Invoice discounting is a financial tool that allows companies to access cash from unpaid invoices, and it can be particularly beneficial for businesses involved in international trade transactions.

One of the main benefits of invoice discounting for international trade transactions is that it can help companies to improve cash flow. International trade transactions often involve longer payment terms and a higher risk of non-payment, which can make it difficult for companies to manage their cash flow. Invoice discounting allows companies to access cash from unpaid invoices much faster than waiting for customers to pay in full, which can help to alleviate cash flow constraints.

Another benefit of invoice discounting for international trade transactions is that it can help companies to manage the risk of non-payment. In international trade, it can be difficult for companies to assess the creditworthiness of customers and the risk of non-payment. Invoice discounting companies will often conduct credit checks on customers before advancing funds, which can help companies to identify potential risks and make more informed decisions about which invoices to discount.

Additionally, invoice discounting can also help companies to manage the currency risk. Invoice discounting can be provided in the local currency, therefore reducing the impact of currency fluctuations on the company’s treasury.

Invoice discounting can also help companies to maintain a good relationship with their customers. Instead of having to wait a long time to get paid, companies can use invoice discounting to get paid quickly and maintain a good relationship with their customers.

Furthermore, Invoice discounting can also help companies to free up working capital that can be used for other purposes such as expanding the business, investing in new equipment, or hiring new staff.

In conclusion, invoice discounting is a valuable tool for companies involved in international trade transactions. It can help companies to improve cash flow, manage the risk of non-payment, manage currency risk, maintain a good relationship with their customers and free up working capital for other purposes. Companies should consider using invoice discounting as a way to better manage the financial impact of international trade and maintain a strong, healthy bottom line.

Tulyp is a BtoB payment and financing solution that supports importers and exporters on a daily basis. As a FinTech specialized in Trade Finance, we support them in their payment guarantee, financing and liquidity issues. If you have any questions, please contact us. One of our experts will contact you within 24 hours.

What is an escrow account?

An escrow account is a financial arrangement in which a neutral third party, known as an escrow agent, holds and regulates the payment of funds required for two parties involved in a given transaction. It is often used in real estate transactions, but can also be used in international trade to ensure the secure and efficient exchange of goods and services.

Why should you use an escrow account?

One of the main benefits of using an escrow account for international trade is that it provides a level of security for both the buyer and the seller. The escrow agent acts as a neutral intermediary, holding payment until the goods or services have been delivered and both parties are satisfied. This eliminates the risk of non-payment or non-delivery, which can be a major concern in international trade.

Another benefit of using an escrow account is that it helps to streamline the payment process. Instead of having to navigate the complexities of international wire transfers or other forms of payment, both parties can simply deposit their funds into the escrow account and the escrow agent will handle the rest. This can be a major time-saver and can help to reduce the risk of errors or misunderstandings.

In addition, an escrow account can also be used to ensure that all necessary documentation is in order before a payment is released. This can include bills of lading, invoices, and other important documents that need to be reviewed and verified before payment can be made. This helps to ensure that all parties are in compliance with the terms of the transaction and can help to avoid disputes or delays.

While there are many benefits to using an escrow account for international trade, there are also some potential drawbacks to consider.

What are the drawbacks of using escrow accounts?

One of the main drawbacks is the cost. Escrow services can be expensive, and the fees associated with using an escrow account can add to the overall cost of a transaction. This can be especially problematic for smaller transactions where the cost of the escrow services may be a significant percentage of the total cost of the transaction.

Another potential drawback is the time it takes to set up and manage an escrow account. It can take time to find a reputable escrow agent and to get the account set up and running. This can be a major inconvenience for businesses that need to move quickly to take advantage of a particular opportunity.

In conclusion, the use of an escrow account in international trade can provide a level of security and efficiency that is not possible with other forms of payment. By providing a neutral third party to hold and regulate funds, an escrow account can help to eliminate the risk of non-payment or non-delivery, streamline the payment process, and ensure that all necessary documentation is in order. This can be a major advantage for businesses looking to expand their international trade activities.

