Financing Commercial Transactions
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Financing Commercial Transactions
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By:
ivanachvich
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A 11 commercial transactions (sales and purchases) require financing. And when these transactions involve a foreign currency, they also require a foreign exchange management decision.
As an introduction to the problems which financing of commercial transactions present, let's look at the problems in isolation.1 In Exhibit 11.1 we present four different cases of export sales. To simplify the presentation, we ignore profits. The cases range from the situation where the treasury does not get involved at all, as in case A, to the more complex situations where both financing and exchange problems have to be solved, as in case D. In cases A and B the export sales are billed in local currency.
Both costs and revenues are in the same currency, the local currency. In case A the payment for labor costs is not made until day 90. Thus. on day 1 when the export sale is made, there is no cash flow;on day 90 the inflow from the collection of the export sale is used to pay labor. In fact, in this case labor finances the export sale until the receivable is collected. Financial officers do not have to find a financing source for this sale. However. in case B labor must be paid on day 1, the same day that the export sale on credit is made. In this case we have a cash outflow on day 1; but the cash inflow does not materialize until day 90, when the export revenues are collected. This is a financing problem.
Borrowings must be arranged, preferably in local currency, on day 1 for 90 days. On day 90 these borrowings will be repaid with the export funds collected on that day.
In cases C and D, the export sales are billed in forex trading currency. Now we have two currencies: export receipts are in foreign currency and labor costs are in local currency. This produces a net exchange position-the other problem which must be managed in trade operations. When in case C the payment for labor can wait until the time the export receivable is collected, as in case A above, we do not have a financing problem. However, because a foreign currency is used to bill exports, when these exports are collected we will have a cash inflow in foreign currency, while the cash outflow for labor is in the local currency. There is a net exchange position-long in foreign currency and short in local currency. For the same reason, in case D we also have a net exchange position. However, to this problem in case D we add the financing problem. The cash outflow for labor payments now occurs on day 1, although the receipts for exports do not materialize until day 90. The finance officer must provide financing for the intervening 90 days.
Thus, the problems which commercial transactions present involve both providing financing and managing the exchange exposure created by many of these transactions. In the following sections we will show alternative approaches to dealing with these problems.
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