How To Pay Overseas Vendors To Better Manage Your Local Customers

Imagine the frustration of not being able to pursue new markets and clients simply due to a lack of financing. Imagine the frustration of losing out on a long-term, large-volume contract because your customer needs 60 to 90 day open credit terms, but you can’t afford to provide those terms because you have to prepay your overseas vendor for purchases. Does this sound all too familiar? If so, then you’re not alone.

Many customers require open credit terms. Managing those requests, while having to prepay overseas vendors for purchases, is a cost most companies can’t overcome. This is where purchase order financing can help. Instead of turning business away, you can use your customer’s order to finance your business and your customer’s purchase.

Most companies can overcome short-term financing issues because they are able to balance their payables with their receivables. After all, it’s much easier to grant your customer 30 to 60 day terms when your company has 30 to 60 day terms with its own vendors. However, it’s something else entirely when your supplier is overseas. Ultimately, they won’t give you terms. Instead, they need you to prepay, partially prepay or provide a letter of credit (LC).

Prepaying and partially prepaying is often not a solution. However, securing an LC is because it’s an advance your vendor won’t receive until you receive a confirmation on the shipment. So, what do you do when your overseas supplier needs a letter of credit (LC), but you can’t secure one with your bank because you don’t have the financing? Simply put, you turn to an asset-based lending option like purchase order financing.

Letter of Credits and Overseas Vendors

The LC is a guarantee that the buyer will pay the seller for the agreed upon purchase. The LC also guarantees that the vendor will receive the payment on time. The amount of the LC is predetermined so that the vendor understands exactly how much they are guaranteed to receive and when.

Banks are predominantly the guarantor on the LC and therefore act on behalf of the buyer. The bank ensures that the vendor is only paid after the bank has confirmation that the order has been fulfilled and shipped. However, no bank will back the LC unless the company holding the LC has the funds available to support the payment. As such, securing that LC is often difficult when financing is hard to come by. Purchase order financing can eliminate this as a concern. Instead of trying in vain to secure financing, companies are simply using their customer’s purchase order or contract as the collateral for the LC.

Using Purchase Order Financing to Secure an LC

Let’s assume your company has the potential to secure a large contract with a customer who requires 60 to 90 day open credit terms. However, your vendor is overseas and requires you to prepay, partially prepay or provide an LC. Unfortunately, you’ve decided that prepaying isn’t feasible. However, you could use your customer’s large contract as collateral with an asset-based lending (ABL) firm. They would advance your company the funds it needs to secure the LC for your vendor. Ultimately, your vendor gets the LC and you secure the contract with your customer. So, how can a company use purchase order financing through an ABL firm in order to secure that all-important LC?

Step 1: Working With an Asset-Based Lending Firm

The first step is to get your customer approved for asset-based lending. The ABL firm acts as an independent financing arm by reviewing the account debtor’s credit rating and history. The account debtor is your customer. Since your customer will pay the invoice, it’s ultimately your customer whose credit rating needs to be reviewed, assessed and approved. Once the review is complete, the financing firm will advance your company a predetermined percentage of the contract’s value. In most cases, that advance ranges from 80 to 90 percent of the total order. This is more than enough to secure the LC with the bank. In addition, the extra capital can be used to cover other day-to-day operating expenses.

Step 2: Use Capital Advance to Secure LC

Once the account debtor is approved, your company can then use those funds to secure the LC with the bank. Those funds will be set aside as collateral on the LC. In most situations, purchase order financing is used to purchase the raw materials and finished goods needed to fulfill backlogs. As such, the ABL firm would typically pay your vendor directly. However, in this case, the funds will be used to secure the LC and will be held in place until the bank receives confirmation of the shipment.

Step 3: Forward LC to Overseas Vendor

Again, most overseas vendors require prepayment or an LC before starting production or accepting the order. Once you have the LC from your bank, you’ll forward that to your overseas vendor so that they can begin to fulfill your requirements.

Step 4: Reconcile Transaction

The final step includes reconciling the entire transaction. When using purchase order financing, you are essentially selling your customer’s order to a third party financing firm. They own the right to collect on the invoice from your customer. After the invoice has been cleared by your customer, your company is credited the difference from the original advance and the final payment. The ABL firm then charges fees and interest rates for their services.

Today’s ABL firms are experts in assessing values to purchase orders and contracts. These orders and contracts can be used to finance the purchase of raw materials and finished goods. In this example, we’ve used this financing solution to secure an LC for an overseas vendor.

It’s common in today’s economy for corporate buyers to insist on open credit terms. Given the current state of the economy, a number of these buyers are pushing for 60, 90 or even 120 days. The cost of financing receivables for these corporate buyers, coupled with the costs of prepaying overseas vendors, simply isn’t feasible for today’s enterprises. Purchase order financing is a solution that reduces these costs while allowing your company to pursue customers worldwide.