Tulyp is a BtoB payment and financing solution that supports importers and exporters on a daily basis. As a FinTech specialized in Trade Finance, we support them in their payment guarantee, financing and liquidity issues. If you have any questions, please contact us. One of our experts will contact you within 24 hours.

Small and medium-sized enterprises (SMEs) often struggle to access trade finance services, which can include things like letters of credit, invoice financing, and supply chain financing. This can be a significant hurdle for SMEs, as trade finance can help these companies grow and compete in the global marketplace.

One reason why SMEs may lack access to trade finance is due to a lack of collateral. Many trade finance providers require collateral, such as real estate or inventory, to secure a loan. However, many SMEs may not have the assets or resources to provide this collateral.

Another reason is a lack of credit history or financial track record. Trade finance providers often rely on credit ratings and financial statements to assess the risk of a loan. SMEs may not have a long history of financial performance or may not have established a credit rating, making it difficult for them to secure trade finance.

Additionally, SMEs may also face difficulty in meeting the documentation requirements of trade finance providers. This can include providing detailed information about the company and its operations, as well as information about the specific trade transaction being financed. SMEs may not have the resources or expertise to provide this information, which can make it difficult for them to access trade finance.

It is difficult to estimate the exact market gap of trade finance services for small and medium-sized enterprises (SMEs), as it can vary depending on factors such as location, industry, and the specific needs of the SME. However, it is widely acknowledged that there is a significant gap in access to trade finance for SMEs.

According to the International Chamber of Commerce (ICC), around 80% of global trade is financed by banks, but only 20-25% of SMEs have access to trade finance. This means that a large percentage of SMEs are unable to access the financing they need to participate in global trade.

The World Bank Group’s International Finance Corporation (IFC) estimates that the global trade finance gap for SMEs is around $1.5 trillion. This gap is particularly acute in developing countries, where the majority of SMEs lack access to trade finance.

Additionally, the trade finance gap is also affected by the COVID-19 pandemic which causes a huge disruption in global trade, causing a huge trade finance gap, making it difficult for SMEs to access the financing they need to continue operations and participate in global trade.

In conclusion, SMEs may lack access to trade finance services due to a lack of collateral, lack of credit history or financial track record, and difficulty in meeting documentation requirements. This lack of access can make it difficult for SMEs to grow and compete in the global marketplace.

Tulyp is a BtoB payment and financing solution that supports importers and exporters on a daily basis. As a FinTech specializing in Trade Finance, we support them in their payment guarantee, financing and liquidity issues. If you have any questions, please contact us. One of our experts will contact you within 24 hours.

Invoice financing is a financial solution that allows businesses to receive cash advances on their outstanding invoices. This can provide a much-needed injection of cash for businesses that are waiting for customers to pay their bills.

There are two main types of invoice financing: invoice factoring and invoice discounting:

Invoice factoring involves selling your unpaid invoices to a third party (called a factor) at a discounted rate. The factor then collects payment from your customers and remits the remaining balance to you, minus their fee. This type of financing is often used by businesses that have a high volume of invoices, and need cash quickly.

  • Advantages of Invoice Financing:
  1. Quick access to cash: Invoice financing can provide businesses with the cash they need quickly, which can be especially useful for businesses that have cash flow gaps due to outstanding invoices.
  2. Flexibility: Businesses can choose between invoice factoring and invoice discounting, depending on their needs and preferences.
  3. Improved cash flow: With invoice financing, businesses can receive cash advances on their invoices, which can help them to meet their financial obligations and invest in growth.
  4. No collateral required: Invoice financing typically does not require collateral, which can be beneficial for businesses that do not have assets to pledge.
  5. Creditworthiness of the customer: Invoice financing companies typically make their lending decision based on the creditworthiness of the customer, not the business.
  • Inconveniences of Invoice Financing:
  1. Cost: Invoice financing comes with a fee, which can be a significant cost for businesses, especially if they have a high volume of invoices.
  2. Loss of control: With invoice factoring, businesses lose control over the collection process, which can be a disadvantage for some businesses.
  3. Impact on credit: When businesses use invoice financing, they are essentially taking on debt, which can have a negative impact on their credit scores.
  4. Risk of default: If a customer defaults on their invoice, the business may be responsible for the unpaid amount, which can be a financial risk.
  5. Not suitable for all businesses: Invoice financing may not be a suitable option for all businesses, particularly those that have a small number of invoices or a high-profit margin.

