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A Guide to Receivables

Finance
GENERAL EDITOR: GEOFFREY WYNNE
SPECIAL REPORT
Market intelligence for trade finance professionals
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A Guide to Receivables Financing
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ARK2740
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By Paolo Provera, IFA chairman; general manager, ABC International Bank Plc
THE GLOBAL economy is in a state of permanent change and international
trade has the potential to maximise a country’s capacity to produce and
acquire goods.
Trading globally gives consumers and countries the opportunity to
purchase goods and services not available in their own countries. The correct
use of all the available trade finance instruments is one of the factors that
contributed to the growth of international trade and supports importers’ and
exporters’ needs.
Chapter 1: Overview of the trade
finance spectrum
Most Advantageous
Least Advantageous 
Highest Risk
 Lowest Risk
BUYER’S
PERSPECTIVE
SELLER’S
PERSPECTIVE
Payment Mechanism
Confrmed Letter of Credit
Cash in advance
Unconfrmed Letter of Credit
Documents against payment
Documents against acceptance
Open account  
Figure 1: Risk ladder
Chapter 1: Overview of the trade finance spectrum
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The opposing interests of buyers and sellers in international trade results in a
risk ‘ladder’ (see Figure 1), in which immediacy of payment bears an inverse
relationship to risk for the two participants. In other words, the quicker a seller
is paid, the more risk exists for the buyer and vice versa. The seller wants
to receive payment as soon as possible whereas the foreign buyer wants to
receive the goods and preferably tries to delay payment as long as possible to
generate enough income to pay the seller.
The trade finance market provides different forms of solutions to satisfy
sellers’ and buyers’ needs. This chapter describes some of them.
Cash in advance
By using a cash-in-advance payment, an exporter completely avoids credit risk
because payment is received before the ownership of the goods is transferred.
For international sales, wire transfers are the most commonly used
cash-in-advance option available to exporters. However, requiring payment in
advance is the least attractive option for the foreign buyer, because it creates
unfavourable cash flow and does not give protection. Foreign buyers are also
concerned that the goods may not be sent if payment is made in advance.
For this reason exporters insisting on this payment method as their sole
manner of doing business may lose competitiveness as other competitors may
offer more attractive payment terms.
Documentary collections
In a documentary collection the exporter’s bank (remitting bank) sends
documents representing the goods to the importer’s bank (collecting bank),
with instructions to release the documents to the foreign buyer for payment or
for acceptance to pay at a certain date.
Funds are received from the importer and remitted to the exporter through
the banks involved in the collection in exchange for those documents.
Documents may be released against payment or against acceptance.
Where the release is against acceptance, the documents must include a draft
or bill of exchange (see later) which is sent for acceptance, thus requiring the
importer to pay the face amount at a specified later date.
Although banks act as facilitators for their clients, documentary
collection does not request a verification process; only the Know Your
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A Guide to Receivables Financing
Customer/Anti-money Laundering (KYC/AML) procedures apply, and exporters
have no recourse to them in the event of non-payment.
Documentary collections are normally governed by the terms of the
ICC Uniform Rules for Collection (URC 522).
Letters of credit
Letters of credit, although not the simplest or cheapest trade finance
instruments, are one of the most utilised and secure instruments available in
the international markets.
A letter of credit is a commitment issued by a bank on behalf of the buyer
and guarantees payment to the exporter upon presentation of documentary
proof that the goods have been shipped as provided by the terms and
conditions stated in the letter of credit.
It protects the buyer simply because no payment obligations are in force
until the goods have been shipped.
A letter of credit is a useful instrument particularly when credit information
on the foreign buyer is not easily available, but the exporter is satisfied with the
creditworthiness of the buyer’s foreign bank (issuing bank).
In no other branch of international trade have efforts to unify the law been
more successful than in letters of credit.
In 1933, the International Chamber of Commerce in Paris published
the Uniform Customs and Practice for Documentary Credits (UCP), which
was revised in 1951, 1962, 1983, 1993, and 2007, and it has been
adopted by banks and by banking associations in almost all countries of
the world.
