Confirmed, irrevocable letters of credit are not always the answer.(international)

Perhaps your company has dabbled with exporting for a few years and management likes the results: increased sales, access to markets that even out seasonal and economic cycles in the United States, new outlets for older products, etc. What was originally an experiment is looking like a strategy. The sales group has been given the green light to hire more people and the objective of raising exports from 10% of annual sales to 25%. Your job in credit management is to protect the company from losses that may result.

Up until now, the job hasn't been too tough. By setting a policy of shipping only against cash in advance (U.S. dollars, to be sure) or confirmed, irrevocable letters of credit, you've avoided the political, economic and commercial risks of exporting. Or perhaps the sales folks have been limited to bringing on customers from Canada and Western Europe, whose culture and legal and accounting systems are similar to those in the U.S. But now your sales people are going to be venturing into new markets--South America, Eastern Europe and Asia--and you know they're going to whine that they won't be competitive unless you, in the credit management (often vilified as "sales obstruction") department, approve more liberal terms of sale.

You know there are other ways to protect your export receivables besides confirmed, irrevocable L/Cs, but what are the trade-offs? When are unconfirmed L/Cs appropriate? How do you use forfaiting? Where can credit insurance help? What are the risks of taking bank guarantees? These are all tools and no single one is appropriate for every situation. What you need is a complete toolkit and an instruction manual that helps you identify when and how to use the hammer, the screwdriver or the power drill.

Think of the chart on page 66 as a cheat sheet. Across the top, I've listed the main categories of risk encountered in export sales. Along the left, I've listed the major risk mitigation tools. Depending on the combination of risks you are trying to cover, use the chart to pick the tool.

Step 1. Quantify the Risks in the Deal

This is no simple task, but having a list of export-related risks will give you a starting point. I believe most of the risks enumerated in the chart on page 68 are fairly self-explanatory. They are derived from definitions found in credit insurance policies. The first four categories may be grouped as commercial risks while the next four are country risks. (Note: This includes natural as well as man-made disasters, as either may disrupt business in a country.) I've listed "World War" as a category because it is often specified in credit insurance policies that losses due to such an event are not covered--I call this the "end of civilization" gap. The idea is to assign a probability to each of these risks based on the company you are selling to and the country in which they are located.

The final category only applies to sales made in foreign currencies. The risk of currency devaluation is treated with its own set of tools, in the form of foreign exchange forwards and options--it is not included in any of the other risk mitigants. Different currencies have different amounts of risk. I will not be addressing FX risk any further in this write-up, but your bankers can give you complete instructions for the pertinent risk mitigation tools.