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Trade finance Guide 2023
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Nearly 52,000 Australian companies engage in exports of goods worth approximately AUD$320bn according to the Australian Bureau of Statistics. Another AUD$315bn worth of goods is also imported from abroad, making Australia the 5th freest economy in the world according to Heritage.com.
Australia’s largest trading counterparties are based in China and the European Union, a large and disparate group of countries. With such a diverse group of counterparties operating in different political and economic environments, it is key that Australian companies ensure they have fully assessed the risks inherent in international trade such as currency risk, credit risk, risk of non-delivery and geopolitical risk.
There are numerous financial products and non-financial strategies that can be employed to help minimise or transfer the risk of international transactions. This guide discusses some of the specific risks related to international trade and how trade finance can help you protect your business and grow sales by accessing the international markets.
What are the Risks Inherent in International Trade?
Whether you are exporting goods or services or importing raw materials or finished goods to on-sell, international transactions will create an additional level of complexity. Being cognizant of these provides the opportunity to best protect against them.
Currency risk
Any time you enter into a transaction not denominated in Australian dollars (AUD), you are taking a measure of currency risk. Exchange rates fluctuate constantly and any larger movement can impact the profitability of your transaction positively or negatively.
Currency risk is best mitigated by locking in the exchange rate at the time of the transaction, this can be done through purchasing currency forward contracts or by specifying the exchange rate to be used in your contract with your overseas counterparty.Risks of non-delivery or non-performance
International trade may increase the risk of your contract not being honoured through non-delivery of the product or service you have paid for. The best way to mitigate this is through a letter of credit or consignment purchasing.Credit risk
Credit risk or the risk of non-payment may be more significant when trading with jurisdictions where the creditworthiness and reputation of your counterparty is hard to establish. Credit products such as letters of credit or cash-in-advance payment plans help mitigate these risks. Certain export insurance products can also help reduce the impact of credit risk.Political / Country risk
We live in an uncertain world. Sudden changes in regulations or tariffs can and do occur across the world. Political changes, war and natural disasters also occur which will impact the ability of your counterparty to ship or receive shipments. Various forms of trade insurance products exist to help cushion your business from such blows.
Visualising Trade Finance Payment Risk
There is risk to any type of commercial transaction, however in the case of international trade, these risks are compounded by the challenges associated with distance, currency and different business jurisdictions. Ultimately, successful trade agreements are about balancing the risks of the various stakeholders involved. To help illustrate how to balance these risks we have provide the handy reference diagram below.
Types of Commercial Trade Finance
Trade, in particular exports, benefit countries’ economies significantly. Therefore, most countries in the world, including Australia, provide a range of federal and state support schemes, grants and loans to encourage exports. Taking full advantage of these schemes is a great way to reduce finance costs and also potentially offset some of the extra research and marketing costs associated with overseas trade. See below for an outline of the most significant Australian government-backed trade support schemes below.
Government-Backed Trade Finance
In the inventory finance space, there are lenders who lend to companies operating in specific industries and have tailored finance products to suit these companies.
Floorplan finance is an inventory finance product designed specifically for retailers who want to maintain stock levels and fill shelves. Examples of floorplan finance customers ranges from retailers who need help purchasing high-value items to retailers who need to stock shelves ahead of periods of high demand.
Dealership finance is a form of floorplan finance designed specifically for dealerships such as those selling cars, trucks, motorcycles, agriculture equipment or other large machines. The lender extends a line of credit to the dealer specifically to purchase these big-ticket items. The dealer repays the lender when the item is sold. Dealership finance providers often also provide additional services specifically customized for dealerships including flexible repayment terms, payment extensions and inventory management software.
Export Finance Insurance Corporation (Efic)
The Australian Government’s export credit agency, named Efic, provides loans, guarantees and bonds for Australian businesses looking to expand internationally, secure export-related contracts or win export-related supply chain contracts.
Efic will work with commercial lenders to provide financing that supplements the financing you have from commercial lenders and markets. Efic will also lend directly to companies that are unable to access the private lending markets due to various circumstances including high growth or lack of collateral.
Efic loans are accessible for businesses making revenues of at least AUD$250,000 in the past financial year. Efic provides both traditional loans secured by collateral as well as Small Business Export Loans that are not secured by fixed collateral and have fast approval times but cost incrementally more than traditional loans.
Efic bonds help exporters secure contracts by reducing the risks of international trade for buyers. Should you be unable to deliver on your obligations in relation to a contract, an export bond will help reduce the losses for your buyer(s). The types of bonds provided include Advance Payment Bonds, Performance Bonds, Warranty Bonds and US Surety Bonds.Export Market Development Grants (EMDG)
The EMDG scheme is an Australian Federal Government financial grant program to support small and medium-sized companies currently exporting or looking to start to export. The scheme reimburses 50% of eligible export-related expenses above $5,000. The applicant can receive up to $150,000 per annum and is eligible for a total of 8 grants.
