Safe harbors for overseas shipments.

Ever have to drag payments out of your foreign customers? You can cross that problem off your list after reading this guide to protecting your exports.

What does every exporter want? To get paid for the goods it sells overseas, of course. But this isn't as easy as it sounds in today's ever-shifting economic and political climate. As a financial executive, you know that the economic risks of exporting can seriously affect your bottom line. Now for the good news: You have the option of using several tools to reduce your risks. The chief questions you need to ask are which ones will be most effective for your company's needs, how much they'll cost and what kind of protection you can expect.

The typical exporter is a big company making small but frequent shipments overseas to a few targeted geographic regions. Nationally, three quarters of all export shipments are under $10,000 in value, according to the Census Bureau. In fact, only 6 percent of the 12 million export shipments over $2,500 each year are over $100,000 in value, although they account for 56 percent of the value of U.S. exports.

But that's not to say the risk you carry on these goods is small -- on the contrary, receivables are typically the biggest uninsured asset your company has. The global insurance market perceives export receivables as very risky because these goods carry country and company risk. As an exporter, you seek to insure only your riskiest accounts, while the insurance industry wants only your safest accounts. To protect your profits, you need to guarantee that all the goods you ship overseas are equally well-protected.

For exporters, the world is divided into two parts: the developed world and the rest of the world. For payment purposes, the developed world is all nations with financial institutions that can enforce the payment of current obligations. In these countries, local financial institutions can guarantee the creditworthiness of your customers.

If the locals can't enforce payments, you won't be able to do it either, and that defines the rest of the world. You can further divide the rest of the world into two parts -- the portion that the Export-Import Bank (Eximbank) will guarantee or insure, and the portion that's too risky even for Eximbank.

In looking at your repeat shipment business, you'll probably find that most of your exports go to regular customers in developed countries. Your occasional exports are likely to be destined for new customers, or for customers in nondeveloped countries, and these shipments tend to be larger than the small but frequent shipments typical of a regular customer.

GENTLEMEN, CHOOSE YOUR WEAPONS

Many exporters with regular accounts use an open account or documentary collection to guarantee payments. This option is probably best-suited for repeat customers in developed countries. It involves using a draft to withdraw money from the customer's bank account and transfer it to yours. A draft in simplest terms is nothing more than a check with the parts rearranged and the name of the paying bank left blank. Think of a draft as the check you're writing for your customer, one that your customer can accept on receipt.

Open-account is easy to use, but drafts do take time and cost you money. As an experiment, take a foreign check for $100 to your bank, and see how much time and money you need to collect on the check. If the check is large, the time value of money eats the profit. If the check is small, the transaction costs wipe out the profit.

Therefore, if you concentrate your exports on a few customers in the industrialized world, it pays to sit down with them and work out a cash-flow management account system. To make this work, you need to look at the correspondent relationships and use wire transfers for all amounts.

You also need a mechanism for pursuing late payments and a credit department that can read foreign balance sheets well enough to make the credit decision in the first place. Granting credit for international customers does take time, and it has an associated labor and credit-report cost.

Delayed payments are the biggest problem with an inefficient open-account system. With delayed payments, the customer registers on its books that it has paid you, but your books still show the amount as unpaid. If the customer has paid but you're still holding its shipments, because, say, the customer has already reached its credit limit, you may still end up with a reputation as an unreliable supplier. What's more, sales that could take place this month will get pushed into next month.

Letters of credit have a separate set of pluses and minuses. The major advantage is that the exporter is paid promptly once it presents acceptable shipping documents. On the other hand, while an unconfirmed letter of credit is foreign-bank risk instead of foreign-customer risk, it's still foreign risk. By contract, the U.S. bank is acting on behalf of the foreign bank when it advises you of the letter of credit.

Discrepant letters of credit can cost a great deal of money, and this is one of the drawbacks of this tool. A letter of credit with no discrepancies costs about $250 to $350 per transaction, but if you have discrepancies and amendments, it'll probably cost $600 to $700. Banks regularly report that 50 percent to 60 percent of all letters of credit are discrepant upon first submission. Since the importer's bank will pay 99 percent of all discrepant letters of credit after 90 days, even though the customer doesn't legally have to pay them, the exporter could have shipped the goods open account in the first place and kept the financing cost for itself instead of paying letter-of-credit fees.

