How to take advantage of trade cycle financing Featured

8:01pm EDT September 30, 2011
How to take advantage of trade cycle financing

Interest rates vary throughout the world, and companies that do business internationally can use this knowledge to their advantage.

“Buyers and sellers really need to know the interest rates in the country of their customer and the impact on their trading partner’s cost of doing business,” says Craig Schurr, a senior vice president and the International Banking Division Manager with FirstMerit Bank. “As cost of finance directly impacts cost of purchase,  sellers really need to know their customer’s cost of borrowing and if financing is available to them. When armed with that information, you can create a partnership with the companies with which you do business  and use the overall financial concepts of the trade cycle to benefit one another.”

Smart Business learned more from Schurr about how companies can take advantage of trade cycle financing in international business.

How does trade cycle financing work for importers and exporters?

From the moment an exporter receives an order until the exporter gets paid for the order, someone is using cash to finance that period of time. That is the concept of the financial trade cycle. Everyone knows the old saying that time is money. The trade cycle is all about time, so it is really all about money, too.

If I get an order as a seller on the first of the month and I don’t get paid until the 30th, I’m financing that 30 days with cash that I have in my company, and I know intuitively I’ll pay some interest for that money (because money is not free). Or if my company is short on cash, I may borrow from the bank.

So there is a financial impact from the moment the buyer places the order with the seller until the seller gets paid. And once the buyer pays the seller, the buyer begins its own financial trade cycle.

For instance, imagine I run a steel company. I buy coal from a coal company to make my steel. My financial trade cycle lasts until the steel is manufactured, sold, and I get paid. Then I can consider my trade cycle for the coal complete.

While financial trade cycles exist in all buyer seller business they are more protracted for companies doing business internationally and much more financially impactful. So to summarize, an exporter’s trade cycle starts the moment it gets an order and it ends when it gets paid. For importers, the trade cycle begins the moment it pays and lasts until it can convert what the seller sold it into something that makes it money.

How can importers and exporters benefit from the trade cycle?

An exporter needs to finance its trade cycle, and needs to take into account what its buyer is facing. Let’s focus on an exporter in the U.S. selling to India, where interest rates just went up and are much higher than in the U.S. As an example, a U.S. company can currently borrow working capital from the bank at a prime interest rate (currently 3.5 percent)  to manufacture goods. However, the cost of borrowing for the company in India could be upwards of 15 percent.

The U.S. company has a 3.5 percent cost of finance in its trade cycle until the company in India pays for its purchase. Once this happens, the purchasing company has a 15 percent cost of funds to take into consideration until it converts its purchase into something that generates cash to complete its trade cycle.

If you, as the seller, don’t want to incur that 3.5 percent interest rate, you could ask the buyer for cash in advance and you have no cost of finance; your customer absorbs all of it. However, that may be an unprofitable scenario for the importer as now it is financing your trade cycle with expensive 15 percent cost of funds. If I can borrow at 3.5 percent as the exporter, and I know my buyer is paying 15 percent, I wouldn’t ask for cash in advance because it wouldn’t be very customer-friendly. Instead, I may work with the buyer so we could somehow employ my 3.5 percent to finance our trade cycle. That is one way buyers and sellers who work together can take advantage of the trade cycle.

Now let’s say I am a U.S. importer, and I’m buying from India and my cost of finance remains 3.5 percent and the seller’s cost is 15 percent. I know fundamentally that if they’re doing the same thing I would do as a seller, they’re embedding the cost of their financing in their price. I intuitively know the price I am being quoted by the seller includes a 15 percent cost of financing. So I may suggest to the seller that, if I pay with cash in advance, I should get a discount on the price because I’ve saved the seller the need to borrow from the bank.

Both buyers and sellers stand to benefit from understanding how different interest rates impact trade cycle financing. If you can work with your trading partners to understand the borrowing rates of the company you’re doing business with, you can work within the trade cycle as a business partner, instead of just in a simple buyer/seller relationship.

Where can companies find international interest rates?

There are at least two places companies can look. Visit the foreign currency exchange market website (www.FXstreet.com/fundamental/interest-rates-table/) for a world interest rate table, which has the current interest rates of central banks (what banks charge other banks), and also has a summary of 23 major countries listed by region.

Another interesting and informative source is the Central Intelligence Agency (www.CIA.gov). The CIA collects extremely useful business data. There is information available for businesses in every country in the world, including the rate at which companies borrow within each country. Companies in the U.S. should take advantage of these resources.

Craig Schurr is a senior vice president and international banking division manager with FirstMerit Bank. Reach him at (330) 384-7325 or craig.schurr@firstmerit.com.