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Chapter 2
1. Guide to International Trade Finance
Leverage your buying and selling power with experts in international trade
finance
By Linda C. Ray
International trade finance companies are prepared to help you move your products through the
global market, whether you are new to global trading arena or a seasoned trader. International
trade and finance is so complicated for most business owners that outsourcing to international
trade finance firms is often the best way to go. Trade finance banks often prefer to do business
with people they know.
An international trade finance corporation might provide legal as well as financial advice.
International trade finance firms have relationships built with overseas trade finance banks and
vendors. They can walk you through various customs issues and money exchange rates. An
international trade finance corporation is as important to an importer and exporter as a CFO.
1. Outsource all your global financial trade deals to international trade finance companies
2. Hire an expert on international trade and finance as permanent staff
3. Do your own international trade financing through networking
Action Steps
The best contacts and resources to help you get it done
Look for international trade finance firms for countries where you are interested in
trading
International trade finance companies often specialize, just like other industries. While you want your trade finance company to
understand your industry and keep up-to-date on trends, you also want to find an international trade finance corporation that already
does business in the parts of the world that interest you. With the trade finance connections in place, you can begin to move more
quickly than having to build those relationships from scratch.
I recommend: Meridian Finance Group has global contacts for all your finance needs in most
countries. Export Focus is a good place to look for global trade sources.
Bring your international trade financing specialist on board full-time
If your company is moving more and more to overseas trading and financing, then you might be in a position to hire a professional in
financing international trade. When the fees and retainers are more than the annual salary of an in-house specialist, it may be time
to increase your staff.
2. I recommend: Use a recruiting firm for this very specialized position. International Executive
Recruitment is an online service you can contact for global results. The Executive Development
Group specializes in placement of international trade finance executives.
Build your own network with international trade finance information you find yourself
Join an organization that can put you in contact with international trade finance firms and
international trade finance information. Through the connections your meet in professional
organizations, you can bypass a lot of red tape as well as finding trade finance companies
through direct introductions.
I recommend: The Federation of International Trade Associations has more than 450 members
with 450,000 contacts with which you can link. The Institute of International Finance is a global
association of financial institutions that, as a member, you can call on for global trade issues
affecting your industry.
Free On Board (FOB)
Transportation term meaning that the invoice price includes delivery at the seller's expense to a
specified point and no further. For example, "FOB our Newark warehouse" means that the buyer
must pay all shipping and other charges associated with transporting the merchandise from the
seller's warehouse in Newark to the buyer's receiving point. Title normally passes from seller to
buyer at the FOB point by way of a bill of lading.
C. I. F.
cost, insurance, and freight: used by a seller to indicate that the price quoted includes the cost of
the merchandise, packing, and freight to a specified destination plus insurance charges.
Also,CIF,c.i.f.
Letter of credit
L/C. A binding document that a buyer can request from his bank in order to guarantee that the
payment for goods will be tranferred to the seller. Basically, a letter of credit gives the seller
reassurance that he will receive the payment for the goods. In order for the payment to occur, the
seller has to present the bank with the necessary shipping documents confirming the shipment of
goods within a given time frame. It is often used in international trade to eliminate risks such as
unfamiliarity with the foreign country, customs, or political instability.
3. What is a letter of credit?
A Letter of Credit (LC) is a document issued by your bank that essentially acts as an
irrevocable guarantee of payment to a beneficiary. This means that if you do not perform your
obligations, your bank pays. The letter of credit can also be the source of repayment of the
transaction meaning that the exporter will get paid with the redemption of the letter of credit.
Let me give you an example:
For simplicity sake lets imagine that your company imports radios from a Korean manufacturer
called Seoul Manufacturing, which banks at First Seoul Bank. Your company currently banks
at First American Bank
For the purpose of this example these will be the roles that the parties will play in the letter of
credit transaction:
Your company : applicant
Seoul Manufacturing : beneficiary
First American Bank : Issuing Bank
First Seoul Bank : Advising Bank
The example: You want to buy $50,000 worth of radios from Seoul Manufacturing, which agrees
to sell the merchandise and gives you 60 days to pay it with the condition that you provide them
with a 90 days letter of credit for the full amount. The steps to get the LC would be as follows:
1)You go to First American Bank and request a $50,000 letter of credit with Seoul
Manufacturing as a beneficiary.
2)The bank goes through its underwriting process. Although the bank is not advancing money,
they are extending credit on your behalf and are taking on a contingent liability. If your company
qualifies from a credit standpoint the LC is issued.
