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Hedge export payment risks: Forfaiting, factoring, documentary letter of credit and documentary collection

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Tailored financing relieves the strain on liquidity

Long-lasting accounts receivable that burden liquidity can be financed through factoring and forfaiting. The documentary letter of credit protects the seller and the buyer, as payments are only made when the agreed documents are available. Documentary collection comes into question when a letter of credit is not enforceable but the seller still wants some protection.

Forfaiting

Forfaiting is the purchase of receivables from the delivery of goods and services by banks or specialized financing institutions, whereby the forfaiter (buyer of receivables) purchases only individual, precisely specified receivables, assumes all associated risks and immediately pays the exporter the equivalent value of the receivable, deducting interest.

Factoring

Factoring is also the purchase of receivables, however, the receivables are not assigned individually, but all current and future receivables are assigned as collateral to a lender. As a rule, the factor also offers additional services: Accounting, dunning and collection, checking the creditworthiness of receivables.

The exporter is obliged to assign all short-term receivables from export transactions during the term of the factoring agreement, whereby the group of buyers or countries are precisely defined. This prevents the exporter from assigning only his dubious receivables.

The export receivables must originate from duly rendered services and thus be free of objections. If possible, they should originate from permanent business relationships, because the less the customer base varies, the lower the costs for the exporter.

Documentary credit

A documentary letter of credit is a bank's promise to pay the invoice amount to the exporter against handing over precisely specified documents. If the letter of credit is irrevocable and confirmed, the exporter is independent of the importer's willingness and ability to pay, he is not exposed to any risk of acceptance or bad debts, and is thus secured in every respect.

Another advantage for the exporter is that the bank's promise of payment is detached from the underlying goods transaction, so it is "abstract" just like a bank guarantee. It is honored if the prescribed documents are in order. The bank is not authorized to raise any objections against the exporter arising from the goods transaction (except in the case of clearly identifiable fraud).

The "Uniform Customs and Practice for Documentary Credits" of the International Chamber of Commerce (CCI) in Paris, on the basis of which all Austrian banks operate, states in this regard:

  • "Letters of credit are, by their nature, separate transactions from the purchase and other contracts on which they may be based, and the banks have nothing whatever to do with, and are not bound by, such contracts."

Letters of credit are only enforceable when the exporter is in an extremely strong position; in Europe, they hardly ever occur. This is because the advantages for the exporter are matched only by disadvantages for the importer:

  • The importer shall bear the costs of the letter of credit.
  • He is already bound from the moment he gives his bank the order to open the letter of credit. The exporter, however, is not bound to anything, he can submit the documents or not.
  • The bank checks the documents only from a formal point of view. Therefore, the importer does not know whether the goods really comply with the purchase contract.
  • The importer can file a complaint only after the exporter has already received his payment.

Documentary Collection

In documentary collection, the documents are handed over to the buyer against cash payment or acceptance. According to this, a distinction is made:

  • Cash against documents ("documents against payment (D/P)" or "cash against documents (c.a.d.)").
  • acceptance against documents ("documents against acceptance (D/A").

In the case of "cash against document", the exporter instructs his bank to ensure that the documents representing the goods are tendered to the importer in good time by a correspondent bank in the importer's country and handed over against cash payment. However, the importer may refuse acceptance, so the exporter bears the full risk of acceptance.

In the case of "acceptance against documents", the exporter has the additional risk of dubiousness. This is because it is possible that the importer accepts the bill of exchange but does not honor it when it is due, even though he has long since had the goods at his disposal. But the importer also bears a risk with regard to the goods in accordance with the contract, since he initially only receives the documents and only sees the goods later.

In any case, documentary collection is based on a certain degree of trust between exporter and importer. It comes into question as a payment condition when a letter of credit is not enforceable, but the seller still wants a certain level of security. This is because, despite the risks, documentary collection is safer for him than delivery on open account.