Eligible applicants include Australian companies, associations, cooperatives, trusts, partnerships and individuals that carry out or support the sale of goods, services or intellectual property outside of Australia or that promote certain services to non-residents or tourists within Australia. Applicants should have earnings of less than $50m per year and be spending at least $15,000 on eligible export promotion activities.
The types of expenses which the scheme reimburses includes marketing visits and consultancy expenses, overseas buyer expenses, advertising and promotion expenses and overseas representation expenses. Expenses related to sales to New Zealand, North Korea and Iran cannot be claimed. Neither can costs be claimed that are capital in nature, related to sales or product development or are fraudulent or criminal.
The scheme is administered by Austrade and applications can be made through their website but a broker can help you understand if you are eligible for the scheme and help you collect all the paperwork necessary for a successful application.Other Federal and State Grants
There is a wealth of different federal support schemes and grants for businesses involved in international trade. This includes the extensive guidance and assistance available from trade promotion organisations, Chambers of Commerce, and Australian diplomatic missions around the world. The Duty Drawback Scheme provides a refund on any import duties paid for goods that are later exported. Austrade provides further assistance to small and medium sized businesses through the TradeStart network that helps smaller businesses succeed abroad. Finally, there are scholarships available including the Women in Export Scholarship.
On a state / territory level, each state operates separate trade support schemes. These schemes range from market intelligence and support to financial assistance programs and grants.
The business.gov.au website has a search function that allows you to see which government grants and assistance programs you are eligible for.
Non-Finance Methods of Payment in Trade
An alternative to using financial instruments to reduce or transfer risk in overseas trade, is to simply negotiate with your counterparty to solve for a transaction structure that is inline with your risk appetite. In some situations, you may be willing to take on more of the risk in the transaction to win a contract or charge a higher price, in this case allowing open account sales or consignment sales may make sense. Offering an innovative transaction structure may be the sweetener that wins you customers. We discuss common non-finance methods of payment in trade situations below.
Cash-In-Advance
Requiring cash-in-advance from buyers removes all credit risk for the seller as payment is received before any goods are shipped. Payment is usually made through wire transfers, credit cards or online escrow services. Cash-in-advance terms are usually only set for small to medium-sized transactions.
The draw-back with this method is that all risk is transferred to the buyer who has no certainty or leverage should delivery of the product or service purchased be late, insufficient or non-existent. The buyer / importer is also put in an unfavourable cash flow position as payment may be made long before the goods or services are received. This may put the exporter in a worse position versus competitors who are able to offer more attractive payment terms.Open Account
In open account transactions, sales are made and goods are shipped before payment is made, sometimes for as long as 90 days. This payment structure is beneficial to the importer who is in effect receiving low cost finance from the exporter.
The exporter on the other hand carries the full cost of the adverse impact on working capital due to the long delay between production and payment. The exporter also takes on the risk of non-payment despite having shipped the goods. Some exporters look to offset these risks using different finance structures such as selling their trade invoices, also known as forfaiting.Consignment Sales
Consignment sales are essentially the opposite of cash-in-advance sales in terms of who carries the ultimate risk in a transaction. In a consignment sale situation, the exporter only receives payment once the importer / purchaser has on-sold the goods to the end-customer.
This type of transaction is very favourable to the importer who bears no risk of non-delivery and is also excellent in cash flow terms. Exporters on the other hand will carry the entire risk of non-payment and may wait for payment for long periods, thus adversely impacting cash flows.
Foreign Exchange Risk Management
Foreign exchange risk is always present in any international transaction as any significant movement in the exchange rate between the two currencies will impact the viability and profitability of the deal. The risk becomes more apparent if your counterparty (i.e. the buyer / seller) insists on using their currency for pricing and payment. In this case, structuring the transaction in a way that protects you from significant adverse changes in the exchange rate can be imperative to reducing the risk of the transaction.
The financial markets provide different hedging tools to help companies big and small protect themselves from adverse exchange rate moves. One way of eliminating foreign exchange risk is to purchase a forward contract which specifies an amount which will be exchanged from one currency at a specific future date. For instance, if you know that you will receive $1 million USD in 90 days-time you can purchase a forward contract that obliges you to deliver $1 million USD in 90 days in exchange for a specified amount of AUD. Alternatively, a foreign exchange option contract functions more like an insurance contract in that it will protect you from any downside resulting from adverse currency movements but you retain the upside in the event that the currency moves to your advantage.
The most straightforward non-hedging method to protect against foreign exchange risk is through a cash in advance payment. Paying for the goods immediately allows you to take advantage of prevailing exchange rates but of course exposes you to non-delivery risks as discussed previously. Alternatively, some companies attempt to match foreign currency expenses with revenues in that same currency, effectively offsetting any exchange risk (otherwise known as a “natural hedge”).
In Conclusion
Many Australian businesses sell goods abroad or buy goods produced overseas. Transactions with overseas counterparties introduce additional risks ranging from risks of non-payment to political disturbances to currency movements. There are a multitude of financial products adapted to help protect against these risks as well as different contract structures that can transfer the risk between the two counterparties. An experienced business finance broker can help you better understand your financing options when it comes to international trade. Contact us to discuss your trade finance needs.