Invoice discounting is similar to invoice factoring, but instead of selling the invoices, the business continues to collect payment from its customers. The lender, however, will provide an advance on the invoice amount, minus their fee. This type of financing is often used by businesses that want to maintain control over the collection process.

  • Advantages of Invoice Discounting:
  1. Maintaining control: Invoice discounting allows businesses to maintain control over the collection process, which can be beneficial for businesses that want to maintain a good relationship with their customers.
  2. Flexibility: Invoice discounting allows businesses to choose how much of their invoices they want to finance, which can provide them with more flexibility than other forms of financing.
  3. Quick access to cash: Invoice discounting can provide businesses with quick access to cash, which can be especially useful for businesses that have cash flow gaps due to outstanding invoices.
  4. Confidential: Invoice discounting is often a confidential arrangement between a business and its lender, which can be beneficial for businesses that want to keep their financing arrangements private.
  5. Creditworthiness of the customer: Invoice discounting companies typically make their lending decision based on the creditworthiness of the customer, not the business.
  • Inconveniences of Invoice Discounting:
  1. Cost: Invoice discounting comes with a fee, which can be a significant cost for businesses, especially if they have a high volume of invoices.
  2. Risk of default: If a customer defaults on their invoice, the business may be responsible for the unpaid amount, which can be a financial risk.
  3. Limited amount of funding: Invoice discounting typically provides a business with a limited amount of funding, which may not be sufficient for businesses that need a large injection of cash.
  4. Impact on credit: When businesses use invoice discounting, they are essentially taking on debt, which can have a negative impact on their credit scores.
  5. Not suitable for all businesses: Invoice discounting may not be a suitable option for all businesses, particularly those that have a small number of invoices or a high-profit margin.

Both invoice factoring and invoice discounting can provide businesses with the cash they need to meet their financial obligations and grow their operations. However, it is important to keep in mind that invoice financing comes with a fee, so it is important to carefully consider the cost and compare it to other forms of financing before making a decision.

In conclusion, Invoice financing is a financial solution that can help businesses to bridge cash flow gaps by providing an advance on outstanding invoices. It is important to carefully consider the cost and compare it to other forms of financing before making a decision.

Tulyp is a BtoB payment and financing solution that supports importers and exporters on a daily basis. As a FinTech specializing in Trade Finance, we support them in their payment guarantee, financing and liquidity issues. If you have any questions, please contact us. One of our experts will contact you within 24 hours.

For every company, cashflow is a crucial aspect in order to sustain its activity. In business cash is king specialy right now.

There are many reasons to improve your cashflow. It could be for an investment, to establish a security mattress or simply to have peace of mind without having to run after ways to bring in cash quickly.

There are several ways to improve cashflow. This article written by Agicap specialist on the subject will give you different ways to improve your cash flow:

  • Boosting your sales.
  • Reduce the time needed to collect receivables.
  • Use supplier invoice times wisely.
  • Different means of financing.

However, when working with international suppliers it is a little more complex because there are other factors to consider: transportation time, customs clearance of goods, volatility of the foreign exchange market, etc.

When a company imports goods, payment is usually requested at the time of order. The company will take out cash before the goods are shipped. Depending on the geolocation of the supplier, the delivery time can be more or less long. It is necessary to count on average by sea way from France:

  • 30 to 45 days for China and Asian countries.
  • 10 to 20 days for the USA and Canada.
  • Between 15 to 30 days for South American countries.

To know the transport time of your goods: Searates

With a payment at the order, the company will increase enormously its need for working capital and will put at risk its treasury.

