This business case study shows how factoring financing can be used to fund export transactions, in which a U.S. company sells goods to a foreign-based corporate customer. Export transactions can be difficult to finance due to their complexities. This case study is interesting because one of the transactions also includes the use of purchase order finance services. Purchase order financing is not commonly used with export factoring due to the high transaction risk.
To protect client confidentiality, some details of the case have been changed. However, the key lessons of this business case are clear.
Setting up the case
ABC Aviation Inc., a fictional reseller of aviation parts, has focused on international sales and was recently awarded contracts by companies in Guatemala and Peru. Two of these contracts were small, totaling $250,000 in sales, and were due in one month. The third contract, however, was valued at $500,000 – a substantial amount for ABC Aviation. The parts for this contract were due in two months. The following table outlines the orders:
The company has $150,000 in the bank – enough to cover the Cost of Goods Sold (COGS) for the first two contracts, but not enough to cover the third contract. The only way that ABC Aviation can fulfill these contracts is to use financing.
Working with the Export Import Bank
Using the Ex-Im Bank’s export credit insurance was critical to the success of the transaction. We managed to get the foreign clients approved, which covered up to 90% of the receivable face value in case of default. This coverage limited the risk to the point that the transaction could be financed using factoring. However, the Ex-Im Bank also has a program that covers up to 60% of the receivable face value if the goods are rejected by the client. This added feature was essential in enabling us to offer purchase order (PO) financing as well. Here are some details on the basics of PO financing and the basics of invoice factoring.
Step 1: Deliver Contracts #1 and #2
Since ABC Aviation had enough funds in the bank to deliver the parts on their first two contracts, they went ahead and fulfilled the orders. Their suppliers provided ABC Aviation with net 20 days to pay their invoices, so they did not need to pay them immediately. These costs are noted under General Expenses. The following table shows the financials of the company after delivering the first 2 contracts: As the table shows, after all expenses, the company has a cash surplus of $2,500. Unfortunately, this amount is not enough cover the expenses to fulfill the third contract.
Step #2: Use export factoring on first two invoices
After the sales, ABC Aviation implemented an export factoring program. This program offered an 80% advance on the company’s accounts receivable. The following table shows the financial state of the company after factoring its foreign receivables: As you can see, by financing their foreign accounts receivable, the company improves their cash position significantly. Note that a significant portion of the cash in the bank must be used to pay suppliers for the first two orders. This expense leaves $202,500 to apply to the third contract. However, the COGS of the third contract is $300,000, and ABC Aviation doesn’t have sufficient funds to fulfill the transaction.
Step #3: Deploy purchase order finance
ABC Aviation uses PO funding to help cover the supplier expenses associated with the third contract. The purchase order finance company provides an additional $100,000 and handles paying the aviation parts supplier. The following table shows the financial state of the company after having factored their two prior receivables and financed their third order:
Step #4: Factor the invoice for the last contract
Lastly, ABC Aviation financed their remaining invoice to improve their cash position one more time. This step is taken for two reasons. First, while the company has a cash surplus, it’s fairly small. And second, combining factoring with PO funding often lowers transaction costs. This table shows the final state of the company’s finances. Note that, at this time, the suppliers have not yet been paid nor have the foreign clients paid their invoices. To simplify this business case, we have not included the factoring and po funding fees in the transaction. However, the profit margins in the transaction were such that factoring was an affordable solution.
What if a foreign client does not pay?
Account debtor default is an inherent risk in international transactions, where collections can be difficult. However, this risk was greatly minimized by using the Ex-Im Bank’s credit insurance program. This program enabled the transaction to be financed.