To cut the number of discrepant letters of credit, the pro-forma invoice submitted to the customer before it opens a letter of credit should have the same format as the one used for the customer's invoice. Many companies let the marketing department write the pro-forma (since marketing is making the sale) and then submit a computer-generated invoice with the letter of credit. If the customer has used the pro-forma to write the letter of credit, the language may be different, even though the meaning is the same. Banks do a letter-by-letter analysis of the documents; they're not interested in the meaning.

AN EXPENSIVE PROPOSITION

A letter of credit poses some other disadvantages. It's expensive for the customer, which must provide some collateral to its bank to open the letter of credit. From the perspective of, say, a Portuguese customer faced with a local interest rate of about 22 percent, opening a letter of credit effectively adds 2 percent a month to the cost of your goods for as long as the letter of credit remains open. During a six-month manufacturing and delivery cycle, your letter-of-credit requirement to this customer makes you 11 percent more expensive than your competition.

Under banking law, an unconfirmed letter of credit is a foreign receivable, and many domestic U.S. banks won't lend against it. Often, that's also true for goods manufactured for a foreign sale. Letter-of-credit sales, as well as foreign open-account sales, reduce your borrowing capacity. This means that the faster you grow your export business, the more likely you are to be cash-short, since your borrowing capacity goes down as your cash needs go up.

Many companies get immediate cash for their letter-of-credit receivables upon presentation. What actually happens is that the bank pays the letter of credit against your credit line. In effect, you've guaranteed to the bank a receivable from a company or its foreign bank to which you denied credit in the first place. Plus, you've paid the bank a fee for doing so.

Banks make good money by confirming letters of credit for correspondent banks in low-risk countries. By adding a confirmation, the bank transforms a foreign risk into a U.S. domestic risk. Typically, a bank will charge 0.125 percent per quarter, with a minimum $100 charge. That's one-half of 1 percent annually, which is quite small, except when you look at the minimum $100 per quarter or $400 per year. The minimum is exceeded only when the letter of credit is greater than $80,000.

Note also that the bank's typical fee for advising an unconfirmed letter of credit is 0.1 percent, again with a minimum $100 charge. The minimum thus applies to all letters of credit less than $100,000. On a $10,000 letter of credit, the advising fee is 1 percent of the transaction value. And the letter-of-credit advice informs the exporter that the U.S. bank is acting "without engagement" on its part, which is really saying the bank has a contractual relationship with the buyer rather than with the seller.

These are all factors you should think about when assessing a letter of credit as a business tool. To determine whether it's a good choice for your company, look at all the transactions in the past year that your company covered with letters of credit. List the invoice amount and the net amount or fees you paid. Take your company's net margin before taxes, calculate the profit on each export transaction and subtract the letter-of-credit fees. Estimate the transaction cost and subtract that, too. This will tell you how much your company lost on smaller transactions, where the fees are fixed. But don't forget that the transaction size, and therefore the profit, is variable.

A THIRD SOLUTION

What if neither the open-account systems nor the letter of credit is right for your company? Export factoring is another alternative, and it's an especially cost-effective solution for companies with export sales to developed countries of more than $5 million annually. Export factoring is a credit-management technique that outsources the international credit responsibility and converts the foreign receivable into a domestic receivable at competitive prices. It differs from discount factoring, where somebody advances money to a manufacturer for existing receivables and collects the balances.

International factoring is a two-party system. The U.S. factor agrees to pay the invoice on collection or to pay the face amount 90 days past the due date. The U.S. factor looks to the factor in the importer's country to pay on the due date or to pay the face amount 90 days past the due date. But remember the invoice isn't just guaranteed -- it's sold. The receivable in the United States from the U.S. factor is considered an AA domestic receivable. Only in the event of a merchandise dispute will the exporter not receive payment. The only paperwork is the invoice assigned to the U.S. factor, who in turn assigns it to the factor in the foreign country. That's because the factor in the importer's country is probably owned by a local bank and is more likely to get paid first than you, the exporter, who's thousands of miles away speaking a different language.

