Solutions such as documentary credit and supply-chain finance help reduce the financial risks associated with import-export.
In the context of international trade, the buyer (importer) and seller (exporter) do not always have the same priorities. While the buyer aims to receive the goods ordered in accordance with the quality, quantity and deadlines agreed, the seller wants above all to be paid on time. To reduce the risks assumed by both parties and strengthen their business relations, banks have developed different financing solutions, including documentary credit and the supply-chain finance method.
Documentary credit: A guarantee of payment for the seller
Documentary credit is a method of financing international transactions which offers the buyer and seller greater security. The principle is as follows: the buyer’s bank undertakes irrevocably to pay the seller a certain amount against remittance, within an agreed timeframe, of a document proving that the goods have been dispatched or that the service has been provided in accordance with the contract. To do this, the buyer must have the corresponding funds or credit facility with its bank.
Documentary credit then guarantees the buyer that it will have to pay its invoice only if the seller has fulfilled its contractual obligations; in particular, the schedule for dispatch. The seller, for its part, benefits from a payment guarantee and a reduction of commercial risks (late payment, insolvency) or risks associated with the buyer’s country.
But this method does present some disadvantages. The seller usually has to finance the production of its goods in advance, because it is not paid until after those goods have been dispatched. In addition, the system entails administrative charges and costs for both parties.
Supply-chain finance: A choice between several transaction procedures
Faced with the disadvantages of documentary credit, banks have developed another financing solution called supply-chain finance. The system operates according to the following principle: at the time of the order, the buyer sends its bank an irrevocable promise to pay. In all cases, its account will be debited when the invoice falls due.
For its part, the seller has the option of asking the buyer’s bank for a payment in advance; for example, 20 days before the due date. In this case, the bank will pay it a sum slightly less than the total invoice amount. The difference, which corresponds to costs, is calculated on the basis of the buyer’s solvency and not the supplier’s, as is usual in credit transactions. However, if the seller does not wish to be paid in advance, the money will be transferred to it on the agreed due date, at no cost.
The fact that the buyer’s account is not debited until the due date of the invoice improves its cash flow (it can work with its capital in the meantime) and reduces the risks associated with product quality. This solution offers the seller access to additional capital under advantageous conditions in the context of other transactions, which helps it reduce its payment deadlines.