3)Even if your company does not qualify for credit, you can still get an LC if you are willing to
put cash collateral CD secured letters of credit are very common for small business .
4)The bank sends a copy of the letter of credit to First Seoul Bank, which lets the vendor knows
and the merchandise is shipped.
Take into consideration that the letter of credit itself might be the source of repayment of the
transaction. It could be that Seoul Manufacturing is interested in getting paid as soon as the
merchandise is shipped. Therefore, the letter of credit will indicate that payment shall be made as
soon as Seoul Manufacturing can present proof of shipping.
If the letter of credit that your vendor requires is not tied to a particular transactions, but they are
asking for a guarantee that makes sure that you will not default. They are probably asking for a
Stand-By letter of credit or a Revolving letter of credit. These types of LCs are usually for a
longer term. Usually a year and are the vendor?s guarantee that they will get paid.
4. The example above describes the simplest of letter of credit transactions. Although there are
other factors involved such as the role of correspondent banks and confirmations, the thing that
you should be concerned as a customer is expediency and the fees involved, which can run
anywhere from 1.5% to 8% of the value of the LC
TYPES OF LETTERS OF CREDIT
Revocable letter of credit
Just like the name says the LC can be revoked by the Issuing Bank without the agreement of the
beneficiary.
Irrevocable letter of credit
Can not be cancelled or amended without all the parties agreement.
Standby letter of credit
Guarantee of payment. If the beneficiary does not get paid from its customer it can then demand
payment from the Bank by forwarding the copy of the invoice that was not paid and supporting
documentation.
Revolving letter of credit
It is established when there are regular shipments of the same commodity between supplier and
customer. Eliminates the need to issue an LC for each individual transaction
Post shipment financing:
Credit covering the company’s financial needs for the period following the shipment, to ensure
sufficient liquidity until the shipped products have reached the purchaser and payment has been
received. Post-shipment financing is generally of a short-term nature (less than twelve months).
Compare with Pre-shipment financing.
Pre-shipment financing:
Financing advanced to the exporter to support the costs of activities undertaken prior to shipment
of the goods (i.e. purchase of inputs and components, payment of salaries, wages and overheads
etc.) and to provide him with additional working capital. Pre-shipment financing may take the
form of a short-term loan, an overdraft, a cash credit, etc.
Balance of trade
5. The balance of trade encompasses the activity of exports and imports, like the work of this cargo
ship going through the Panama Canal.
The balance of trade (or net exports, sometimes symbolized as NX) is the difference between
the monetary value of exports and imports of output in an economy over a certain period. It is the
relationship between a nation's imports and exports.[1] A favorable balance of trade is known as a
trade surplus and consists of exporting more than is imported; an unfavorable balance of trade
is known as a trade deficit or, informally, a trade gap. The balance of trade is sometimes divided
into a goods and a services balance.
Definition
The balance of trade forms part of the current account, which includes other transactions such as
income from the international investment position as well as international aid. If the current
account is in surplus, the country's net international asset position increases correspondingly.
Equally, a deficit decreases the net international asset position.
The trade balance is identical to the difference between a country's output and its domestic
demand (the difference between what goods a country produces and how many goods it buys
from abroad; this does not include money re-spent on foreign stocks, nor does it factor the
concept of importing goods to produce for the domestic market).
Measuring the balance of trade can be problematic because of problems with recording and
collecting data. As an illustration of this problem, when official data for all the world's countries
are added up, exports exceed imports by a few percent; it appears the world is running a positive
balance of trade with itself. This cannot be true, because all transactions involve an equal credit
or debit in the account of each nation. The discrepancy is widely believed to be explained by
transactions intended to launder money or evade taxes, smuggling and other visibility problems.
However, especially for developed countries, accuracy is likely.
Factors that can affect the balance of trade include:
• The cost of production (land, labor, capital, taxes, incentives, etc.) in the exporting
economy vis-à-vis those in the importing economy;
• The cost and availability of raw materials, intermediate goods and other inputs;
• Exchange rate movements;
• Multilateral, bilateral and unilateral taxes or restrictions on trade;
• Non-tariff barriers such as environmental, health or safety standards;
• The availability of adequate foreign exchange with which to pay for imports; and
• Prices of goods manufactured at home (influenced by the responsiveness of supply)
In addition, the trade balance is likely to differ across the business cycle. In export led growth
(such as oil and early industrial goods), the balance of trade will improve during an economic
6. expansion. However, with domestic demand led growth (as in the United States and Australia)
the trade balance will worsen at the same stage in the business cycle.
