Cross-border trade financing presents unique challenges due to the inherent risks associated with international business. These risks directly impact a company’s working capital and can significantly impact its financial health. Below are those risks:
- Credit Risk
Buyers’ Financial Stability:
- Credit risk is directly linked to the buyer’s financial health. Factors such as the buyer’s financial history, creditworthiness, cash flow, and overall financial stability can influence their ability to meet payment obligations.
- A financially unstable buyer, facing challenges like liquidity issues, high debt levels, or declining profitability, is more likely to default on payments.
Contractual Issues:
- Disputes over contract terms, quality of goods or services, or delivery timelines can lead to payment disputes and potential non-payment.
Impact of These Credit Risks:
- Financial Losses: Non-payment can result in significant financial losses for the sellers, including lost revenue, increased bad debt expenses, and potential damage to cash flow.
- Disrupted Operations: Non-payment can disrupt cash flow, making it difficult for the sellers to meet their own financial obligations, such as paying suppliers, employees, and other expenses.
- Damage to Reputation: Persistent issues with non-payment can damage a seller’s reputation and make it difficult to secure future business.
- Currency Risk
Currency risk, also known as exchange rate risk, refers to the potential for financial losses or gains resulting from fluctuations in the value of one currency relative to another.
Here’s how currency risk impacts businesses involved in international trade:
Impact on Revenue:
- Weakening Domestic Currency: If a company exports goods or services and its domestic currency weakens, its foreign currency revenues translate into more domestic currency, increasing profits.
- Strengthening Domestic Currency: A stronger domestic currency reduces the value of foreign currency revenues when converted back to the domestic currency, potentially eroding profits.
Impact on Costs:
- Weakening Domestic Currency: Increases the cost of imports as it takes more domestic currency to purchase foreign goods.
- Strengthening Domestic Currency: Reduces the cost of imports, improving profitability margins.
Impact on Financial Statements:
- Fluctuating exchange rates can impact the value of foreign currency assets and liabilities on a company’s balance sheet.
- Changes in exchange rates can also impact a company’s reported income and expenses.
- Liquidity Risk
In the context of cross-border trade, liquidity risk refers to the potential inability of a company to meet its short-term financial obligations. These obligations include paying suppliers, meeting payroll, or fulfilling other immediate financial commitments.
Also Read: Export Performance: April-September 2024 vs. April-September 2023
Here’s a breakdown:
- Delayed Payments from Customers: As discussed earlier, delayed payments from foreign buyers can significantly strain cash flow, impacting a company’s ability to meet its own financial obligations.
- Longer Lead Times: Longer lead times in international trade can exacerbate liquidity issues as businesses may need to finance inventory for extended periods.
- Currency Fluctuations: Rapid and unexpected currency fluctuations can impact the value of receivables and payables, potentially creating liquidity shortages.
- Funding Constraints: Difficulty in accessing affordable financing options, such as loans or lines of credit, can limit a company’s ability to manage cash flow and meet its financial obligations.
- Unexpected Events: Unforeseen events such as natural disasters, political instability, or global economic slowdowns can disrupt trade flows and significantly impact a company’s cash position.
Consequences of this Kind of Risk:
- Inability to meet financial obligations: Difficulty in paying suppliers, employees, and other creditors.
- Forced asset sales: May be forced to sell assets at a discount to generate cash.
- Difficulty in accessing financing: Difficulty in securing loans or other forms of financing from lenders.
- Potential for bankruptcy: In severe cases, liquidity shortages can lead to financial distress and even bankruptcy.
- Other Risks
- Operational risk in a supply chain refers to the potential for disruptions or losses stemming from internal processes, human errors, or systems failures within the organisation itself.
- Political risk in international trade refers to the potential for unexpected political events or changes in government policies to negatively impact a company’s operations, investments, or profits.
One of the best ways to either prevent or deal with the negative impacts of these risks is to utilise an online platform that can help in cross-border supply chain management.
M1 NXT is a digital trade finance platform for cross-border or international trade finance management. It is a next-generation leading provider of cross-border working capital solutions.
In addition to financing international trade for open-account sales and purchases, M1 NXT specialises in cross-border transactions. By letting suppliers and buyers choose when to pay and when to get paid, the platform frees up money for all businesses to thrive. This trade finance platform is approved by the International Financial Services Centres Authority (IFSCA) to set up the International Trade Financing Services Platform in GIFT City.
In Conclusion
The risks that come with doing business internationally make cross-border trade finance particularly difficult. These risks are credit, liquidity, currency, etc.
M1 NXT is a leading digital platform for cross-border trade finance. By providing multiple payment alternatives for both suppliers and purchasers in international trade transactions, it enables firms to maximise cash flow.