Sources of risk, International Terms of Payment, & Export Finance

1. Sources of risk, International Terms of Payment, & Export Finance

2. Risk As with market entry methods, all firms modify their behaviour to accommodate risk. Nelson (p122) identifies 5 sources of risk in international business: Fifth risk is commercial risk: the normal risk inherent in business activities: can’t be avoided, only minimised by planning, information, trustworthiness, anticipation.

3. Of these, foreign exchange risk is the most important, but is dealt with in 200094 International Marketing (in outline) and 200055 International Finance (in depth); transportation risk is in Lecture 9. Political risk (q1&2) Political risk refers to the possibility of unwanted consequences from political activity after the firm is committed to a market Political risk arises from: General instability – war or revolution eg. Fiji, Iraq Expropriation/Confiscation – gov’t theft with/out compensation (expropriation equals take it with money otherwise confiscation without money) Operational factors (administrative or operational risks) – tax, local content requirements, employ nationals (eg Vanauatu), import restrictions Finance – profit repatriation restrictions – blocking money going out Political risk reduction strategies for investing firms: Spreading risk between several markets – manage risk Borrowing locally – pay with a local bank Joint ventures Good corporate citizenship – provide public services , fair local contracts; positive contribution of investment

4. Market insurance (= export payments insurance or sovereign risk insurance) MNEs use this to insure large long-term projects (investments, plant/equipment/loans), but for SMEs main value is insuring ongoing export shipments against political or credit risk Largely unavailable from private sector insurers, but essential for intnl trade, hence govt creation of EFIC. For SMEs cover is offered for: Political risks - events in the buyer’s country: Hostilities, civil disturbances, administrative or legislative measures that prevent performance of seller’s contract Imposition of laws, directives or decisions that prevent the conversion of local currency or block the international transfer of payments due under seller’s contract Cancellation or non-renewal of buyer's import permits Commercial risks: Insolvency of buyer Buyer’s wrongful failure to meet contractual payment obligations

5. Credit risk Most economies are lubricated by credit; without credit from suppliers firms require more capital> buy less. Hence govt established EFIC (e.g. finance extensions… and guarantees) For exporting firms main risk is non-payment. For SMEs risk is magnified by their limited resources. Risk is reflected in payment terms, offset by trust: Czinkota et al 2008

6. What these payment terms mean: Consignment: goods kept as inventory in buyer’s store, paid for as used (used monthly) Open account: goods supplied on credit with no bank gtee D/A, D/P: goods supplied on buyer’s signing bank draft agreeing to pay at a future date (D/A) or immediately (D/P at sight). Seller may discount a term draft for cash Letter of Credit: payment is guaranteed by a bank. Most important Cash in advance: payment by buyer

7. Letter of Credit (or documentary credit): very common in exporting; )(example Nelson p128) developed with intnl banking law to g’tee payment in foreign trade; simultaneous transfer of title & payment via independent third party (ie a bank); can be used to Raise finance irrevocable confirmation • Westpac demonstration: http://www.westpac.com.au/flash/export-demo/BBIT_letterofc_export.swf

8. Sources of export finance for SMEs Firms often need finance beyond the company’s working capital. Export orders can be used to finance the production of the goods, or improve cash flow. Letters of Credit: because they carry a bank g’tee they can be used as collateral Factoring: selling export receivables, discounted by time to settlement; Forfaiting: Gov’t ‘lending’: eg EFIC ‘Headway’ scheme – g’tee issued to exporter’s bank

9. Extra slide on Ch 3 Qu 4 & Qu 5 (F&Ls, SSs) Finance Finance is to a company what oil is to an engine. Firms’ need for/use of finance and hence their financial structure varies with their type of product and industry, Corporate finance: capital that the company raises to start or expand its operations (eg buy equipment, lease factory). • How much? Big co’s like BCs need a lot because their type of Biz involves big projects (coal mine, LNG project) needing upfront funding. Hence rely on capital from parent co (MNE subsidiary), banks, stockmarket (public raising). SMEs usually start with founder’s own finance, eg founding shareholders’ funds  then add working capital from bank loans, overdrafts, mortgages, retained earnings etc.

10. Trade finance: finance to fund the production of goods & services. • Why? Firms should be generally self-funded, but as they grow they need more money to fund their expansion. There’s a time lag between getting an order to supply goods/supplying a service and getting paid. This gap needs financing • Where from? Domestic sources such as turning receivables into immediate cash (factoring, forfaiting), or trade related. Basically loans secured against future payment. Eg L/C is a bank guarantee  g’tee of payment can be collateral for a loan to fund the manufacture of the ordered goods. Ref EFIC. Terms of payment: • Tangibles have supply of goods as evidence of contract completion; intangibles don’t. • Tangibles are paid for the goods, services may be ongoing hence often time-based  unit of supply may be hours/month. • Services consumed, not onsold

11. Next week… Export transactions (2): International Terms of Sale Documents of title (Bills of Lading) Export transaction law