Financial Risks

Sources of Financial Risk in Export Risk

Global companies depend upon the secure and reliable transportation of goods and the transfer of money.

Domestically it is easier to communicate, make and receive payments and solve any problems.

Dealing with export customers and the banking system in different countries makes international transportation riskier.

Distance and different legal systems in different countries makes resolving disputes and errors more difficult.

Financial Risk

Financial risk include:

• Non-payment by export markets

• Financial loss due to exchange rate variations

Currency Fluctuations

• The value of the Australian dollar is determined by market forces and is outside of control of exporting companies.

• A currency exchange rate is the price at which one currency is exchanged for another currency at one point in time.

• Exporters face financial risk from fluctuations in currency exchange rates.

• For example, if the Australian dollar falls in value between the time of a transaction and payment.

• One way to manage the risk is to list goods and services in Australian dollars and require customers to pay in the currency.

• Another method is hedging – where arrangements are made now in anticipation of possible currency changes in the future to minimise losses. For example:

An Australian exporter sells goods to a customer in France for $5,000EUR. At the time of the sale, the exchange rate is $1.00EUR=$1.59AUD. This means that at the time the contract was signed, the Australian business would receive:

5,000EUR x $1.59 = $7,960AUD

The goods are sent a week later, and the customer makes payment. At the time of payment, the exchange rate has changed and is now $1.00EUR=$1.35AUD. The customer pays the invoice, the Australian business receives:

5,000EUR x $1.35 = $6,750 AUD

The business has lost a cash inflow of $1,210 because of the currency fluctuation.

Non-payment of Monies

• An exporter can face a financial loss after incurring costs and delivering payment from the customer.

• It is much more difficult to chase a payment from a customer in another country than a domestic one.

• A way to manage this risk is with prepayment from customers, either in full, instalments or a deposit.

Strategies for minimising financial risk in export markets

Exporting companies must consider and monitor these risks in order to maintain financial viability and profitability. Market success can be undone by the impact on cash flow from these financial risks.

Documentation

The policies, procedures and paperwork related to the payment on international transactions. It is advisable for exporters to establish that their foreign buyers are creditworthy by assessing their personal information and credit history.

Two main forms:

• Documentary letter of credit

• Documents against payment

• (or ideally for the exporter, take payment in advance)

Documentation - strategies for minimising financial risk

1. Documentary letter of credit
A guarantee from the export customer’s bank that the money will be paid. The letter of credit includes terms and conditions for payment such as the safe delivery of the goods with a certain time. The bank will make the payment if the terms are met and then seek reimbursement form the customer.

2. Document against payment
An exporter sends their goods to the customer’s country, and they are held in customs. The exporter sends documents to a bank in the customer’s country that allows them to collect the goods from customs after payment is made. Once the customer pays, the bank gives the documents to the customers, and they can collect the goods.

Or Payment in advance
Payment by the buyer to the seller is received in part or full before the goods are sent. Offers no risk for the exporter but full risk for the importer.

Insurance - strategies for minimising financial risk

Insurance is a way for an exporter to mitigate or minimise the financial impact of these risks.

• If there is a loss, the exporter can make a claim to cover the financial loss.

• Exporter can obtain insurance for:

  • Credit insurance for non-payment

  • Loss and damage in transit

  • Political risk such as war, civil unrest, government regulations that impact on the importing of goods

  • Currency fluctuations

Sources of Insurance

• Export Finance Australia (EFA)

• Banks and specialist insurance brokers

• Freight forwarding companies can offer transit insurance

• The Export Markets Development Grant (EMDG) can reimburse insurance on intellectual property

Hedging - strategies for minimising financial risk

Hedging
Hedging can take two forms – Forwards and Options.

Let's say AUD $1 = USD $0.60 today. In 3 months time, a company wants to buy your goods.

• Forward – an agreement is made between the exporter and the customer to FIX an exchange rate for payment. This protects the exporter from a loss but also prevents any gains from a stronger Australian dollar.

  • "In three months time, we agree to exchange at AUD $1 = USD $0.58".

• Options – an optional exchange rate is agreed to by the exporter and customer. If the exchange rate is better for the exporter at the time of payment, they will take the current rate instead of the option rate.

  • "In three months time, I can choose to exchange at AUD $1 = USD $0.56, or accept the current rate".

• Note – you are paying a premium for this flexibility.