Seyoum 13

Updated on 05/05/2015

BusAd 175: Introduction to International Trade

Spring 2011

Course #3819

Apr 18 - Jun 8, 2011

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Chapter Outlines, Sample Tests and Review Questions
	with your questions

Chapter 13: Capital Requirements and Private Sources of Financing

The Class Text-Book

Export-Import Theory, Practices and Procedures by Belay Seyoum

(2nd Edition: Routledge, 2009) ISBN: 978-0-7890-3420-5

Click here on this image on the left to browse the information about this book at amazon.com

Chapter Outline

Seyoum Chapter 13

	Sample Multiple Choice Questions
	Talking-Points for the Review Questions

Information and materials on this page are based on those provided by the author, Dr. Belay Seyoum

Chapter Outline

Background

	Many small and medium–sized businesses suffer from undercapitalization and/or poor management of financial resources, often during the first few years of operation.
	The entrepreneur typically either overestimates demand for the product or severely underestimates the need for capital resources and organizational skills.
	Undercapitalization may also be a result of the entrepreneur’s aversion to equity financing (fear of loss of control over the business) or the lender’s resistance to provide capital due to the entrepreneur’s lack of credit history and a comprehensive business plan (Hutchinson, 1995; Gardner, 1994).
	Technology, Globalization and Deregulation have brought about significant changes in Small Business Financing.

	Chapter 01. Growth and Direction of International Trade
	Chapter 02. International and Regional Agreements Affecting Trade
	Chapter 03. Setting Up the Business
	Chapter 04. Planning and Preparations for Export
	Chapter 05. Export Channels of Distribution
	Chapter 06. International Logistics, Risk, and Insurance
	Chapter 07. Pricing in International Trade
	Chapter 08. Export Sales Contracts
	Chapter 09. Trade Documents and Transportation
	Chapter 10. Exchange Rates and International Trade
	Chapter 11. Methods of Payment
	Chapter 12. Countertrade
	Chapter 13. Capital Requirements and Private Sources of Financing
	Chapter 14. Government Export Financing Programs
	Chapter 15. Regulations and Policies Affecting Exports
	Chapter 16. Import Regulations, Trade Intermediaries, and Services
	Chapter 17. Selecting Import Products and Suppliers
	Chapter 18. The Entry Process for Imports
	Chapter 19. Import Relief to Domestic Industry
	Chapter 20. Intellectual Property Rights

Determinants of Capital Needs and Financing Alternatives

	The principal determinants are (a) stage of evolution, (b) ownership structure and (c) distribution channels.
	A very small sum of money is often needed to start the business as an agent because no payments are made for merchandise, transportation, or distribution of the product.
	However, initial capital needs are substantial if a person starts the business as a merchant, distributor, or trading company with products available for resale. This entails payments for transportation, distribution, advertising and promotion, travel, and other expenses.
	Capital needs at the start–up stage may be smaller compared to those needed during the growth and expansion period.

Internal Financing

Internal financing should be explored before resorting to external funding sources.
This includes:

using one’s own resources for initial capital needs
and then retaining more profits in the business
or reducing accounts receivables and inventories to meet current obligations and finance growth and expansion.

Sources of Internal Financing:

Money in saving accounts, certificates of deposit, and other personal accounts
Money in stocks, bonds, and money market funds

Types External Financing

	Debt or equity financing: Debt financing occurs when an export–import firm borrows money from a lender with a promise to repay (principal and interest) at some predetermined future date.
	Short–term, intermediate, or long–term financing: Short–term financing involves a credit period of less than one year, while intermediate financing is credit extended for a period of one to five years.
	Investment, inventory, or working capital financing: Investment financing is money used to start the business (computer, fax machine, telephone, etc).

Sources of external financing:

	Family and Friends: This is the second–best option for raising capital for an export–import business.
	Banks and Other Commercial Lenders: The largest challenge to successful lending is the turnover rate of small businesses. Due to the level of risk, banks and other commercial lenders tend to avoid start–up financing without collateral. Asset–based financing: Banks and other commercial lenders provide loans secured by fixed assets, such as land, buildings, and machinery. Lines of credit: These are short–term loans (for a period of one year) intended for purchases of inventory and payment of operating costs. Personal and commercial loans: Owners with good credit standing could obtain personal loans that are backed by the mere signature and guarantee of the borrower. Credit cards: Credit cards are generally not recommended for capital needs for new or existing export–import businesses because they are one of the costliest forms of business financing.
	Small Business Administration (SBA): The SBA has several facilities for lending that can be used by export–import businesses for capital needs at different stages of their growth cycle (see Table alongside).
	The Certified Development Company: The Certified Development Company (CDC 504) program assists in the development and expansion of small firms and the creation of jobs.
	Equity Sources: For many export–import businesses, the ability to raise equity finance is quite limited. The options include Family and friends

Business angels (invisible venture capitalists): Business angels provide
start–up or expansion capital and are the biggest providers of equity capital for small businesses.

Venture capitalists: Venture capitalists provide equity capital to businesses that are already established and need working or expansion capital.

Private Sources of Export Financing

Financing by the Exporter

Open account: Payment is deferred for a specified period of time.
Consignment contract: Importer pays after merchandise is sold to a third party.

Financing by the Overseas Customer

Advance payment: Payment is before shipment is effected.
Progress payment: Payment is related to performance.

Financing by Third Parties

Short–Term Methods

Loan Secured by a foreign accounts receivable: Account receivable used as collateral to meet short–term financing needs.
Trade/banker’s acceptance: A draft accepted by the importer is used as collateral to obtain financing.
Letter of credit: Transferable letter of credit (L/C), assignment of proceeds under an L/C, and a back–to–back L/C used to secure financing.
Factoring: An arrangement between a factoring concern and exporter whereby the factor purchases export receivables for a discount.