Let’s take a common example:

Company A orders 10,000 Euros of materials from Shenzhen in China. Its supplier asks for cash payment at the time the purchase order is issued. We will call this date N.

The shipping journey of the goods :

shipping journey

 

Simulation on the cashflow of company A :

  • Date N company A pays its supplier -> Cashflow = -10 000 EUR.
  • Date N+5 days: the supplier sends the goods. -> Cashflow = -10 000 EUR.
  • Date N + 45 days (with a France-China delivery time of 40 days): The goods arrive in France -> Cashflow = -10 000 EUR.
  • Date N + 50 days (5 days to sell its goods, which is a record): Company A sells its entire inventory to a customer with a 30-day payment term -> Cashflow = -10,000 EUR.
  • Date N + 80 days: Company A collects its sale -> Cashflow= +10 000 EUR + margin.

In our example above company A has a negative working capital requirement of 80 days. Of course the example is simplified to the maximum but due to the transport time the cash flow risk on the transaction is indeed 80 days.

Negotiating payment terms if possible with your international suppliers is therefore essential. However, this does not solve the problem in its entirety.

Let’s take the same example again, this time company A will have negotiated a payment term of 30 days after the delivery of the purchase order.

Simulation on the cashflow of company A :

  • Date N company A receives the purchase order -> Cashflow = 0 EUR
  • Date N+5 days: the supplier sends the goods. -> Cashflow = 0 EUR
  • Date N+30 days: Company A pays its supplier -> Cashflow = -10 000 EUR.
  • Date N + 45 days (with a France-China delivery time of 40 days): The goods arrive in France -> Cashflow = -10 000 EUR.
  • Date N + 50 days: Company A sells its entire inventory to a customer with a 30-day payment term -> Cashflow = -10,000 EUR.
  • Date N + 80 days: Company A collects its sale -> Cashflow= +10 000 EUR + margin.

In this example, Company A will have reduced its working capital requirement by 30 days, but will still have a 50-day gap. The impact of transportation delays is a major issue for importing companies. However, there are different ways to limit this impact:

  • Negotiate payment terms: 50% on order and 50% on delivery. Your supplier will not totally lose his liquidity and you will only commit a part of your cash flow on the medium term. This is a good way to create a win-win situation for both parties and therefore to establish long-term trust.
  • Work with a financial institution that finances your invoice. At Tulyp, for example, we support our clients in these operations by financing their invoices from 30 days to 120 days. We pay their suppliers when they prove that the goods are on their way and our clients pay us back on the date agreed upfront.

It is imperative for an importing company to have the right partners to manage these different impacts in the best possible way.

Tulyp is a BtoB payment and financing solution that supports importers and exporters on a daily basis. As a FinTech specialized in Trade Finance, we support them in their payment guarantee, financing and liquidity issues. If you have any questions, please contact us. One of our experts will contact you within 24 hours.

Cash is king in business, that is why working capital is one of the most trending subjects right now. They are multiple ways for companies to finance their needs from long-term debt, revenue-based financing, or short terms loans, the financial market offers various instruments for businesses to find the right financing tools.

One of the most common for SMEs is invoice financing which is very common around the world.

What is invoice financing?

Invoice financing is a short-term loan that a financial institution gives to a business based on a face value of an invoice. It can be used on the sale side based on the value of the company clients’ invoices which is called factoring or on the buying side to finance their supply needs

Invoice financing or Factoring on the client-side:

Invoice financing helps businesses improve cash flow, pay employees and suppliers, and reinvest in operations and growth earlier than they could if they had to wait until their customers paid their balances in full. Businesses pay a percentage of the invoice amount to the lender as a fee for borrowing the money.

Invoice financing can solve problems associated with customers taking a long time to pay as well as difficulties obtaining other types of business credit.

Consider an exporting company that is using factoring to offset the credit risk on their sales :

  1. The company ships the goods to their client and invoice them.
  2. She sends the invoice details to the invoice financing provider- the factor.
  3. The company received a percentage of the face value of the invoice depending upon the lender’s own risk criteria.
  4. The company collects the payment from their client.
  5. She pays back the factor of the amount lent and receives the portion of the invoice that wasn’t part of the lending deal. (less a service fee)

This financing tool is often used by companies as a liquidity tool to maintain their treasury and offset potential cashflow issues due to late client payments. It is a way of hedging against potential delays on their clients’ repayment.

