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Doing business overseas comes with a lot of adventure and opportunity, but it also comes with a lot of risks. As a result, companies that take such positions frequently engage the use of various financial tools to protect their interests. In some cases, these tools require sharing a piece of the revenue to ensure payment. In other cases the companies have to establish partnerships with affiliates overseas to make sure things stay on track. Each method works to some extent. However, the degree of revenue-sharing can be very different, depending on the tool used.
The process of export factoring essentially involves taking a business' accounts receivable and selling them to third party to do the actual collection of the funds. In return, the original owner of the accounts receivable gets its funds right away for the product or services provided with cash up front. This factoring approach requires the business to give away a percentage of the revenue due to receive payment up front. While the factoring service may seem like an unnecessary significant expense, it can still mean opening up larger markets overseas as well as making some level of profit overall with a guaranteed revenue stream. With scales of economies the profit involved, while small per unit, can be far more in the aggregate, making the entire approach worthwhile after all. More importantly, the money earned is collected in a reliable manner, rather than the higher risk approach of relying on overseas customers directly to come through consistently.
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The factoring company, on the other hand, sees its revenue from the service it provides and the payments it collects from the accounts receivable purchased. Since the factoring company usually has a foothold in the overseas country the customer is in, it also usually has an advantage in revenue collection success.
Partnering With Affiliates
A second approach involves partnering with an in-country affiliate to manage the field operations and sales. Similar to factoring, the approach involves a sharing of the revenue made from the overseas market. However, because both companies have a stake in making the overseas partnership work, it ends up being a win-win situation in the long-term. The main company provides the product and manufacturing while the in-country affiliate provides the field resources and sales/collection function. As a result, they work in tandem to open up and grow the overseas market and mutually benefit from the ongoing approach.
A number of companies use the partnership approach when they want to have more of a foothold on overseas operations, especially where sensitive activities are involved and field activity control is important.
Using escrow transactions through local financial institutions can be a third method of ensuring proper financial flow of sales and related revenue. Under this financial approach the seller chooses an in-country bank to be an escrow agent the buying customer deposits payment into an escrow account with a local financial institution overseas. The home company produces the product or services and delivers them to the customer. The customer signals satisfaction and releases the escrow funds for payment. Both have a third party intermediary protecting their interests while keeping the business transaction moving.
The escrow approach tends to be a bit more formal and technical. As a result, it's seen as potentially detrimental to a potential sales transaction and winning new customers because it essentially says, “I don't trust you to follow through with payment so I'm bringing in this third party to hold your money until payment is due.” That said, some businesses find with large sums involved an escrow approach is exactly the method of business they want to protect their investments in a sale and production situation.
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While it can seem like an expensive approach, the use of business insurance can be another method of protecting sales revenue. Under the insurance approach, the business seeks an insurance provider to carry a policy that will payout should the opposite transaction partner not come through on a sale. The insurer will definitely want to investigate the buyer to determine how much of a risk is involved before issuing a policy. However, where there is a consistent track record of transactions, the export seller may not want to take overt steps to ensure revenue collection but also doesn't want to be fully exposed. As a result, an insurance policy behind the scene makes up the difference.
The insurance approach can be expensive both in single instances and over the long-term because the insurance provider wants to make a profit or at least cover a good portion of the risk involved versus the entire pool of clients insured. As a result, related coverage premiums may only work for some unique overseas business situations where a financial safety net is paramount.
Set Up a Direct Presence
For some companies a direct presence overseas is the most viable approach. It is also the most expensive of all the models discussed above. The direct approach involves obtaining all the necessary permitting and licensing to be in-country overseas and then establishing a physical presence. This can and usually does include facilities, personnel, supply systems, resources and sales offices. For large chain operations and corporation the approach can make sense, even after permit fees, taxes and local costs of operation.
The direct presence approach does not work well for small or medium-sized companies due to the cost involved. The one exception to this fact tends to be family-owned businesses which are able to rely on relatives in different countries to keep operations going. The family bond helps ensure trust and keep costs down which would otherwise be an issue under normal business conditions.
Lines of credit and credit protection tend to shift a company's risk over to a lender on a cash flow basis, but this can be a bit of an illusion. While the company uses borrowed money to pay for costs to sell overseas until the customer pays up, a bad customer transaction doesn't absolve the borrower of his loan. So while the producing company hasn't lost its own funds up-front to a bad overseas customer, the loan still has to be paid back, causing a loss with interest over time. For some companies, this is a price that can be paid with more business overseas in aggregate, thereby eventually paying the loan with a majority of good sales offsetting a once-in-a-while bad sale. And on a cash flow basis the lender takes the heat in the immediate financial situation rather than the export company.
As discussed above, export financial tools and approaches come in different colors and models. Some work better than others for different size companies or what they sell specifically. There is no sure-fire standard that works in every situation, so every company considering cross-border ventures will need to do its homework to find the best approach for overseas sales and business. More information on Export Trade Finance
- Navigate the Global Economy with International Banking
- Handling Multiple Currencies in Business Transactions
- Financing for Importers and Exporters
- Retaining Control of Import-Export Firms with Alternative Lending Options
- Can invoice factoring help global distributors overcome working capital shortages?
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