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For years now, U.S. companies have heard about the emerging global economy and the abundant opportunities abroad to increase sales, insulate themselves from business cycles, and build brand equity. But for a variety of reasons — trade barriers, inexperience with international trade, and financial risk — many business owners have elected to bypass global markets. Today, a conflux of competitive and regulatory forces are driving many businesses from the sidelines to the playing field. And international factoring — the sale of accounts receivable to international finance companies with the resources, expertise, and local presence to actively manage trade risk — is providing a solid platform for success.
Rethinking Global Trade
It’s easy for business owners to view international trade as an insurmountable challenge because of the many business risks involved. In many countries, for example, accurate credit information on potential trading partners is difficult to obtain, and credit analysis is further complicated by differences in accounting standards and procedures. Foreign banking systems can present further impediments — everything from forward and back valuing on payment instruments, to foreign exchange transaction exposure, to delays in clearing international funds. Further, traditional trade finance tools such as bank Letters of Credit (LCs) and credit insurance can be costly to use and difficult to manage. Most important, exporters must weigh carefully the financial risks of offering trading partners the open account terms they require — especially in countries whose legal systems protect debtors from their creditors.
In today’s environment, however, maintaining solely a domestic focus can be every bit as risky — especially as competitors gain strength by tapping global markets. Consequently, in industries as diverse as high-tech and plastics, more and more companies are committing themselves to global trade and making it work. For example, U.S. electronic exports reached $135.4 billion in 1996, an 8 percent increase over the previous year, and more than double from 1990. The plastics industry is also evolving into a truly global business. Steady demand for American-made plastics products from established markets in Western Europe and Japan, and significant pockets of growth in developing Asian and South American countries, have produced a trade surplus of approximately $4 billion a year.
Much of this momentum stems from the ongoing efforts of organizations such as the U.S. Department of Commerce and the impact of trade agreements like NAFTA, opening new markets in Latin America, the Pacific Rim, and other regions. But there is clearly another force at work: the steady rise of international factoring as a financing strategy. According to Factors Chain International, a network of 100 independent factoring companies that serve approximately three dozen countries, factoring contributed $28 billion to U.S. international trade in 1996 — an increase of 19 percent over 1995. Indeed, factoring is proving especially well-suited to small- and mid-sized companies that either lack the resources to manage the administration of their international accounts, or that prefer to outsource this function.
Weighing the Options
One of the first decisions companies face when contemplating global trade is how to address the attendant credit risks and administrative responsibilities involved. The three traditional payment practices — cash in advance, bank LCs, and credit insurance — are all effective, proven strategies for facilitating cross-border transactions. But each has significant limitations. The drawback to cash in advance is that customers accustomed to the flexibility and convenience of open account relationships will typically object to payment before delivery. Another well-established option, bank Lcs, are effective and relatively convenient for the seller, but they are growing unpopular with buyers because they place a significant administrative and financial burden on the buyer to open, maintain, and pay the expenses associated with the LC. LCs also limit the buyer’s financial flexibility by tying up valuable credit lines that could be used for other purposes. Plus, confirmation is not available for all banks, and disputes can be difficult and costly to resolve. The third option, credit insurance, usually does not provide full coverage, and its deductible and/or co-insurance payments expose exporters to additional credit risk. Further, credit insurance provides limited collection support; it typically requires exporters to perform their own credit investigations, and it places the burden on exporters to prove their claims.
By combining the best features of LCs and credit insurance, international factoring has emerged as an attractive alternative because it addresses the needs of both exporters and their customers. When exporters sell their accounts receivable to international factors, they can strengthen their selling power and solidify their trading relationships by offering their customers the open account terms they prefer. Companies can also minimize the credit risk and eliminate much of the administrative burden of global trade, because the factor assumes the credit risk and handles difficult and time consuming processes such as credit investigations, collection of receivables, and remittance of the proceeds directly to the exporter.
Exporters are also drawn to factoring because they can select the specific financial products and services — receivables management (including bookkeeping and collection), 100 percent credit protection, and receivables financing — that best suit their export program and financial situation.