Invoice financing on the supply side :

On the supply side invoice financing is used as a mechanism to finance operating needs and operations. Based on an invoice due to a supplier, a financial institution will lend the money to a business to pay the amount. The amount lent will be paid back to the financial institution on pre-agreed terms and time frame. This kind of financial tool is a means for companies to finance their treasury and cashflows. A good example of an invoice financing tool for importers is the letter of credit, which is often used for treasury reasons.

Consider a company, that is importing goods they are looking to improve their cashflow so they decide to use the following financing tool describe earlier :

  1. The company and her supplier negotiate the purchase order.
  2. The company goes to see their financial institution and agrees on the following terms. The financial institution will lend them money and the company will pay the loan back in 60 days.
  3. The company pays the supplier with the loan amount and the supplier sends the goods.
  4. The goods arrive 30 days later, the company sells the goods to their clients and gets pays.
  5. On the 60th day, the company pays back the financial institution with small interest.

Using this mechanism, the company didn’t have to engage funds until the 60th day. If the sales cycle allows it, the company pays back the financial institution using the amount she recovered from selling the goods. The cash flow will be impacted positively by this operation.

At Tulyp, we offer these invoice financing tools for our imports & exports clients. As a FinTech specialized in Trade Finance, the Tulyp solution supports international trade actors on their payment guarantees, financing, and liquidity issues. If you have any questions you can contact us, one of our experts will contact you within 24 hours.

Using an escrow account is nothing new in most industries. Often used in real estate or in consumer-to-consumer transactions, escrow accounts are used to offset the counterparty risk for both buyers & sellers.

What is an escrow account?

Escrow is a legal concept describing a financial agreement between a buyer and a seller where a third neutral party will be mandated to hold the funds on their behalf until certain rules or steps are reached in a commercial transaction.

To keep it simple, an escrow account is a temporary pass-through account held by a neutral third party in a transaction. This trusted third party – the escrow agent, will hold the funds until the completion of a transaction process, which is implemented after all conditions between the buyer and seller are settled.

In essence, companies use escrow services when two parties take part in a transaction and there is uncertainty about the fulfillment of their obligations. Escrow services respond to trust issues between both parties.

In International Trade, trust is a key pillar for trading businesses but how do you make sure that the counterparty will hold its position if you send the goods in advance or payment? Escrow services respond to this question by securing both buyer and seller.

How can an escrow account be used for international trading business to offset risk?

To answer this question, it is important to understand the mechanism of an escrow service.

Consider a company that is buying goods internationally. The company needs assurance that it will receive the goods after making a payment. The risk here is that the supplier vanishes after receiving the payment.

To offset that risk the transaction can be made using escrow services:

  1. Buyer & seller will mandate an escrow agent to hold the fund until pre-determined key rules are reached: validation of shipping documents for example.
  2. Buyer transfers the funds to the escrow account that is determined for the transaction.
  3. Escrow agent notifies the seller that the money is held into the account. The sellers now has the assurance that he will receive payment when pre-determided rules are respected.
  4. Sellers shipped the goods and send the shipping document to the escrow agent.
  5. Escrow agent verifies the authenticity of the shipping documents.
  6. Escrow agent release the payment to the seller after validation of the pre-determined documents.

In this transaction example both buyers and sellers have the assurance that the other party will fulfill their obligations :

  • Sellers know that he will receive the payment from the seller if he completes his obligations.
  • Buyer knows that the funds will only be released if the seller complete his obligation before receiving the payment.

In international trade, escrow services offset the international counterparty risk and the fear of the unknown of both parties while mitigating the financial engagement of their respected companies.

Tulyp is a FinTech specialized in Trade Finance. The Tulyp solution supports international trade actors on their payment guarantees, financing, and liquidity issues. If you have any questions you can contact us, one of our experts will contact you within 24 hours.

