Rewards & risks of export payment terms

Offering flexible payment terms can give you a competitive edge in your international business, but if you choose the wrong terms, you may increase your risk of payment problems. Understanding the terms you can realistically offer and managing their potential hazards can help you achieve success. 

In most international sales, the exporter and importer use one of the following to manage global payments:

• Cash in advance: Through this payment, the buyer pays you before you ship their order. This method is the most secure for you, as it removes the risk of non-payment. But for your customers, cash in advance is the least satisfactory way to pay because it cuts into their cash reserves or credit line and they have no guarantee that you’ll deliver the goods. Few international customers will agree to cash in advance.
• Open account: If you offer open account terms, you agree to ship your goods and invoice your customers before they pay you. The customer must pay you before a deadline specified in your contract—usually within 30 to 180 days of receiving the shipment. Buyers prefer these terms because of their low risk and the cash flow benefits they provide—they obtain the goods before paying for them and can hang onto their money for an extra one to six months. Consequently, offering an open account will make your products or service exports more competitive in many markets and industries.
  For you, the big risk of an open account is non-payment since the customer gets possession of your goods before paying for them. For this reason, it’s vital to do credit checks and conduct due diligence on the buyer before you sign a contract using these payment terms. You can reduce your risk further by using export credit insurance (see below).
• Letters of credit (LCs): LCs provide security to both you and your buyers because they use banks to receive and verify trade documents and guarantee payment. But requiring payment via LCs can be a major drawback when you’re trying to be competitive because your buyer is usually responsible for obtaining the LC from their bank and the fees can be steep. The buyer will also have to provide collateral with their bank to support the LC, which could deplete their working capital. As a result, requiring payment via an LC can make you less competitive in the eyes of a potential customer. But in some instances, this may be the only way to transfer funds internationally for that buyer due to currency restrictions in some international markets.
• Documentary collections: With this form of payment, you get your money from your customer in exchange for the shipping documents. Since the buyer needs this paperwork to bring the shipment through local customs, they have to pay you before they can use the documents to take possession of the goods. The mechanics of the process and the document traffic are normally handled by your bank and the buyer’s bank.
   

Your international competitiveness is affected by several factors, including:

• price
• quality
• delivery
• warranties

Another element, which you shouldn’t overlook when trying to make a sale, is your ability to offer attractive payment terms.

“For example, suppose your competitor is offering an open account payment with a 30-day term to your prospective buyer. If you can offer an open account payment with a 60-day term, the buyer may prefer the extra flexibility you can provide and accept your deal,” says Karkas.

But what if offering an open account seems too risky with this market and this customer? “Then, you can use export credit insurance to lower your risk to a comfortable level,”  he says. “The insurance protects your receivables if the buyer fails to pay, and it can allow you to offer payment terms that will get the deal done.”

EDC offers a full suite of insurance products to help you mitigate this risk. 

Enhancing your competitiveness by offering flexible payment terms can be very successful, but you need to do it carefully. “This means finding an acceptable balance between your risk and that of your potential customer,” says Karkas.

Trying to get a prospect to accept most of the risk of the transaction—for example, by demanding cash in advance—may cost you a lucrative deal. At the other extreme, your terms shouldn’t be too lenient. If they are, you may have to wait months to get paid, which will impact your cash flow. Karkas adds, “Neither result is what you want, so it’s crucial to choose the right payment method for your particular market, customer and transaction.”

How you negotiate will also depend on knowing the normal practices of the local business culture. Companies in the United States, for example, usually expect open account terms of 30 to 60 days, while buyers in other markets often prefer LCs and may demand credit terms of up to 180 days. Longer terms are common in export markets, especially for capital goods. This is largely because of the complex logistics involved in international shipping, customs regulations, and the time required to set up financing arrangements.

At EDC, we’re committed to sustainable and responsible business practices. Read about our due diligence review here.
 

Having a clear idea of a prospective buyer’s creditworthiness will help significantly when you’re deciding how flexible your payment terms can be. The better the buyer’s credit record and financial capacity, the more lenient—within reason—you can be with your terms. Here are four tips  to help uncover and use this vital information:

1. Thoroughly check a new customer’s credit record. Finding international corporate information can be difficult, especially for emerging markets, but local consulting firms may be able to help. You can also get assistance from the Canadian Trade Commissioner Service (TCS) office and through EDC Company InSight.

2. Discuss your credit terms with a new customer before you extend credit. This will help you gauge the customer’s attitudes toward credit and ensure that they clearly understand what you expect of them. Here’s where your negotiation skills come in handy.

3. Establish credit limits using tools such as credit agency reports, bank reports and audited financial statements if available.

4. Make sure your contract clearly specifies the payment terms of the sale. If a purchase order is part of the paperwork, make sure the payment terms are also included and are the same as the terms in the contract.

Foreign exchange (FX) rates

“Cost certainty is being eroded in today’s global market,” Karkas warns. “In some countries, the value of the local currency is fluctuating almost day by day. If you’re selling to buyers in such markets, you should take FX rate fluctuations into account when you offer payment terms.”

Why? Because the longer the term, the longer you’re exposed to potentially adverse FX rate changes, and the higher your FX risk becomes as a result. A shorter term, if you can negotiate it, may keep that risk to an acceptable level. This situation is aggravated when the buyer pays late. According to Cribis Dun & Bradstreet’s Payment Study 2023, for example, 7.4% of invoices in India were paid more than 90 days after the due date in December 2022.

But it’s not just countries with unstable currencies that can be an FX risk. “A Canadian exporter who’s selling into a supply chain anywhere abroad, including the United States, and is receiving payment in the local currency, will be exposed to FX risk,” Karkas says.

“Moreover, if the company is purchasing products from Country A in A’s currency, and selling them in Country B for B’s currency, it creates multiple exposure points: First, when it buys from Country A, and again, when it sells the goods in Country B. Again, keep payment terms as short as you can to mitigate your FX risk,” says.

Admittedly, you may lose sales or new international contracts if you insist on a 30-day term when a customer wants 90 days. But if you use EDC’s Foreign Exchange Facility Guarantee to back the sale, this doesn’t need to happen. The FX guarantee is used as a tool for Canadian companies to assist with thawing frozen margin/collateral, so that the company may utilize these dollars as working capital within their business.

Flirting with disaster

Imagine a company, XYZ Widgets, that’s eager to land a large export sale. To ensure it beats out the competition, XYZ accepts a deal with these characteristics:

• The sale is an open account with a 180-day term.
• It’s to a new customer whose credit record is so hard to find that XYZ doesn’t pursue it.
• The customer is in a high-risk market that’s new to XYZ.
• XYZ doesn’t use credit insurance or an FX guarantee.
• The payment terms aren’t clearly spelled out in the contract or purchase order.

If the amount of the sale is large enough and things go wrong, XYZ Widgets could be in serious financial straits. Real-life companies have gone bankrupt in such situations.

Resources

One key resource is EDC’s Global Economic Outlook, which outlines the potential risks, including the gross domestic product (GDP) growth of the world’s key economies, commodity prices, interest rates and exchange rates, that could impact Canadian businesses.

“The bottom line is that risk is always present and how you structure your response to uncertainty will be a key determining factor of your success,” Karkas says.