A letter of credit (L/C) is a tremendous tool for managing international financial risk. And limiting financial risk is an essential part of any successful global transaction. But a new trend toward open account — which is gaining momentum — is helping to streamline supply chain operations and eliminate inefficiencies.

The Good, the Bad and the L/C

In order to determine whether or not the foreign buyer’s debt obligations are likely to be paid on time, a number of questions must be answered. For example, is the foreign customer creditworthy for the shipment, or suffering cash flow problems that might delay payment? What is the foreign customer’s reputation for honesty and dependability? How long has the prospect been with his/her bank? When answers to these and other questions leave doubt, an L/C tends to be the document of choice.

According to Daniel Scanlan, Senior Vice President and Global Product Manager for Trade at Bank of America, “Very simply, sellers request L/Cs because they are concerned about receiving payment for their goods. When you consider that exporters place their goods on vessels destined for far-away lands, where they have no presence and little ability to press the buyer for payment, the concern is very legitimate.”

Over time, however, as the relationship between an exporter and importer evolves and a certain level of trust is reached, the financial arrangements often change. “Once a seller becomes familiar with a buyer, he or she may reach a level of comfort that relaxes a previous L/C requirement and facilitate a move to open account trading,” Scanlan notes.

In this situation, the goods are shipped on good faith, with no guarantee of payment other than a handshake or promise to pay. So, why is this different today and what is driving the trend toward open account? The need to improve supply chain efficiency is a likely factor. Plus, the exporter’s ability to obtain better and faster research on foreign buyers via new technology unavailable just a few years ago may be a reason.

The Benefits of Open Account Trade

Although riskier than most other payment methods, open account trading has been an accepted practice between exporters and importers for years. And when the risk is minimal, open account can be a favorable method.

The switch to open account can benefit exporters in a number of ways. For example, for some financial institutions and their customers, L/Cs can be paper-intensive, time-consuming and expensive process. Furthermore, common mistakes often delay payment. In fact, “Seventy to 85 percent of companies do not complete their LC paperwork properly. This can delay payment for days and even weeks,” says Chip Thomas, an international trade financial expert and presenter of Bank of America’s International Trade Payments Workshops. But when completed correctly, an LC can be a fast and efficient method to control risk and ensure payment.

Asia Is Slow To Adopt the Open Account Transaction Method

A unique situation exists in the relationship between buyers who are purchasing from sellers in Asia. Scanlan notes, “Asian banks often view the L/C as a confirmed purchase order, and on its strength are willing to lend a percentage of the L/C value to the seller. In turn, this allows the seller to purchase raw materials to manufacture the end product.”

As a result, even when buyers and sellers have been doing business with each other for years, they rarely develop an open trade arrangement with their Asian partners.

A shift away from L/Cs will undoubtedly affect the way suppliers do business and ultimately change the way many companies fund themselves. Therefore, an important goal of Asian treasurers is to find alternatives to L/Cs. But to lessen their reliance on L/Cs for financing, many Asian companies — as well as many non-Asian firms — will be forced to realign their working capital or find other sources of capital.

Streamlining the Supply Chain

The use of open account transactions is an important way companies are simplifying a manual and typically paper-intensive trade process. Additionally, traders are increasingly interested in converting this laborious process into an electronic transaction — or series of electronic transactions that provide complete accounting from the time the purchase order is issued until the invoice is paid.

Some treasurers remain sceptical about the ability of electronic platforms to adequately automate a transaction when several parties are involved. Over time, however, this concern is likely to diminish. Plus, the vast benefits of an electronic system — including greater visibility into the entire order-to-payment process, on-time payment and improved cash management — are likely to offset other concerns that treasurers and traders might have about electronic or paperless trading.

Taking the Paper Out of the Process

Paperless transactions are proving to be faster, easier and cheaper than the traditional way of trading. While software and systems may vary, electronic trading provides a number of common benefits, including the following:

Improved turnarounds

Once a company’s transactions have been entered, verified and authorized, they are automatically sent to the back office. This immediately triggers a “transaction event” such as the issuing of an L/C that is ready for verification and authorization. Electronic trading eliminates the need to complete forms manually — and fax, mail or deliver them to the bank.

Greater efficiency

Some software provides templates with pre-saved information and drop-down lists for common trading partners, documentation requirement clauses that the user can define, goods descriptions, and other features specific for trade financing needs.

Fewer errors

By eliminating the need for manual handling, input and re-keying of information, electronic trading is reducing the number of errors and subsequent documentation discrepancies.

Real-time speed

Delivering physical documents takes time. Electronic trading offers a real-time channel for delivering information and documents, which can be immediately acted on and can speed up the payment process.

Banks Now Offer Electronic Trade Solutions

More and more banks are beginning to provide electronic solutions to help companies manage the time-consuming documentary and accounts-receivable processes inherent in international trade.

“At Bank of America, we have recently gone live with a Purchase Order to Pay system which provides complete reconciliation between P.O. and invoices,” states Scanlan. “It allows our buyers to electronically upload the P.O.s to our web-based system or send them to us via Electronic Data Interchange (EDI).”

“Our database then stores this information and when invoices are submitted to the bank, we input the data and the system compares the invoice and the original P.O.,” continues Scanlan. “The comparison results are then sent to the buyer who decides whether to pay or not.”

Bringing Asia on Board

As indicated earlier, Asia has been much slower to embrace paperless technology than other parts of the world. In fact, in many parts of Asia the red-ink stamp is still the preferred method of issuing document approvals. The distrust of technology in traditional cultures may be the primary reason for their wariness of electronic trade.

But that’s all starting to change. Some Asian governments are beginning to accept documents in electronic form. For instance, Singapore, Hong Kong, Thailand, Indonesia, and the Philippines now accept corporate tax payments via the Internet.

How quickly governments embrace technology often depends on the developmental stage of their economy. This would explain why, at this writing, Mainland China does not currently accept trade documents in electronic form, whereas Hong Kong started accepting electronic versions of trade documents last year.

Your Future May Involve Open Account and Supply Chain Improvements

Scanlan says that Bank of America is preparing for the day when Asian exporters are ready to send invoices and other shipping documents electronically. “We are expanding our web-based products to allow for electronic communication with Asian exporters and other parties to the trade transactions. This then turns Trade Direct Services on Bank of America Direct®, our web product for trade, into an e-commerce system that facilitates the creation of exporters’ electronic documents and allows them to make a full electronic document presentation,” Scanlan said.

The ultimate goal is for banks to process trade transactions in a completely automated fashion, allowing both importers and exporters to operate in a paperless environment — and get updates to their back office systems automatically. This is not new to Bank of America, which is helping to streamline open account trading. “Bank of America is establishing services that successfully automate the trade transaction, whether it’s done on open account or under an L/C, so that exporters and importers will be linked from one end of the transaction to the other,” Scanlan concludes.

This article appeared in September 2003. (BA)

John Manzella
About The Author John Manzella [Full Bio]
John Manzella is a world-recognized author and speaker on global business, competitive strategies and the latest economic trends. He also is founder of the ManzellaReport.com and Manzella Trade Communications, Inc. His latest book is Global America: Understanding Global and Economic Trends and How To Ensure Competitiveness.

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