Today’s global marketplace continues to grow at a rapid pace.(1) Advances in communication, development and trade have opened markets that simply haven’t been accessible to small businesses in the past. Yet, many owners are held back by the uncertainty of purchasing and selling internationally. Doing business overseas holds new risks and business owners are understandably reticent. Owners should educate themselves on the following types of risk and work with their business partners to explore ways to mitigate them.
Cash Flow Risks
Global suppliers and customers can increase the need for inventory and working capital. For example, importing a product from China means one party or the other has to fund over 30 days of “floating inventory.” As a consequence, cash-to-cash cycles can be 50 percent longer for global commerce. Global sellers and buyers also often take on unfavorable open payment terms that require sellers to self-fund inventory. The risk of loss from extending buyer credit often strains working capital.
Buying and selling in different currencies exposes a business to changes in the cost of money. It is not uncommon for currency prices to change by 10 percent or more during the life of a contract. These changes can impact top and bottom lines significantly, especially when currency shifts are particularly volatile. Talk to your banker and business partners about the following questions:
- When purchasing internationally, are you taking full advantage of savings made possible by paying in local currency?
- How might a strong or weak dollar affect your position against the competition? How might it change your product costs? Your pricing in the marketplace? Your overall strategy?
- What is your exposure to foreign exchange? How can you hedge that exposure today and in the face of market changes?
Do you have adequate capacity for foreign exchange transaction activities?
Payment risks increase internationally. The track record of overseas trading partners is often difficult to determine. When letters of credit are involved, complying with complex rules is just as important as product delivery. Language and distance make settling quality or collection issues challenging.
The Potential for Loss
Doing business internationally introduces a range of new possibilities for loss — from pirates to misdirected merchandise, and natural disasters to political instability.
It is important to understand the risks of doing business internationally, and to arrive at the right balance that allows you to compete successfully without compromising profits or wasting precious capital resources. Exporters who want to lower risk often ask customers for cash in advance. The tradeoff is that few customers can afford to do business this way. More likely, a willing buyer will look for some form of seller financing.
On the other end of the risk spectrum, the vast majority of U.S. export transactions take on unnecessary risk by offering clients “open terms” — or letting them pay cash upon delivery, effectively an IOU. Waiting for cash payment puts pressure on working capital and limits the amount of trade your business can support with existing financial resources. In many cases, open account sales are made without insuring for losses or non-payment and without hedging against changes in currency exchange rates — creating additional exposure.
The challenge is to mitigate your risk without narrowing the market to only those willing to pay in advance. To accomplish this, it is important to know about several practical and affordable risk management solutions, such as:
- Export credit insurance. A simple and cost-effective insurance policy that simultaneously protects sellers from commercial, political and non-payment risks, while making them more competitive. Credit insurance allows sellers to securely offer buyers 30, 60 or even 90-day payment terms.
- Currency risk management. Also called foreign exchange (FX) services, it can provide both importers and exporters effective ways to reduce the risks of currency shifts on offshore revenues and profits. By helping you manage your exposure to volatile currencies, you protect your top line and bottom line from currency fluctuations. You guarantee the projections for your deal by locking in favorable rates over the life of a contract or lease. FX services can also help you win business — by allowing you to offer better terms by conducting business in the local currency.
- Letters of credit. These are legal instruments that protect buyers and sellers from payment, non-compliance or default.
A global bank with a broad set of international capabilities can explain how these tools can protect your profits and help you find the right balance of risk and reward for your company.