As a buyer, your company may want inexpensive credit and in the case of commercial buyers, credit can provide better business opportunities, such as being able to resell goods first before having to pay for it. As a seller, the high cost of the initial investment in producing the goods may make your company less willing to accept credit.
The choice of who will bear the credit risk can be thought of as a Pareto efficiency problem. Every deal struck upon between a supplier and a buyer will carry a certain amount of credit risk that is necessary to successfully carry out the agreement and if the buyer bears less risk, then the seller will bear more risk and vice versa. Why is this the case? The buyer prefers the seller to bear the risk until the purchased items are received and the seller prefers the buyer to bear the risk until payment is received for shipped items. Either the buyer or the seller will need to bear the credit risk during the period after the goods have been purchased by the seller, but have not yet been received by the buyer.
Financing raises concerns between the buyer and the seller similar to the credit risk. After goods leave the seller’s warehouse, it may take months before the buyer receives it and financing is often necessary during this period in order to export the goods. For instance, the goods may need to be transported from the seller’s warehouse to the port where it will be exported. Since the buyer has not yet received the goods and the goods have already left the seller’s hands, the buyer and the seller will often need to compromise in order for the transaction to occur. Including clear terms in your contract to address scenarios similar to the one just described is the best way to minimize your financial risk.
Political and Legal Risks
A buyer or seller’s country can directly impact the amount of risk associated with a transaction. Both the buyer and seller’s governments can influence trade policies, impose export restrictions, delay the transport of goods, and cause the fluctuation of foreign exchange rates. Without strong legal protection in place, the buyer or the seller runs the risk of receiving little to no protection over their investment. So it is always prudent to keep a finger on the political pulse of countries you do business in.
Receiving payments from customers can become complex for businesses that offer products or services overseas and exposing some of the hidden risks can be a huge factor in your international success. Here are some questions to consider when assessing the risks associated with receiving international payments?
- What course of action can you take if you never get paid?
- How likely is it that you will not be paid and how does it compare to the likelihood of not being paid by local customers or clients?
- What method of payment will you accept?
In addition, your company's financial situation, industry, location, country, type of distribution, and the types of goods purchased will play an important role in determining whether you can conduct business and secure payments overseas.
Foreign Currency Risks
Currency exchange variations can be another area of complexity for businesses that offer products or services overseas. For one thing, there is always an exchange rate that needs to be used to convert one form of currency into another and exchange rates not only vary by country, but also can fluctuate throughout the course of a day. The value of a currency at the moment that a business deal is made may change by the time that the payment is made. The currency selected for payments in a contract can directly impact your profits. For example, suppose your business makes a deal to purchase goods using foreign currency and you have agreed to pay when the shipment arrives at your factory. By the time the goods arrive, the foreign currency may decrease in value and lower the value of the goods received, thus changing your entire purchase order.
How to Avoid International Payment Problems
Resolving an international payment issue can be challenging. Your business can reduce the likelihood of encountering a payment problem by following these tips:
1. Research. Conduct research on the laws, export regulations, currency rate fluctuations, and political stability of the countries where your potential customers or suppliers reside. Also research your suppliers by conducting credit checks where possible.
2. Contract. Make sure your contract outlines the risk that your company is expected to take on. For contracts with foreign suppliers, consider the following questions:
- What goods are being bought?
- What is the price (and in what currency)?
- How will the goods be delivered?
- Is there insurance coverage? Who will bear the risk at each stage of the transaction?
- Is there a process to address issues that arise (i.e. due to an error made by the supplier or the buyer)?
- How will legal disputes be addressed?
- When, and how, will payments be made?
3. Payment terms. Select your payment terms wisely. Consider using a cash in advance payment system and request part of the payment upfront. This can lower the risk having customers or clients that are unable to pay in the future. Also consider requesting a letter of credit to guarantee payment once the customer receives goods or services.
4. Build trust. The benefits of establishing trust with customers, clients, or suppliers are endless and a good relationship can save time, energy, and money in the long run.