 

What is a letter of credit?

The letter of credit is one of the most widely used means of BtoB payment in the world of international trade.

It is a bank financial guarantee that allows the exporter to know that he will be paid on the condition that he sends the goods. For the importer, he has the assurance that he will receive the goods, in accordance with the purchase contract and the documentation related to the term defined by the contract.

This means of guaranteeing payments, which is very popular with international trade players, works directly with the banks. It is in fact the customer’s (buyer) bank that undertakes to pay the beneficiary, who is the seller, on delivery of the documents in conformity with the contract.

What guarantees does a letter of credit provide?

If you are an importer, a letter of credit is an assurance that your company will pay for the goods only if the exporter proves that he has sent the goods. It is a form of insurance that allows you to minimize your counterparty risk and protect you in case of attempted fraud by a supplier. The letter of credit also allows you in some cases to keep your liquidity. The buyer don’t have to make an initial payment or advance payment to prove good faith because his bank is committing herself on the company’s behalf.

For the exporter, the letter of credit protects against the risk of non-payment of the goods he has sent to his customer. As the payment is insured by the customer’s bank, the letter of credit protects the exporter against legal risks because the payment of the contract is assured as long as the delivery conditions previously agreed upon are respected.

The letter of credit is therefore a financial hedge for the buyer and seller in an international business transaction.

The different types of letters of credit:

  • Revocable or Irrevocable:

In most cases, a letter of credit is irrevocable by default. When issued by the importer’s bank, it guarantees the exporter that he will be paid if he meets his contractual obligations. To cancel an irrevocable letter of credit, all parties to the transaction must agree.

A revocable letter of credit, on the other hand, gives the buyer or his bank the right to modify the terms of the contract. The seller is therefore only partially protected, which is why revocable letters of credit are no longer used.

  • Revolving Letter of Credit:

A letter of credit is normally made for each international transaction. In case the importer buys several times from the same supplier, he can ask for the opening of a revolving letter of credit, allowing him to make several commercial transactions within a predetermined amount.

  • Transferable letter of credit :

This type of letter of credit applies when there are several commercial actors in a transaction:

  1. The importer.
  2. A commercial intermediary: an intermediary seller or trader for example.
  3. The exporter.

The transferable letter of credit therefore protects the 3rd actor in the financial transaction.

  • Confirmed or not confirmed :

Depending on whether a letter of credit is confirmed or not, the exporter who is always the beneficiary of the transaction will have more or less collateral.

When a letter of credit is confirmed, a second guarantee is obtained with another financial institution. It is generally used when there are doubts about the solvency of the bank issuing the first letter of credit. The seller therefore seeks a second guarantee to ensure that he will be paid.

If the letter of credit is not confirmed by a second bank, it is considered unconfirmed.

How does a letter of credit work?

  1. The importer and exporter decide to work together and an order is placed.
  2. The importer goes to his bank to set up a letter of credit. The cost of setting up a letter of credit is often taken by the importer and can vary from 1% to 8% in extreme cases when the buyer’s creditworthiness is low.The average cost is around 2.5% to 3% + documents movement fees. (without counting the expenses of exchange)
  3. The bank transmits the letter of credit to the exporter as a guarantee of payment.
  4. The exporter entrusts the goods to the carrier who provides him with the transport documents. The latter gives the documents to the bank issuing the letter of credit.
  5. After verification, the bank presents the bill of lading and acceptance to the importer.
  6. Payment is issued and the exporter receives payment from the bank.

It is important to note that this is a lengthy process. It takes an average of 5 to 10 business days to set up a letter of credit (acceptance) and about 10 days for the bank to receive and verify the contractual documents.

Letter of credit framework :

 

Advantages and disadvantages of letters of credit :

Advantages:

  • The letter of credit protects both parties equally against counterparty risk.
  • It is also an interesting cash flow tool for the buyer because in some cases, he does not commit cash until he receives the goods.
  • It allows to explore new commercial territories with less risk and protects against external parties to the commercial transaction.