To facilitate collection and improve cash flow, exporters can also leverage the local presence and resources of factors to help them turn receivables faster, improve their cash flow cycle, and strengthen trade relationships by resolving billing and payment issues. Factors even offer additional back office services such as bookkeeping and receivables management reporting.
If credit risk is a significant issue, factors can analyze the credit-worthiness of potential trading partners and also protect exporters from credit losses by assuming the credit risk themselves and paying off any outstanding invoices at 100 percent (less commission and fees) after a designated time period. Both receivables management and Credit protection are fee-based services. Fees are generally expressed as a small percentage of the invoice amount, with that percentage varying based on sales volume, invoice amount, credit quality of customers, and frequency and destination of shipments.
If business cycles create unsteady cash flow, factors can offer financing services based on international accounts receivable. Factors advance funds at an agreed-upon percentage of an invoice the day the title to the goods is transferred. Interest is accrued as with any normal loan, and the factor reduces the loan balance as customer payments are received by the factor.
Favorable Pricing
Exporters might expect to pay a steep price for factoring services, but direct comparisons between credit insurance, LCs, and factoring reveal the economic advantages of factoring. The chart on the previous page details these costs using the hypothetical case of a manufacturer with yearly overseas sales of $10 million, who ships to 50 overseas buyers with an average order and invoice size of $75,000 and maximum payment terms of 90 days.
Total expenses only tell part of the story, however. Though credit insurance enables the exporter to extend open account terms to its customers, it offers exporters only 90 percent credit coverage. If a credit loss occurs, exporters can expect their total costs to rise significantly. With LCs, the cost of credit protection for the exporter is borne by the buyer, and the fee structure of LCs — which involves separate charges for activities such as issuance, amendments, discrepancies, and cancellation — makes total costs difficult to estimate. With factoring, however, the exporter is fully insulated from credit risk and can offer open account terms for approximately 10 percent less than the LC cost.
Success Stories
Conex Cable, Inc., a Dublin, Calif.-based manufacturer of aluminum-clad steel wire products, began operation as a joint-venture company. In 1995, Hitachi Cable Ltd. of Japan became a 100 percent owner of Conex Cable, Inc. Since then, the company has been expanding its range of production and products and the business has gradually taken on a more international flavor.
When Conex set its sights on Mexico following the passage of NAFRA, it tumed to an international factor to provide credit protection for an initial transaction that, when completed, will total an estimated $1.6 million. Conex’s president, Akira Kaneko, was drawn to the factor in part because its affiliate office in Mexico City offered a valuable local presence. But he also embraced the program the factoring company proposed. “Our single biggest concern with international trade was credit protection. When we expressed our reservations about export credit insurance and the exposure to deductibles and co-payments we would face, the factor recommended a non-recourse, non-notification export factoring program that eliminated this exposure altogether,” Kaneko remarked.
New Jersey-based ITP, a mid-sized manufacturer of zippered plastic bags used for packaging, has also taken full advantage of the broad services and comparatively low costs that factors can offer. “We sell to Belgium, Canada, Chile, Colombia, Finland, France, Holland, Israel, Italy, Spain, and Switzerland, among others,” says Gina Peter, Assistant Credit Manager. “If we had to rely solely on Letters of Credit, work would be a nightmare. Instead, we sell our receivables to our factor, which in turn collects for us and then credits our account.”
Peter also calls upon her factor to perform credit checks when she’s establishing trading relationships with new customers. “It’s difficult to get reliable bank information from some foreign customers,” she explains. “Factoring has helped us tremendously and has even given us some extra interest income. And, although we don’t borrow against our receivables, it gives us an extra measure of comfort and security to know that we could, if necessary.”
A Foundation for Growth
At a time when new trade agreements are making global trade more attractive than ever before, international factoring offers small- and mid-sized companies a practical, cost-effective strategy for penetrating global markets. By giving exporters the protection they need, and by extending open credit terms to their customers, international factoring provides a solid foundation for profitable new trading relationships that keep businesses on track for greater growth.
Written by Kenley A. Tarter

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