This chapter discusses various financing instruments for domestic and international transactions. Before considering available instruments, however, it is important to emphasis that domestic and international transactions differ in many respects. International transactions involve risks not present in domestic ones. Every element of a commercial transaction is complicated by the realities of cross-border interaction.
These challenges begin at the earliest stages of a new international venture when a business initiates market analysis, feasibility assessments and in- market activities. The challenges unique to international business include higher travel expenses, complications from operating in a new environment, and the need for intercultural effectiveness. Complications continue as a business attempts to conduct due diligence on prospective partners – financial and commercial information is not always available (or trustworthy) –, and considers options for dispute resolution, including recourse against a foreign business partner, which can be expensive and complex.
International business involves macro-issues such as political instability, foreign currency exposure, complications related to logistics, and transport of goods to overseas markets. The list of issues that differentiates domestic from international business is long and varied, and specific challenges vary by market.
Those very challenges and complications are the factors that can increase profitability for successful, well-managed international ventures. They also tend to discourage timid or conservative businesses and, therefore, may reduce competition in some markets. At the very least, international business involves a change in the competitive landscape.
Unique risks and challenges exist at the transactional level. SMEs have to consider exchange rate fluctuations in sales and profit projections. Depending on the currency in which buyer and seller agree to do business, exchange rate fluctuations can work for you, or work against you. If you are a net exporter, you benefit from depreciation in your home currency against the currency of the importing market because you improve your competitiveness abroad through reduced pricing, as well as obtaining more local currency equivalent of your international sale, once you convert foreign currency receipts to domestic funds. As a net importer, you will tend to benefit from an appreciation of the domestic currency because you will spend less to purchase the same foreign products. Doing business internationally involves less tangible, but equally or more important elements. International transactions require the creation, development and ongoing management of commercial relationships from a distance. There is relatively less face-to-face contact than in domestic ventures. To the extent that face-to-face interaction helps in developing mutual trust, lessen the number of unknowns, and thus reduce the riskiness of business transactions, then international transactions tend to be riskier than domestic ones. While advances in communication technology have mitigated this challenge to some degree, it remains an important issue, particularly when either or both trading partners originate from cultures, where personal relationships are more important than contractual covenants. In developing and emerging markets, the information and communications technology may not be as effective in supporting long-distance contact and relationship management.
Disputes arising from domestic transactions generally are more easily resolved than those arising from international transactions. The former normally can be more easily litigated in the local courts of law. In international trade disputes, unless the parties have agreed in advance which court and legal system will have jurisdiction over the dispute, complicated jurisdictional and choice of law questions can arise protracting resolution of the dispute. Even non-judicial dispute resolution options, such as arbitration, are more complicated by an international element.
The distance and the length of the payment period can affect the financing needs of the firm engaged in international transactions. Longer payment periods may be required due to long shipping periods plus the time needed to complete all the necessary paperwork that usually accompanies international shipments. In addition, the increasing leverage exercised by large retailers against small suppliers/exporters has forced exporters to extend generous terms, and to accept settlement on open account terms. This development puts pressure on the working capital requirement of many SME exporters. Besides differences in risk levels and financing requirements, the sources of finance can also vary for international and domestic transactions. While international transactions tend to be riskier, they have greater possibilities to tap financial institutions that are more oriented towards foreign markets. Some of these financial institutions, such as export credit agencies or export insurance facilities, are specifically suited to firms engaged in international business. These specialist firms and service providers are discussed in this chapter.
We also describe the most commonly used methods of payment and the types of short-term credit facilities best suited for each method. These methods are generally applicable for both domestic and international transactions.
Not all of these may be available in all developing countries since either the legal framework for particular financial transactions does not yet exist or the financial institutions lack the necessary sophistication. The discussion here only serves as a guide to the different possibilities of finance.