A guide to import financing begins from the first thought of starting an import/export business. Importing goods into the US brings its own set of challenges—import financing being one of them. Through “end to end” import or trade financing, small business owners can often “punch above their weight”; be meaningful players in this vital business sector.
A guide to import financing, importing goods for sale to US customers can be an attractive small business offering. Overseas markets can be home to both unique products not available locally or to products costing much less to produce. The US imported close to USD 3 trillion in goods; services in 2017, representing a significant percentage of overall consumption.
What is an Import Financing Facility?
Import Financing is usually an off-balance sheet transaction. In this process, a factor purchases goods for a customer leading to a non-recourse invoice factoring funding. Typically, you can have Invoice Factoring with PO Funding, but you cannot have PO funding without Invoice Factoring.
How does Financing work as a Bridge?
All commercial transactions involve inherent tension in the timing of payments to suppliers and settlement from customers. Suppliers want to get paid as early as possible, while buyers benefit from stretching payments as much as they can on the other end. The business of importing adds another dimension involving trust and assurance of payment regardless of the timing.
What are the pressure points that present themselves for each party in an import transaction?
- The Supplier
An overseas supplier will understandably be cautious about entering a new relationship with a foreign buyer. Will they receive a payment? Moreover, if not—what recourse do they have to pursue a collection effort in a foreign jurisdiction? What level of exposure is appropriate?
- The Importer
A small business owner should likewise be cautious; not tie up imprudently high levels of working capital executing an import deal. Will the Buyer pay? Moreover, if so, will the gap between making and receiving payments be so long. Also, there will be an increased risk of running out of cash to fund ordinary business operations. More simply: How does the importer make what can appear to be attractive operating margins on import deals, without risking bankrupting the enterprise at the same time?
- The Buyer
The buyer needs goods delivered on time. The meeting agreed upon specifications and naturally wants to insulate themselves from accepting and paying for delivery of any shipment failing these tests. Assuming this requirement can be routinely satisfied, the timing of payment then becomes a matter of negotiation as part of the overall commercial terms.
Financing can address all these pressure points. As we will see, a comprehensive financing program can bridge timing gaps throughout the delivery and payment cycle while preserving profit margins that make the business worth pursuing in the first place.
What is The Financing Process, Steps, and Alternatives?
Let’s next walk through an import transaction and examine the financing alternatives open to the business owner at each step of the process.
Step 1: How to Get the Seller Comfortable
Thinking back to the pressure points noted above, chief among them for the Seller is gaining assurance they will receive payment. The willingness to offer pricing discounts, the ability to provide extended payment terms, and offers of added flexibility, all stem from the Seller’s belief they will pay in full within an acceptable period. Like all relationships, import arrangements often evolve and change over time. Buying on open account with extended payment terms may be a worthy long-term goal. However, new relationships almost always require a foundation of trust engineered by an experienced lending institution which can facilitate early trades. Financing ensures success and satisfaction for both Seller and Importer.
Commercial lenders offer three general services that start off the import process and address the needs of the Seller:
a) Sight Letters of Credit
Sight Letters of Credit are a form of guarantee put up by a recognized and credit-worthy banking institution that provides for the Seller to be paid, essentially upon request. Independent commercial finance companies typically maintain relationships or their lines of credit with larger banks that offer this service on behalf of the finance company’s clients. Bank charges are passed on to the Importer, along with a modest markup.
A Sight Letter of Credit is a negotiable instrument and is typically issued clean. Meaning there no preconditions. The Seller is free to present the document to its local bank for payment at a time of its choosing, providing comfort then that the payment will be received. For this reason, the Importer can often negotiate better pricing terms, boosting margins and helping to offset costs associated with putting up the Letter of Credit. The Importer will need to post collateral to the Lender, often including a personal guarantee.
b) Documentary Collections
Documentary Collections (often referred to as “cash against documents”), is a variation on the same theme. Under these arrangements, the Seller is required to produce documents supporting the sale and transfer of goods before receiving payment.
Well recognized international banks also issue documentary Collections. Also, have the added benefit to the Importer of having an experienced “set of eyes” involved in the transaction. The Bank issues the documentation of Collections in favor of the Seller and agrees to pay upon presentation of supporting documents including bills of lading, packing slips. If requested by the Importer, an inspection report by an accredited third party confirming the contents of the shipment.
Payment is typically arranged to take place once the goods are delivered to a designated port of origin. The Seller still receives the assurance of getting a payment, backed by the good faith of a credit-worthy bank. Sellers may be inclined to bargain on pricing. The added benefit to the Importer is that with payment, title to the goods shifts to the shipping company or to the Importer, where it can often be used as collateral and security for the Factoring Company.
c) Purchase Order Finance
Importers often secure a purchase order from a qualified buyer, before initiating trade with the Seller. Provided when financially strong companies issue these purchase orders which can be used to secure financing without having to rely on Letters of Credit. Under this arrangement and depending on their level of comfort with the Buyer, the commercial lender may be prepared to advance up to 100% of the purchase price. Sometimes even including freight costs and insurance.
It works particularly well when the distribution of products are direct to the Buyer, and not remanufactured in some fashion. The Lender can take title to the underlying goods allowing it to resell the items to liquidate the debt if need be. Importers should still expect to post collateral to support the transaction consistent with the financing techniques noted above.
All these financing methods give the overseas Seller what it needs- assurance of payment. The Importer can accomplish this without tying up a significant amount of working capital for extended periods and sometimes piggybacking of the creditworthiness of the Buyer.
Step 2: How to Bridge the Payment Cycle
Having now paid for the goods and satisfied the Seller, the Importer must bridge the timing gap until the Buyer makes the payment. Commercial finance companies can help at this stage as well, as follows:
a) Inventory financing
Financing is available for a shipment of goods once the title has passed from the Seller. Some lenders will advance against goods in transit (otherwise known as “goods on the water”). However, others will lend against inventory once landed “in the country.”
Besides, at a third party bonded warehouse where lenders can track the shipment with identity, and separates from other stock. In both cases, the Importer can obtain valuable working capital support during the transfer stage. Inventory financing is particularly helpful when transporting goods by ship where delivery times can stretch to several days.
b) Work in Progress (WIP) financing
Importers can seek further financing support when they are re-manufacturing imported goods. In some cases, a lender will finance the entire process of converting raw materials into finished products, providing working capital support that is particularly valuable the longer the production cycle. The Importer gives the title to the goods to the Lender. Typically puts up additional collateral along with a personal guarantee.
c) Receivables financing
Once the finished products are delivered to the Buyer, the Importer can quickly accelerate payment by discounting or factoring the invoice. Commercial finance companies are well established and well suited to provide this service. The Importer receives a portion of the payment total upon presentation or sale of the invoice to the Lender. Payment is typically arranged to be made directly to the Lender with the Importer receiving a residual amount back from the Lender, net of fees, once the sale is consummated. The better the credit profile of the Buyer, the higher the initial advance rate and lower the associated fees. Payment terms also have a bearing on pricing – the shorter the term, the quicker the overall cost to the Importer.
Importing Goods Financing Summary:
Importing goods and services is big business. Small business owners can be active players in this market providing steps to consider in securing import financing support throughout the entire procurement and delivery cycle. Building relationships with foreign suppliers can be profitable and rewarding. These companies are looking to expand the market for their products and will often be receptive to doing business. Commercial finance companies like WIP Funding with experience in Import finance can bridge cultural divides. Also, it will help build long-term relationships and shorten otherwise long payment cycles. Finally, commercial finance companies will protect the financial health of enterprises whether active in this arena or just starting.