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 firstname.lastname@example.org.
With uncertain markets, what seems today like a good international business deal could turn into a major loss tomorrow.
To protect your business against volatile currency markets, consider hedging, says Jeannie Kao, executive vice president/division manager, International Banking Division at Bridge Bank.
“When negotiating with a foreign buyer or vendor, what is on the table now might make you money today,” says Kao. “But the only way to guarantee that profit is to lock in the exchange rate so you know that when you do get paid, your margin is protected.”
Smart Business spoke with Kao about how hedging can impact your business and how doing business with an EX-IM-affiliated bank can help you gain access to capital.
What is the first thing to consider when thinking about doing business overseas?
Think about where you are in this trading relationship. Are you a buyer or a seller? Do you have more negotiating power when compared to your counterpart, or do you not really have a say? If you are a small company dealing with a large company, your negotiating power is weak. But if you are a bigger company dealing with a smaller vendor, you’ll have a lot more say.
You also need to evaluate yourself. Look at what you are selling. Are you buying offshore, as well? What currencies will you be dealing with? Do you need financing? What kind of instrument will you use to conclude the sales transaction? Your banker can point out things you may not have thought of and suggest instruments to help you secure and protect yourself.
How can hedging help a business protect itself?
Due to recent volatility in currency markets, the U.S. dollar is no longer the king of currency. Ten years ago, companies didn’t want to deal in foreign currency because the risk was too great, so they only dealt with companies that would take U.S. dollars. But today, when you want to get a good deal, sometimes you have to pay, or buy, in the local currency of the market you’re dealing in.
A simple hedging scenario is a forward contract. Let’s say, today, pricing per unit on your foreign transaction is $1.41. But you won’t be paying for 90 days. Today, you may be getting a good deal, but if the exchange rate goes up to $1.45 in this scenario, your margin has suddenly diminished, and you may now be losing money. To protect your costs on transactions like this, get a forward contract to ensure that your costs are locked in
So your strategy should be to manage this process closely, rather than to take what could be costly chances. Many businesses choose the latter, and if by chance the market swings in their favor their profit margin will widen. But if the market goes against them, their margins could disappear completely. It’s not worth the risk.
How can the Export-Import Bank of the United States help a company do business overseas?
The EX-IM Bank is the official export credit agency for the U.S. Its primary aim is to promote export activities, but it is a small agency.
Commercial lenders in the market, however, have contacts with exporters. So the EX-IM Bank names certain commercial banks as delegated authority lenders to provide lending to exporters, with the EX-IM Bank providing a 90 percent guarantee on loans that these particular commercial banks make.
For example, if a commercial bank is not a delegated authority lender, it wouldn’t even look at using international receivables as collateral for lending because those receivables represent a higher risk. So they only want to consider domestic receivables as potential collateral.
A company that is heavily into exporting doesn’t have much in domestic receivables but does have foreign receivables, making it difficult to get working capital from a regular commercial bank. So the EX-IM Bank designed this program in which, if commercial banks are willing to lend to exporters, it will guarantee the lender 90 percent of the loan, and the commercial bank is only exposed to 10 percent of the risk. That makes it easier for the commercial lender to help the exporter. And the exporter still deals with its own bank; EX-IM only comes into play if the loan goes into default.
What should a business look for when doing business with a bank?
Look at the banking relationship. Businesses tend to think that, if they’re importing or exporting, they have to go to a global bank. There’s nothing wrong with that, but if a business is small, it may not get the attention it needs to help it structure deals. At a bigger bank, smaller companies tend to get lost.
By going to a bank that caters to smaller companies, you can get the attention that you need to move your business forward. Your bank can do so much more than just provide you with a loan. Look for a bank that really wants to help you and that can ask the right questions to urge you to think through the details of what needs to be in place to achieve your business objectives.
Find a bank that will get to know your company. It should really understand what your business model is, and what kinds of products you do and don’t need, and provide you with an honest assessment.
By finding the right bank to partner with, your business can take advantage of the growing opportunities in international markets.
Jeannie Kao is executive vice president/division manager, International Banking Division at Bridge Bank. Reach her at (408) 556-8375 or Jeannie.Kao@BridgeBank.com.