Canada’s small population translates into a small domestic market forcing small businesses to look beyond their borders in order to compete in today’s global marketplace. Foreign market expansion brings a whole new set of risks to the small business owner, the most obvious being those associated with accounts receivable collections. Does the buyer have the habit of paying immediately or paying whenever they want to? What if the buyer actually becomes insolvent or bankrupt? What if they refuse to pay you? What if the buyer is experiencing financial difficulties and asks for a payment extension? What if the buyer disappears? Or the country of the buyer has experienced a change in government, political turmoil, or a natural disaster? What ever the case, any payment delay is going to adversely affect the small business owner. How can the small business owner protect him or herself?
Payment in Advance: If really fortunate, a small business can negotiate payment in advance. This is the least risky for the Exporter/Seller and most risky for the Importer/Buyer. This agreement is based on trust and the seller's good name. Payment in advance is very difficult to negotiate with a buyer.
Open Account transactions are where the buyer agrees to pay once the goods are received. Open account transactions are the most risky to the seller and least risky to the buyer. The buyer may not pay or there is lag time for payment to be received. Either way costs the seller money.
Risk compromise transactions include documentary credit and letters of credit and both involve the buyer’s and seller’s respective banks.
Documentary Collection agreements involve a moderate risk to both the buyer and seller. The sales contract stipulates payment via documents – shipping documents and a bill of exchange as either document against payment or document against acceptance. The risk to the seller is that documentary credit is only secure to the extent to which the buyer is willing to adhere to their obligations. The buyer can still refuse to pay even though banks are involved.
Letter of Credit transactions provide minimal risk to the seller. Letters of credit are similar to documentary credit with the added assurance that the opening bank guarantees that the seller’s draft or bill of exchange will be honoured if all the terms and conditions of the credit are met by the seller.
For both of these risky compromise transactions it is the bank that deals with the documents. What if the buyer is in a risky country or their bank falls into questionable stability? The seller can protect himself by purchasing Accounts Receivable Insurance. If conducting business in politically sensitive countries, Political Risk Insurance is also available. Political risk insurance protects Canadian investments overseas and covers political risks such as war, expropriation, transfer difficulties, etc. Both of these insurances benefit Canada and the host country. Canadian business investments are protected as well as project development, profits and jobs. Benefits to the host country from more Canadian investments include job creation,research and development opportunities.
Accounts receivable insurance and political risk insurance are available from Export Development Canada (EDC), export credit agencies around the world and private insurers. With accounts receivable insurance you get paid even if your buyer doesn’t pay, with one major exception: Risk of dispute and failure of you to perform under your purchase order or contract. Be very specific and know exactly what is ordered in your contract.
Risks typically covered:
- Buyer insolvency or bankruptcy
- Payment default
- Repudiation (buyer doesn’t accept delivery even if it is as specified)
- Contract cancellation
- Political risks (war, revolution, transfer difficulties, cancellation of export/import permits)
How does accounts receivable insurance work? Account receivables insurance covers 90% of your loss if the foreign buyer does not pay. Options are also available to small business owners to cover longer repayment periods requested by a potential buyer. For more information on either accounts receivable or political risk insurance contact the EDC or your bank.
