A Credit Management Guide for New Zealand Exporters
Credit management is about managing the risk of customers not paying. A general rule is that distance increases risk. This means that, other things being equal, exporting is a higher risk game than selling domestically.
Take the case of a shipment of wool sold to India. Aware of the risk of non-payment, the seller stipulated a form of "documentary collection" known as documents against payment or "D/P". The buyer wouldn’t be allowed to take possession of the shipping documents (and hence the wool) until payment had been made to the exporter's representative in India. This turned out to be a wise move because no payment was forthcoming.
So the wool never changed hands. Instead it was left sitting in India, being pilfered and racking up insurance and warehousing charges. There was no queue of buyers waiting to make an offer for it, and in the end it was sold for cash at a much reduced price. It later turned out that the new purchaser was the original buyer, using a different name. The point is that, in general, the nearer you are to your customer, the better your knowledge of and communication with the customer, and the easier it is to deal with any problems that occur.
Here are five simple rules for understanding and dealing with export credit risk.
1. Check the country risk
The world is a dangerous and uncertain place so check the country risk. Tradenz, (tradenz.govt.nz), the major banks, and the various international credit reporters are good places to start. You particularly want to know about the economy, the currency and the political situation.
But bear in mind that no crystal ball has 100% accuracy. In December 1994, the Mexican peso devalued by 40%. Closer to home, the series of coups in Fiji in the 1980s affected the ability of some Fijian importers to meet their obligations. And more recently, as everyone knows, Asia’s economic bubble burst. Hardly any experts saw any of these crises coming until it was too late.
Remember also that there are some countries where only a very brave or foolish creditor sells on anything even remotely approaching credit terms. One cautious export credit manager tells me that if the Nigerian subsidiary of Shell Oil, or IBM or any other blue chip company came to him wanting credit, he would ask them to arrange for him to bill their UK or US operation, and failing that he would tell them "no".
2. Cash in advance if possible
If feasible get payment in advance or guaranteed payment. There are two good options. The simplest and cheapest method is telegraphic transfer - a sort of international direct credit, transferring funds between banks before the goods are sent.
Obviously, there are circumstances where this is impracticable. If your goods are air-freighted, no problem, but if they take three months to arrive by sea...
The other option is a letter of credit. With an "LC" the overseas buyer arranges to have a bank promise to pay the exporter on the date specified, providing the terms of the letter of credit are complied with. The exporter then ships the goods, and as long as the letter of credit is irrevocable and the bank doesn't fail, payment is guaranteed.
Remember, as with all credit, the terms you can demand depend on the strength of your position. If your competition offer a comparable product on open account terms, you’ll struggle to convince customers to provide LCs.
If the buyer insists on open account terms you must decide whether or not to take the risk. This means making a credit decision like you would for a local customer. One compromise which your buyer may find acceptable is a trial of a number of shipments with payment by LC in order to build a track record before you take the risk of open account terms.
3. Consider credit insurance
If you do decide to sell on open account or on any terms where there is risk, consider reducing your risk with credit insurance. Premiums usually range between 0.1% and 3%. There is always an element of self-insurance - at least 10% - to give the creditor some incentive to make sure its credit management is done properly. Credit insurance generally covers all types of export credit risk, including civil war or the buyer’s refusal to accept goods.
4. Carry out credit checks
Sensible export creditors will obtain credit reports on export customers, just as they should on domestic customers. Don’t skimp on them. Let’s say you are sending $100,000 worth of product to a new foreign customer on letter of credit terms. Your payment is guaranteed by an New Zealand bank so why worry about getting a credit report? One reason is that once a trading relationship is established, terms will often be altered without going through the proper credit approval process. Get a comprehensive credit check, then update it on a regular basis.
Not only can you source reports from New Zealand-based companies which provide international credit reports but now you can also get them directly from credit reporters based in Venezuela or Finland or wherever you are selling to, via the internet. The best website to locate these overseas credit reporters is Credit Management Information & Support (www.creditworthy.com).
5. Check the documents
Finally, get the documentation right. An issuing bank is only obliged to pay if the documents presented under a letter of credit - items such as a bill of exchange, an invoice, a bill of lading and an insurance certificate - comply exactly with all of its terms and conditions. If it finds any discrepancy in the documents, it will reject them and decline payment. It follows that the exporter should thoroughly check the documentation before presenting it to the bank.
Bills of exchange, also known as drafts or sometimes simply bills, are an integral part of many export transactions so it is important to understand them (and also promissory notes which are similar). It may be helpful to understand that a cheque is a type of bill of exchange. Unlike a cheque, a typical bill of exchange is drawn up by the creditor. If you are granting credit, you make it payable at a future date, like a post-dated cheque. If the debtor accepts it, it then becomes a public acknowledgment of the debt. (If she doesn't accept it, she is unlikely to be given the goods.) A sight draft is a bill of exchange which is payable on demand.
A US banker cites a case where a Chinese bank demanded a price concession because an invoice was signed in blue ink when it was supposed to be signed in black. To be fair, this may be an example of another problem: in the Chinese culture it’s not uncommon for agreements to be renegotiated after the foreign creditor thought the deal was done. Essentially the question is, "what will you give me to do what I've said I will do?"
However, a high proportion of documents presented under letters of credit will be rejected by banks due to discrepancies. The penalties for exporters include delay, extra work and costs, and, in extreme cases, the failure of the transaction.
Chartered Accountants Journal of New Zealand