The documents used in export factoring are among the very few international legal documents protecting exporters. Most international factors belong to an organization called Factors Chain International, a commercial framework within which each member recognizes the other's legal factoring documents. FCI has members in 90 countries, although for practical purposes only about 30 are broadly based enough to be useful to U.S. exporters.

The factor acts as the credit department, too, establishing credit lines for each foreign account. Who's likely to understand the nuances of a foreign balance sheet better -- the factor in the importer's country or an overworked domestic credit department? The cost is about the same as it is for a confirmed letter of credit without any of the paperwork.

For example, suppose you have two transactions, both valued at $15,000, one of which is secured through a confirmed letter of credit and the other through a factor. Assuming the transaction is open in both instances for more than 90 days but less than 180 days, the confirmed letter of credit (a domestic receivable) will cost $100 in advising fees, $150 in various payment fees, and $100 per quarter for confirmation, for a total of $450.

Factoring export receivables also generates a domestic receivable. Depending on dollar volume, factoring costs less than 3 percent of the transaction. In this example, $450 is 3 percent of $15,000, so you'll still come out ahead. And, assuming the terms are less than 90 days, you'll get paid under a factoring arrangement within 180 days. On a straight cost-comparison basis, factoring is viable for nearly all U.S. export shipments. And since the letter-of-credit charges are all minimums, the $450 would apply to all transactions under $15,000 -- about 87 percent of U.S. export shipments -- which is why most exporters don't confirm these small amounts.

If you add in the cost of running an international credit department, losses on credit decisions for open-account sales, or the transaction cost of preparing documentation for letters of credit and correcting discrepant letters of credit, the export value and cost-effectiveness of factoring increase substantially. With the tendency of just-in-time shipping to reduce shipment sizes, lower export shipment values should make factoring increasingly desirable for developed-country sales, especially since manually prepared shipments can cost up to $1,000 per transaction.

Finally, to supplement these tools, try putting technology on your side. Using export management software that integrates the whole process can reduce your transaction costs to the $100 range. It pays for itself in less than one year and allows your export business to double or triple before you need additional software capacity or personnel.

Although managing your export risk might sound complex, it really comes down to simple mathematics. If your transaction costs are high, the more you sell, the more you lose. The sooner you begin to reduce those costs, the faster your bottom line will improve. And that's something you, as a financial executive, can't afford to overlook.

WHAT YOU SHOULD ASK ABOUT YOUR EXPORTS

1 What are the key characteristics of your export business?

First, add up the number of total shipments your company makes in a year. Then try to categorize your transactions to get a clearer picture of your export business. You can divide your shipments by transaction size, such as under $2,500; $2,500-$10,000; $10,000-$50,000; and $50,000 and up. Destination is another important category. Do most of your shipments go to North America, European industrialized countries or developing nations? And how do they get there -- by ocean, air or rail?

2 How much money do you spend managing your foreign receivables?

This includes bank charges and fees on letters of credit, drafts and electronic deposits. Also, figure in other associated expenses, such as forwarders' fees, consularization fees, document-courier fees and inspection fees. Charges for credit reports and credit insurance are part of this sum, too. Although this might seem basic, many of these charges go directly into corporate overhead and therefore are never associated with export shipments. You need to unbundle this information to find out how much your exports cost you.

3 What are your time-related costs?

In answering this question, you need to examine the factors that may be slowing down your cash flow. How many days are your receivables outstanding before your customer pays you? If your domestic receivables take 45 to 60 days, while your international receivables take 120 to 150 days, you'll have a big cash-flow problem on your hands as your exports become a larger percentage of your total sales.

Find out how much time the international credit function spends on filling out forms and otherwise expediting transaction processing. Most companies underestimate this cost, so if the answer you get shocks you, consider devoting some time and energy to streamlining inefficient processes. And don't forget that the employees in this area will probably be your most valuable people, so make sure they're getting the resources they need.

Mr. Stroh is the publisher of The Exporter magazine and a former international trader.