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Pre shipment export finance Documentary credit A documentary creditalso called a letter of creditis a conditional guarantee of payment in which

an overseas bank takes responsibility for paying you after you ship your goods, provided you present all the required documents (such as documents of title, insurance policies, commercial invoices and regulatory documents). A documentary credit is a separate contract from an export contract. The parties to a documentary credit deal with documents, not the goods that the documents relate to. Documentary credits are a common method of payment in the international trade of goods as they offer some protection to both you and your buyer.
The main steps in a typical documentary credit transaction are: 1. When youve finalised the export contract, your buyer (the applicant) arranges with a bank to open a documentary credit in your favour. This foreign bank is called the issuing bank (or opening bank) and will usually check your buyers creditworthiness. 2. The issuing bank sends the documentary credit to an Australian bank (the advising bank). The advising bank verifies the authenticity of the documentary credit and forwards it to you (the beneficiary). 3. The documentary credit sets out the documents you must present to receive payment. When youve shipped the goods and compiled all the necessary documents, you lodge the documents with your Australian bankcalled the negotiating bankto arrange the payment. In most cases, the advising bank and the negotiating bank are the same bank and may be your regular business bank. 4. The negotiating bank checks the documents to ensure the terms of the documentary credit have been met. It then sends the documents to the issuing bank with a request for payment. Sometimes a third bank, called a reimbursing bank, acts as an intermediary between the negotiating and issuing banks. 5. If the issuing bank is satisfied that youve provided all the necessary documents in the exact form required by the documentary credit, it forwards the payment to the negotiating bank, which in turn pays you. A documentary credit will state whether you receive payment at sight (immediately after bank verification of the documents) or at an extended term (for example, 30 days after sight). Types of documentary credit include:

irrevocablecannot be cancelled or amended without the consent of all parties, including the beneficiary. This is the most common type of documentary credit in the international trade of goods revocablecan be cancelled by the issuing bank without warning to the beneficiary

confirmeda confirming bank (either in Australia or overseas) agrees to pay you under a documentary credit, whether or not payment is received from the issuing bank transferablethe original beneficiary of the documentary credit can transfer their rights to a second beneficiary on the same or similar terms as the original documentary credit (the original beneficiary may be an intermediary between you and your ultimate buyer) revolvingallows automatic reinstatement of the documentary credit after the amount for the original shipment has been paid, so subsequent shipments to your buyer are covered by a single documentary credit standbya contingency documentary credit which you can draw on if your buyer, using another payment method, defaults in making a payment to you under the export contract back-to-back/complementarywhere your buyer is the beneficiary of a separate documentary credit (in their capacity as a seller under a separate sales contract), they can sometimes use this credit as security to apply to their bank for a complementary documentary credit to cover their payment under an export contract with you red clausepre-shipment finance that allows you (the beneficiary) to receive an advance from the advising bank of all or part of the amount owed to you under a documentary credit so you can buy raw materials or other inputs required to manufacture the product for export.

The diagram below shows the main steps in a transaction involving payment by irrevocable documentary credit.

Notes to diagram 1. You enter into an export contract with your overseas buyer. 2. The buyer asks its bank (the issuing bank) to issue an irrevocable documentary credit (IDC) in your favour. 3. The issuing bank issues the IDC to your bank (which in this example acts as both the advising and the negotiating bank). Your bank forwards the IDC to you. You send the goods to the buyer in accordance with your export contract. You provide to your bank the documents required by the IDC. Your bank sends the documents to the issuing bank. The issuing bank checks that the documents comply with the IDC and if so, pays your bank. 9. Your bank pays you. 4. 5. 6. 7. 8.

How risky is it?


A range of payment methods is used in international trade, with payment taking place at a different stage of the export transaction in each. In general, this means that each method has a different level of non-payment risk for you, the exporter, and non-delivery risk for your buyer. The diagram below illustrates the risk of payment by documentary credit compared with other payment methods.

What are the pros and cons?


Pros Cons You take the risk that the foreign bank issuing the documentary Transfers the payment risk credit may not be able to pay you. You can reduce this risk by from your buyer to your asking another bank to confirm the documentary credit (see buyers bank 'Types of documentary credit' above) Your buyer has assurance The documents you present to your bank for payment must that payment wont be comply exactly with the terms of the documentary credit, made until the goods are otherwise the issuing bank or confirming bank may not pay you shipped As you dont receive payment until after youve shipped the goods, a sale using a documentary credit may strain your cash flow If the export contract is in a foreign currency, you are exposed to exchange rate risk from the date of the sale contract to the time of payment

What costs are involved?

Your buyer pays the issuing bank to open and process a documentary credit. The Australian bank will charge you a fee for advising and negotiating the documentary credit. You may pay a further fee if the credit is confirmed by another bank or if you receive an advance.

Post shipment export finance Post shipment finance is also an export finance extended to an exporter ,but after the export has taken place. Normally it is extended upto the time of realisation of the export bills. The characteristics of the post shipment finance Finance after the shipment of goods. 1. It is extended to those exporters in whose name the documents stand. ( He may be the original exporter or the documents would have been transferred in his name.) 2. It can be a short term finance (for cash exports), or long term finance (for deferred exports) 3. It is a working capital finance since it is against receivables. 4. It is extended only against the evidence of authenticated documents evidencing shipment of goods. 5. Only a fund based finance. 6. Concessionary rate of interest upto due dates (for normal transit period for sight bills and upto notional due date in case of usance bills). Rate of interest as per RBI guidelines. 7. Finance can be extended upto 100 % of the bill. Working capital Export working capital (EWC) financing allows exporters to purchase the goods and services they need to support their export sales. More specifically, EWC facilities extended by commercial lenders provide a means for small and medium-sized enterprises (SMEs) that lack sufficient internal liquidity to process and acquire goods and services to fulfill export orders and extend open

account terms to their foreign buyers. EWC financing also helps exporters of consigned goods have access to financing and credit while waiting for payment from the foreign distributor. EWC funds are commonly used to finance three different areas: (a) materials, (b) labor, and (c) inventory, but they can also be used to finance receivables generated from export sales and/or standby letters of credit used as performance bonds or payment guarantees to foreign buyers.

Factoring
Export factoring is a complete financial package that combines export working capital financing, credit protection, foreign accounts receivable bookkeeping, and collection services. A factoring house, or factor, is a bank or a specialized financial firm that performs financing through the purchase of invoices or accounts receivable. Export factoring is offered under an agreement between the factor and exporter, in which the factor purchases the exporters short-term foreign accounts receivable for cash at a discount from the face value, normally without recourse. The factor also assumes the risk on the ability of the foreign buyer to pay, and handles collections on the receivables. Thus, by virtually eliminating the risk of non-payment by foreign buyers, factoring allows the exporter to offer open account terms, improves liquidity position, and boosts competitiveness in the global marketplace. Factoring foreign accounts receivables can be a viable alternative to export credit insurance, long-term bank financing, expensive short-term bridge loans or other types of borrowing that create debt on the balance sheet. Characteristics of Export Factoring Applicability Best suited for an established exporter who wants (a) to have the flexibility to sell on open account terms, (b) to avoid incurring any credit losses, or (c) to outsource credit and collection functions Risk Risk of non-payment inherent in an export sale is virtually

eliminated Pros

Eliminates the risk of non-payment by foreign buyers Maximizes cash flows More costly than export credit insurance Generally not available in developing countries

Cons