Intermediate– and Long–Term Methods

Buyer credit: Importer obtains a credit from a bank or financial institution to pay the exporter.
Forfeiting: Purchase of deferred debts arising from international sales contracts without recourse to the exporter.
Export leasing: A firm purchases and exports capital equipment with a view to leasing.

Sample Multiple Choice Questions

	True	False
1.			Many small and medium-sized businesses suffer from undercapitalization and/or poor management of financial resources, often during the first few years of operation.
2.			Forms of external financing includes debt or equity financing, short-term/intermediate/long-term financing, and investment, inventory, or working capital financing.

Which of these is an example of internal, as compared to external, financing?		9.			Family and friends
		10.			Credit cards

Talking-Points for the Review Questions

What are the major changes taking place in small and medium-sized business financing?

Technology enables the financial world to operate more efficiently and to choose from a vast range of financial instruments; globalization allows businesses to turn increasingly to international markets to raise capital; deregulation allows for competition across all depository institutions.

What factors determine capital needs and financing alternatives in export-import trade?
Stage of evolution, ownership structure, and distribution channel choice. See the box alongside for elaboration.

State the common external sources of financing for export-import businesses.
Debt or equity financing; short-term/intermediate/long-term financing; investment, inventory, or working capital financing.

Studies on small business financing indicate the following salient features:

Incorporated companies are more likely to receive equity (and other nondebt) financing than debt financing because lenders perceive the incorporated entity as having a greater incentive to take on risky ventures due to its limited liability (Brewer et al., 1996).
Younger firms are more likely to obtain equity (nondebt) than debt financing. The probability of receiving debt financing increases with age. This is consistent with standard theories of capital structure, which state that such businesses have little or no track record on which to base financing decisions and are often perceived as risky by lenders.
Firms with high growth opportunities, a volatile cash flow, and low liquidation value are more likely to finance their business with equity than debt. In firms with high growth opportunities, conflicts are likely between management and shareholders over the direction and pace of growth options, and this reduces the chances of debt financing. However, businesses with a good track record and high liquidation value (with assets that can be easily liquidated) have a greater chance of financing their business with debt rather than equity (Williamson, 1988; Stulz, 1990; Schleifer and Vishny, 1992).

Describe the following: SBICs, Certifed Development Company, CDC/504 loan program, International trade loan.
Small business investment companies (SBICs): private companies funded by the SBA to provide loan capital to small businesses. Certified Development Company (CDC 504): a program designed to provide fixed asset financing to small businesses. It can be used to purchase land, machinery, or equipment. International trade loan: used to develop/expand export market or for working capital.

Discuss the various methods in which a letter of credit can be used to finance exports.

Letters of credit such as transferable L/C, back to back L/C, or assignment of proceeds can be used to finance exports.

What is export factoring? How does it differ from forfaiting?

Export factoring is an arrangement between a factoring concern and exporter whereby the factor purchases export receivables for a discount. Factors are used to finance consumer goods, whereas forfeiters usually work with capital goods, commodities, and projects; factors are used for continuous transactions, but forfeiters finance one-time deals; factors generally work with short-term receivables, whereas forfeiters finance receivables with a maturity of more than 180 days.

Of the two tables on the right, the top one compares the advantages and disadvantages of export factoring whereas the bottom one compares the advantages and disadvantages of forfaiting, the practice of purchasing deferred debts arising from international sales contracts without recourse to the exporter. The exporter surrenders possession of export receivables (deferred-debt obligation from the importer), which are usually guaranteed by a bank in the importing country, by selling to a forfaiter at a discount in exchange for cash. The deferred debt may be in the form of a promissory note, bill of exchange, trade acceptance, or documentary credit, which are unconditional and easily transferable debt instruments that can be sold on the secondary market.

State the typical steps involved in export factoring.

As shown in the figure alongside, the following steps are involved here:

Exporter and importer enter into a commercial contract and agree on the terms of sale (i.e., open account),

the exporter ships the goods to the importer,

the exporter submits the invoice to the export factor,

the export factor provides (cash in advance) funds to the exporter against receivables until money is collected from the importer. The exporter often receives up to 30 percent of the value of the receivables ahead of time and pay the factor interest on the money received, or the factor pays the exporter, less a commission (usually 1-3%) charge, when receivables are due (or shortly thereafter).

the export factor passes the invoice to the import factor for assumption of credit risk, administration, and collection of the receivables,

the import factor presents the invoice to the importer for payment on the agreed-upon date,

the importer pays the import factor, and

the import factor pays the export factor.

What are the disadvantages of factoring?
As explained in the table, factoring is not available for low value shipments or for receivables with a maturity of more than 180 days. Factors also do not work with developing countries due to their inadequate legal and financial framework. Exporter could be liable for disputes concerning quality/condition of the goods.

Is venture capital generally suitable for export firms?
No. Minimum investment is between $50,000 to $100,000, they seldom provide start-up capital, they expect high returns on their investments.

What are the various loan facilities provided by the SBA to export businesses?
Microloans, export working capital, fast track, international trade loan, SBICs, CDC/504, 7(a) loan guarantee.

			True	False
What type of financing occurs when an export-import firm borrows money from a lender with a promise to repay (principal and interest) at some predetermined future date?	3.	Short-term
	4.	Intermediate
	5.	Debt
The practice of purchasing deferred debts arising from international sales contracts without recourse to the exporter is called ...	6.	Forfeiting
	7.	Discounting
	8.	Discrepancy