Negotiable instruments
For many decades, if not centuries, it has been common practice in
international trade to deal with negotiable instruments that guarantee the
unconditional payment of a specific amount of money on demand or at a
future defined date by a named payer.
The most common negotiable instruments in use are promissory notes and
bills of exchange. A promissory note is a signed, unconditional promise to pay.
The individual who promises to pay is the maker, and the person to whom
payment is promised is called the payee or holder.
Chapter 1: Overview of the trade finance spectrum
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When signed by the maker, a promissory note becomes a negotiable
instrument because it contains an unconditional promise to pay a certain
sum to the order of a specifically named person or bearer – that is, to any
individual presenting the note. A promissory note can be either payable on
demand or at a specific time and it can be sold at a discount – an amount
below its face value. Promissory notes can be subsequently redeemed on
the date of maturity for the entire face value or prior to the due date for an
amount less than the face value.
A bill of exchange is an unconditional order in writing addressed by one
person to another, signed by the person giving it (the drawer), and requiring
the person to whom it is addressed (the drawee) to pay on demand or at a
fixed or determinable future time a certain sum of money to, or to the order
of, a specified person (the payee) or to the bearer.
A bill of exchange may be endorsed by the payee in favour of a third
party, who may in turn endorse it to a fourth party, and so on indefinitely.
The ‘holder in due course’ may claim the amount of the bill against the
drawee and all previous endorsers, regardless of any counterclaims that may
have disabled the previous payee or endorser from doing so.
Legally, negotiable instruments tend to fall into one of two camps – those
governed by the English Bills of Exchange Act 1882 or its derivatives, and
those governed by the 1930 Geneva Convention providing a Uniform Law
for Bills of Exchange and Promissory Notes or laws inspired by it. The first
generally applies in English law-inspired common law countries, while the
second applies in civil law countries. In the latter case, some countries have
simply transposed the terms of the convention into their own law or have
passed new laws largely based on it.
Trade finance techniques offer different opportunities, and promissory
notes and bills of exchange are instruments that can be discounted creating
immediate liquidity for the seller and improving its balance sheet.
Due to the nature of the negotiable instrument, most countries have
adopted laws specifically related to negotiable instruments.
Nowadays, the trade of these instruments may be regulated by the Uniform
Rules for Forfaiting (URF 800), recently issued by the International Chamber of
Commerce in partnership with the International Forfaiting Association.
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A Guide to Receivables Financing
Open account
Open account trading is commonly utilised when there is complete trust
between the exporter and the importer because it is a sale where the goods
are shipped and delivered before payment is due, typically in 30, 60,
or 90 days. This is one of the most advantageous options for the importer in
terms of cash flow and cost, but it is one of the highest risk options for
the exporter.
Foreign buyers often force exporters for open account terms because of
the high competition in export markets. Exporters who are reluctant to extend
credit terms may lose a sale to their competitors and for this reason the offer
of competitive open account terms has become extremely popular.
A true accounts receivable is money due for a product that has been
shipped, received, and accepted or for a service that has been rendered
and it is created when the supplier invoices the recipient.
Accounts receivable financing is the selling of outstanding invoices or
receivables at a discount to a financer that assumes the risk on the receivables
and provides cash to the exporter. The financer sets up a revolving line of
credit to either buy the receivables or use them as collateral.
The risk of non-payment may also be mitigated through export credit or
private insurance, as well as by using the appropriate trade finance techniques
covered in later chapters.
Accounts receivable financing certainly gives benefits to the exporters by
allowing them to free up capital that is normally tied up in inventory and gives
them the possibility to outsource the accounts receivable management to
another company and concentrate on selling.
In certain circumstances, accounts receivable financing gives small
exporters the chance to qualify with their bank for a credit line that otherwise
would be difficult to obtain.This instrument can be a valid alternative to
expensive short-term loans or other types of borrowing that create debt on
the balance sheet.
The subsequent chapters deal with a number of approaches and
techniques for extending this kind of financing.