Alfonso Llanes, Master Degree in International Development
In general, higher receivables turnover ratios suggest that a company is managing its accounts receivable efficiently. Nonetheless, analysis of receivables turnover ratio in terms of credit policy management is split-level in nature. The ratio informs the company about the proficiency of credit policy management. As the ratio computes how many times a company’s accounts receivable are generated and collected during the year, the higher the ratio, the more competent the receivables management. A low or declining accounts receivable turnover ratio may indicate the company is either becoming too lax in its efforts to collect receivables or is not writing off receivables that are unlikely to be ultimately collected.
When these same ideas are applied to international trade the method commonly used is an open account meaning that the goods are shipped and delivered before payment is due, usually in 30-90 days. This is the most beneficial option to the importer in cash flow and cost terms, but it is also the highest risk option for an exporter. Because of the intense competition for export markets, foreign buyers often press exporters for open account terms. In addition, the extension of credit by the seller to the buyer is very common abroad. Therefore, exporters who are reluctant to extend credit may face the possibility of losing sales to their competitors. However, while this method of payment will definitely improve export competitiveness, exporters should thoroughly examine the political, economic, and commercial risks, as well as cultural influences to ensure that payment will be received in full and on time. A preferred way to mitigate the risk of nonpayment associated with open account sales is by using trade finance as export credit insurance and factoring. Exporters may also wish to pursue export working-capital-financing to ensure that they have access to financing export production and for a credit extension that might arise, while waiting to be paid. This effort can work well specially when interest rates are favorably low and waiting to be paid is not a significant cost to the business. On the other hand, the business would be affected if the waiting period between payments is beyond the cash reserves of the firm to continue production and borrowing money becomes expensive.
Here is an outline from the U.S. Department of Commerce International Trade Administration
Characteristics of an Open Account Applicability
Recommended for use
(1) In secure trading relationships or markets
(2) In competitive markets to win customers with the use of one or more appropriate trade finance techniques.
Risk
Exporter faces significant risk as the buyer could default on payment obligation after shipment of the goods.
Pros
• Boost competitiveness in the global market
• Establish and maintain a successful trade relationship
Cons
• Exposed significantly to the risk of nonpayment
• Additional costs associated with risk mitigation measure
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