The disadvantages:

  • The cost is a major drawback to the use of these products. The average cost is around 2.5% to 3% + document movement fees. (without counting the exchange fees)
  • It is a product mainly reserved for large groups. The latter can bear the cost but also prove to the bank that they are solvent and have access to these products.
  • The execution time is also a major drawback. It is necessary to count on average 25 working days for the realization of an operation of letter of credit end to end

Tulyp is a FinTech specialized in Trade Finance. The Tulyp solution supports international trade actors on their payment guarantees, financing, and liquidity issues. If you have any questions you can contact us, one of our experts will contact you within 24 hours.

As you should know, each country or economic zone has its own currency.

To begin with, you need to understand one important point: there is always a currency risk when you work with a partner that does not have the same currency as you.

The question is, who bears the risk? The importer or the exporter? There is no right answer to this question, but if the currency exchange is well mastered it can become a real commercial and financial asset.

Foreign exchange risk is the uncertainty of the conversion rate of one currency to another. This is an important point for companies because fluctuations can affect invoice amounts and therefore the commercial margin.It is important to understand that an exchange rate at one moment will not be the same 30 days later, when the invoice is paid.

The rate changes every second, so no one can predict the impact it will have on costs and margins. Whether you are exporting or importing, it will have an impact because your partners will also take into account the exchange rate when working with you.

Example:

The French company Dupont sources most of its products from China. Today, they have just received an invoice to be paid in 30 days for an amount of 100 000 USD. The EURUSD exchange rate is currently 1.10, i.e. EUR 90,909. Mr. Smith decides to wait before buying dollars.

The settlement date has arrived and Mr. Smith must now buy dollars.

  • Scenario 1: the price is now 1.07. Mr Smith buys 100,000 USD for 93,457.94 EUR. This means a margin loss of EUR 2,548.94.
  • Scenario 2: the price is now 1.13. Mr. Smith buys 100,000 USD against 88,495.57 EUR. This means a margin gain of EUR 2,413.43.

Both scenarios are spot transactions. That is, you buy the currency you want at the current market price.

The important thing to note here is that the loss or gain is a risk for the company making the trade. No one could have predicted the rate 30 days before. What you have to consider is that the final prices are not necessarily changeable with the final customers. So if scenario 1 happens you can lose all the margin because of the volatility of the exchange rates. That’s what we call currency risk.

Ways to protect yourself from price volatility:

However, there are ways to protect oneself from volatility and therefore to secure the margin and costs: forward contracts.

Forward contracts are financial products that allow you to lock in the exchange rate on a specific date or between two dates without committing cash or committing a limited portion of the desired amount. There are different types of forward contracts with varying degrees of participation, but all have the same purpose: to protect you from volatility. The names of these contracts may vary depending on the financial institution you work with.

To understand how futures contracts work, let’s go back to our example with Mr. Smith.

Example:

The company Dupont receives an invoice for 100 000 USD to be paid in 30 days. However, this time Mr. Smith does not want to risk his margin and decides to protect himself.

The current rate of the EURUSD is 1.10. Mr. Smith calls his financial institution and decides to take out a forward contract to buy 100,000 USD in 30 days at today’s rate.

  • Single scenario: 30 days later, Mr. Smith buys 100,000 USD at 1.10, i.e. EUR 90,909.

The current rate is not important when converting because Mr. Smith has protected himself against the exchange rate risk. If the rate was 1.07 as in scenario 1, he would have made a very good operation. In the case of scenario 2, he will have lost an opportunity. But in any case Mr. Smith will have secured his margin.

There are several types of forward contracts. Some also allow you to participate in the market to take advantage of an opportunity in your favour. However, it is important to understand that these products allow you to secure your margin and not to impact your costs unfavorably. Foreign exchange risk is a risk that can be controlled if you are well accompanied.

Tulyp is a FinTech specialized in Trade Finance. The Tulyp solution supports international trade actors on their payment guarantee, financing and liquidity issues. If you have any question you can contact us, one of our experts will contact you within 24 hours.