do not sell on open account.

• Letters of credit

  Letters of credit (LCs) offer the best protection for exporters because they designate banks to receive and check shipping documents and to guarantee payment.

  There are two major types of LC: confirmed LCs and unconfirmed LCs. A confirmed LC has been issued on behalf of the U.S. customer by the customer's bank, and its validity has been confirmed by a domestic Canadian bank. If you have a confirmed LC, you are reasonably assured of receiving payment from the Canadian bank even if the U.S customer or the customer's bank defaults.

  An unconfirmed LC is less secure, since it has been guaranteed only by the bank that issued it, not by a receiving bank in Canada. The issuing bank merely informs you that the LC has been opened, and tells you what the credit terms and conditions are.

  LCs can also be irrevocable. This means they cannot be cancelled or amended without your approval. The most secure form of payment is an LC that is both confirmed and irrevocable.

• Documentary collections

  To use a collection, you entrust the collection of payment to a remitting bank, usually your own. The remitting bank sends documents to a collecting bank (usually the importer's bank), along with instructions for payment. The collecting bank accepts your buyer's payment and sends it to the remitting bank, which then pays you. Collections are less complicated but also less secure than LCs, because you are exposed to your buyer's credit risks until you receive payment. However, they are preferable to the open-account approach.

5.5 Dealing with non-payment

If you have delivered your goods to the U.S. company but it has not paid you, what recourse do you have?

You can hire a lawyer or a collection agency, but it can still be very difficult for a Canadian exporter to recover payment from recalcitrant U.S. customers, especially if the customers have sought bankruptcy protection. Legal action can be exceedingly costly, so arbitration or mediation to settle out of court is preferable if you can arrange it. This, of course, presupposes that you wrote an arbitration/mediation clause into the contract with your buyer. If you did not, your best course is to obtain legal advice and consider whether it is even worthwhile to pursue payment.

Hiring a licenced collection agency can also help to encourage payment. Although cheaper than hiring a lawyer, this is still expensive because collection agents take as payment a percentage of the amount they recover.

5.6 Reducing financial risk through buyer credit checks

A buyer's failure to pay, whether because of bankruptcy or for some other reason, can spell serious financial trouble for a Canadian exporter that is badly exposed to the buyer's risk. However, you can do a lot to protect yourself from the risk of non-payment by carrying out a careful credit check before signing the contract. Some of the questions you need to ask are:

• Is the U.S. company creditworthy?
• How long has it been in business?
• Is its financial record clear of irregularities?
• What reputation does its management have?
• Do other suppliers give it a good credit report?

There are several places you can go to obtain this information:

• Export Development Canada's database contains detailed credit information on millions of U.S. buyers. Its EXPORTCheck service is a convenient way to review an online credit profile of your potential U.S. buyer before you export. Starting at a fee of $30, an EXPORTCheck Report is one of the best ways to manage the risks of an unfamiliar customer. For more information, refer to www.edc.ca/english/creditinformation.htm.
• Contact your Canadian bank and ask if it has a correspondent bank that can report on the buyer's reputation.
• Find out if the buyer deals with other Canadian companies and check with them to see what they think of the buyer. Mention the buyer to Canadian companies you've dealt with in the past, in case they may have pertinent information.
• There are many consulting firms and credit reporting agencies in Canada and the United States that will help you check out a buyer. This checking can be expensive, but if it uncovers serious risks for your company it is worth every penny.

5.7 Reducing financial risk through export insurance

If you cannot get cash in advance, purchasing some form or export insurance is the best way to avoid the most serious consequences of buyer non-payment. In Canada, these types of insurance are the specialty of Export Development Canada and include:

• Accounts Receivable Insurance

  EDC will protect you against non-payment by covering up to 90 percent of your losses resulting from a wide range of commercial and political risks. Better still, you will be able to free up capital and possibly extend more attractive payment terms and credit options to new customers. For more information, refer to
  www.edc.ca/english/insurance_accounts_receivable.htm.

• Single Buyer Insurance

  If you are an occasional exporter or are concerned about selling to a new customer or a new market, you can insure your sales with Single Buyer Insurance. This covers you for up to 90 percent of losses due to non-payment, on an unlimited number of sales to the same customer, for up to US$250,000 during a sixmonth period. For more information, refer to
  www.edc.ca/english/insurance_single_buyer.htm.

• Contract Frustration Insurance

  EDC's Contract Frustration Insurance covers up to 90 percent of costs that might arise from risks such as buyer insolvency, political instability or sudden contract cancellation. For more information, refer to
  www.edc.ca/english/insurance_contract_frustration.htm.

• Performance Security Insurance

  This covers you for up to 95 percent of your losses if your customer demands payment of a bond issued by your bank without valid reason. For more information, refer to
  www.edc.ca/english/insurance_performance_security.htm.

• Political Risk Insurance

  Political Risk Insurance (PRI) helps protect your overseas assets for up to 90 percent of losses from political risks, including breach of contract, conversion, expropriation, non-payment by a foreign government, political violence, repossession and transfer. For more information, refer to
  www.edc.ca/english/insurance_political_risk.htm.

5.8 Currency fluctuations

Fluctuations in the value of the Canadian dollar relative to that of the United States can affect export profits either positively or negatively. The risk presented by such currency fluctuations is called foreign exchange risk or FX risk, and you have to factor it into your operations plans and your pricing. If you do not, your budgeting may go off track, you may not have enough cash to meet payment obligations, and you may even risk bankruptcy.

There are two major types of FX risk or FX exposure:

• Transaction exposure

  Suppose you conclude a contract with a buyer and he commits to pay you in U.S. funds 60 days after delivery. Now suppose the Canadian dollar rises in value against the U.S. dollar by the end of that 60 days. Because of this, your buyer's payment will be worth less to you once it is converted into Canadian currency. Conversely, if the Canadian dollar falls during that 60 days, the payment will be worth more to you after conversion to Canadian currency. This situation is called transaction exposure.

• Economic exposure

  If transaction exposure is the small picture, economic exposure is the big one. When the Canadian dollar rises in value, Canadian goods and services become more expensive in the U.S. market. This may cause U.S. buyers to buy less, drive harder bargains or look for better deals elsewhere. Conversely, Canadian exporters that buy their raw materials, components or equipment from the U.S. will get more for their money when the Canadian dollar is high.

You can minimize your exchange risk by using tools such as the following:

• Currency forward contracts allow you to lock a price at which your company is obligated to buy or sell U.S. currency at your specified date. These forward contracts are non-transferable, and you will need a line of credit for currency transactions. Using them will allow you to protect your revenues, profit margins or expenses at a fixed price.
• Currency futures contracts allow you to specify a price at which U.S. currency will be bought or sold at a future date. Your company can close out these contracts early if it is to your advantage, giving you more flexibility. You will also need to maintain a margin/cash deposit at all times to compensate for the credit risk.
• Currency options give you the right, but not the obligation, to buy or sell U.S. currency at a specified exchange rate during a specific period of time. Regardless of whether you exercise the option, there is a cost.

These financial instruments (also called hedging tools) are complicated, and you should obtain experienced financial and accounting advice to determine which ones are best for your company. They will also cost you money, so be sure to build the required fees into your financial plans.