Don’t Gamble With Your Company


In today’s volatile global trading environment, there’s no disputing the need to mitigate the payment risks associated with – some would say inherent in – international trade. Those risks raise their heads even before you close the sales contract and can continue to cause you sleepless nights until payment is securely deposited in your bank.

BRIC walls
Let’s look at the balance of risk and reward in the context of the BRIC economies – Brazil, Russia, India and China. They’re attracting huge interest from potential importers and investors, but each presents its own set of risks. Brazil is emerging from a period of economic instability, and has yet to fully prove itself.

Russia, while justifiably recognized as a global powerhouse, is giving foreign companies some headaches, over some of its government’s policies and its over-dependence on oil and gas. India has well-established legal and banking systems, giving some assurance to potential investors, but needs desperately to tackle its poor infrastructure.

China is probably the most difficult for foreign companies to penetrate, not least because of the Chinese concept of Guanxi – a network of relationships built on mutual respect and obligation. Even with its reformed insolvency laws, encompassed in the People’s Republic of China Enterprise Insolvency Law, foreign vendors will still find it hard to get satisfaction from an insolvent Chinese debtor. That’s because, while the new law aims to unify the myriad existing laws, it places onerous conditions for the recognition of any ruling by a foreign court.

Question time
Whichever market you have in your sights, knowledge and preparation are essential to success.

Imagine that you’ve contacted a prospective customer. Asking yourself a few questions can highlight the risks you face:

• Where’s the customer based? If it’s in a country that you haven’t dealt with before, what do you know about that country’s laws? How stable is its currency and banking system? How do people conduct business there – what’s the business ‘etiquette’?

• Next, what do you really know about your customer, their financial stability and business ethics? Are they all they claim to be? And where can you go to find out?

• Now to the sale itself. What currency will you be dealing in – yours or the customer’s? Is it wise to offer open account terms on a first contract – even if you have to do so to clinch the deal? What if something goes wrong – the customer refuses to pay you, or worse still, goes bankrupt? What happens then?

Weighing up the risk
It sounds a nightmare, but needn’t be. Anyone in business knows that the higher the risks the higher the reward. How you manage those risks is down to how much you have to lose.

If your manufacturing costs are low and profit margins high, the odd bad debt may not be crucial. Unfortunately, many businesses don’t have that luxury. For them, a bad debt can be a serious setback – even terminal. If a single sale goes bad, how many more will you have to achieve just to recoup your lost capital?

Once you’ve understood the potential financial risk, you can weigh up the options for mitigating that risk.

You could make debt provision on your balance sheet. But what you’re actually doing is setting aside money that could be usefully employed in, say, research and development.

You can – and should, of course – seek information on your customer’s financial standing and keep updating this information as the relationship progresses. Use a reputable credit information agency or seek a report from the customer’s bank.

Basic Instinct
A basic rule, and one that you no doubt already follow instinctively, is ‘avoid oral contracts’. You can bypass many of the pitfalls of international trade simply by ensuring that your written contract is watertight.

Remember the basics.
The contract must specify the nature of the goods or services, price, payment and delivery terms, due date, and the currency of payment.

The A to Z of Letters of Credit
While on the subject of good documentation, Letters of Credit (LCs) – effectively bank guarantees to pay for goods or services supplied – are widely used throughout Asia. They come in many forms: irrevocable/revocable; confirmed/unconfirmed, transferable, back to back, standby, revolving.

If you intend to go down the route of stipulating payment by LC, you’ll need to look carefully at the level of security and suitability of each of these options.

The key to success of an LC is proper documentation. Whatever details are shown on your contract, bill of lading and the LC itself must be absolutely consistent. If they aren’t – if, say, the number of items to be shipped as stated on the contract doesn’t match the number on the LC – the bank can justifiably withhold payment.

While LCs can offer you security, you need to consider whether the risk justifies the means. Are the bank fees out of proportion to the contract value? Are your competitors offering more attractive terms?

True lies
It’s always wise to look out for signs that your customer may not be as well-off as they claim. Not that long ago the high-profile collapses of Enron and WorldCom drew the world’s attention to the hazards faced by suppliers of companies that paint an over-rosy – even fraudulent – picture of their creditworthiness. The complexities of corporate balance sheets can be difficult to unravel – sometimes deliberately so – and the profit and loss account may not give a full and accurate picture.

What’s more important is cashflow. A seemingly profitable company that isn’t generating sufficient cash to pay its suppliers is probably employing ‘creative’ accounting to inflate its income or disguise its expenditure.

If any good has come out of the Enron and WorldCom debacles, it’s that senior management now have to accept personal responsibility for the accuracy of their accounts. Overall, public companies are now more wary of making over-optimistic forecasts of future earnings.

A sting in the tail
Of course, not every fraud is on such a grand scale, but if it hits you it’s no less painful. Be on your guard if:

• your customer isn’t interested in the price tag – why would he be if he doesn’t intend paying?

• he wants to collect the goods – because his business address is fake

• he tells an incoherent story about his own company

• he wants delivery just before a major holiday period such as Chinese New Year

• he puts you under undue pressure to grant him credit

• you’re given a telephone number for verification – check the number yourself and avoid doing business with any company that uses only mobile telephone numbers

Avoiding a title fight
Hopefully, you won’t come across too many fraudsters in the course of your business, but when a customer does go bankrupt it’s often advantageous to have rights to retrieve your goods.

Retention of Title (RoT) can be an effective form of security if it’s a condition of sale, allowing you to retain ownership of your goods until they’re paid for. That said, it’s mainly for use in European sales, and while it can work in Asian countries whose legal systems are based on English law, such as Malaysia and Singapore, it won’t be effective in China.

If you want to consider using RoT, get good legal advice for both drafting and enforcing your RoT clause, and remember that, although returned goods may be useful to you, they may be critical to the insolvency practitioner so he’ll need to pay you if he intends to keep them.

The ultimate safety net …
…is credit insurance.

Quite simply, it shifts the payment risk to the insurer, freeing you to expand your business. But it does more besides, answering many of the questions posed earlier.

A credible credit insurer like Atradius will vet your prospects and customers to ensure that their financial status can justify the amount of credit you plan to afford them – or, if not, recommend a realistic line of credit.

If you’re entering new territory, the better credit insurers will have people ‘on the ground’ who understand the economic, political and legal lie of the land, and can help with your initial approach to a prospect.

And of course, your credit insurance really comes into play if the worst happens and your customer won’t or can’t pay. You’ll have the assurance that your cashflow won’t suffer. If, like Atradius, your insurer has collection and legal experts in the debtor’s country, they’ll seek a negotiated repayment programme, and wherever possible help the debtor recover so you can retain your working relationship.

In the context, say, of China, Atradius has a strong base in Hong Kong and Shanghai, and can advise on Chinese business culture. Without such local expertise, the process for recovering debts can be impenetrable, obstructed by bureaucracy and lengthy court procedures.

The essential message is that good credit management – and that’s what this is all about – is no longer a ‘backroom’ activity. It’s a way to optimise sales and profit potential at every stage of the sales cycle, from first contact with a prospect to receipt of payment. There’s always a way to say ‘Yes’ to a genuine sales enquiry. Understanding the risks simply creates the framework for you to set the terms of that sale – and ensure its success.