Since the mid 1980s, United States has had a growing deficit in tradable goods, especially with
Asian nations (China and Japan) which now hold large sums of U.S debt that has funded the
consumption. The U.S. has a trade surplus with nations such as Australia and Canada. The issue
of trade deficits can be complex. Trade deficits generated in tradable goods such as
manufactured goods or software may impact domestic employment to different degrees than
trade deficits in raw materials.
Economies such as Canada, Japan, and Germany which have savings surpluses, typically run
trade surpluses. China, a high growth economy, has tended to run trade surpluses. A higher
savings rate generally corresponds to a trade surplus. Correspondingly, the United States with its
lower savings rate has tended to run high trade deficits, especially with Asian nations.
Balance of payments
From Wikipedia, the free encyclopedia
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In economics, the balance of payments, (or BOP) measures the payments that flow between any
individual country and all other countries. It is used to summarize all international economic
transactions for that country during a specific time period, usually a year. The BOP is determined
by the country's exports and imports of goods, services, and financial capital, as well as financial
transfers. It reflects all payments and liabilities to foreigners (debits) and all payments and
obligations received from foreigners (credits). Balance of payments is one of the major indicators
of a country's status in international trade, with net capital outflow.[citation needed]
The balance, like other accounting statements, is prepared in a single currency, usually the
domestic. Foreign assets and flows are valued at the exchange rate of the time of transaction.
IMF definition
The IMF definition: "Balance of Payments is a statistical statement that summarizes
transactions between residents and nonresidents during a period."[1] The balance of payments
comprises the current account, the capital account, and the financial account. "Together,
these accounts balance in the sense that the sum of the entries is conceptually zero."[1]
• The current account consists of the goods and services account, the primary
income account and the secondary income account.
• The financial account consists of asset inflows and outflows, such as
international purchases of stocks, bonds and real estate.
• The capital account is much smaller than the other two and consists primarily of
debt forgiveness and assets from migrants coming to or leaving the country.
7. Balance of payments identity
The balance of payments identity states that:
Current Account = Capital Account + Financial Account + Net Errors and Omissions
This is a convention of double entry accounting, where all debit entries must be booked along
with corresponding credit entries such that the net of the Current Account will have a
corresponding net of the Capital and Financial Accounts:
where:
• X = exports
• M = imports
• Ki = capital inflows
• Ko = capital outflows
Forfaiting
• In international trade, the selling of an exporter's receivables for a particular transaction.
It is similar to factoring except in scope. While a company sells all of its accounts
receivable in factoring, an exporter only sells one receivable for one, perhaps high risk,
transaction. In forfaiting, the buyer is known as a forfaiter, and assumes all the risks
associated with collecting the receivables. Generally, the exporter forfaits the receivable
at a discount. This improves cash flow but reduces income
Deferred payment letter of credit (L/C)
That is paid a fixed number of days after shipment or presentation of prescribed
documents. It is used where a buyer and a seller have close working relationship
because, in effect, the seller (beneficiary of the L/C) is financing the purchase by
allowing the buyer a grace period for payment. It differs from a sight draft or time
draft in that no drafts are involved but the payment is guaranteed on the stated date.
However, there being no draft, the beneficiary party's ability to discount or sell his or
her right to payment is restricted. Also called usance letter of credit. See also red
clause letter of credit.
8. An import license is a document issued by a national government authorizing the importation
of certain goods into its territory. Import licenses are considered to be non-tariff barriers to trade
when used as a way to discriminate against another country's goods in order to protect a
domestic industry from foreign competition. Each license specifies the volume of imports
allowed, and the total volume allowed should not exceed the quota. Licenses can be sold to
importing companies at a competitive price, or simply a fee. However, it is argued that this
allocation methods provides incentives for political lobbying and bribery.
How to Get an Import License
A common mistake made by new importers is the assumption that they’ll need a special license
to import goods into the United States. There is a great deal of confusion over this issue for
several reasons:
In some cases and with certain types of goods, an import license is required. Examples include
alcohol, tobacco, firearms, animals, copyrighted materials, food and more. These items are
regulated by the individual agencies governing that type of good. US Customs does not create
the regulations, they simply enforce them for other agencies. In addition to the licensing of
certain types of goods, the US Department of Homeland Security also regulates the licensing of
Customs Brokers. A Customs Broker is an individual authorized by US Customs and the Dept.
of Homeland security to transact Customs business on someone else’s behalf. Customs Brokers
are extremely useful for first-time and experienced importers because they often have access to
systems and knowledge to file Customs entries in an efficient manner and utilize importer best-
practices to speed import clearances and reduce import duties.