managing late payments for international sales

If chief executiveofficers and chieffinancial officers

do not monitor latepayments, then netmargin can be signifi-cantly negativelyimpacted. The policies for latepayments become even moreimportant when the company hasinternational sales. This articledeals with late payments forinternational customers. Firmsworking with overseas customerswho are late in making paymentsare faced with issues such as:How do we determine the cost oflate payments? How do we buildthis cost into the price of theproduct? How do we makeadjustments for payments in for-eign currencies? To the extentthat adjusting the margin is fea-sible, such adjustments shouldbe a function of the firm’s costof capital. When payments are inforeign currencies, additionaladjustments to margin must bemade to accommodate currencyhedging costs. See Exhibit 1 fora list of key tips in handling lateforeign payments. We’ll discussthem in more depth later.

It is crucial for a firm’sprofitability that senior man-agement such as the CEO andCFO monitor credit terms andpayment patterns. In the exam-ple below, we will see how afirm’s net margin could bedecreased if this part ofaccounts receivable policy isignored.

Firms consistently havesome customers who make pay-ments beyond the stated credit

terms. For example,assume a firm’s totalannual sales are$5,000,000, all salesare on credit, thefirm’s net margin is 5 percent, and the

firm’s cost of capital is 10 percent.If the firm’s credit terms are net30, and customers take 45 days,on the average, to pay, then theselate payments will cost the firmover $20,000 for the year, asillustrated below.

As can be seen, the impacton net margin is significant,reducing it from 5 percent to4.6 percent.

The CEO and CFO musttherefore work to make sure that

With the global economic downturn, more of yourcustomers worldwide will be paying late. But latepayments can significantly affect your firm’s netmargin. © 2009 Wiley Periodicals, Inc.

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© 2009 Wiley Periodicals, Inc.Published online in Wiley InterScience (www.interscience.wiley.com).DOI 10.1002/jcaf.20527

Managing Late Payments

for International Sales

Bento J. Lobo, Christi Wann, and John G. Fulmer Jr.

Example:Sales � $5,000,000Net Margin � 5%Cost of Capital � 10%Credit Terms � Net 30If customers pay in 45 days, it costs the firm:$5,000,000 � 10% � 15/360 � $20,833Impact on net margin � �0.42%

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this cost of accounts receivableis avoided. The policy decision issomewhat more involved whenthe customer is overseas. BothCEOs and CFOs must under-stand the unique issues relativeto late payments when dealingwith international customers,and be able to communicate thefirm’s policies. These issues areexamined in this article.

To the extent that overseascustomers also make paymentsbeyond the agreed-upon creditterms, certain issues need atten-tion. Below, we paraphrase theCFO of a company as headdressed this problem. Thecompany sells its productdomestically and internationally:

We have some interna-tional customers whochronically pay up in 45 days or so when theterms are net 30. I wouldlike to apply a certainpercentage to my com-pany’s margin to coverthese late payments. Forexample, assume that wesell our product in thedomestic market with a39 percent markup. Wesomewhat arbitrarily

made the decision to sellthe same product inter-nationally with a highermarkup to cover latepayments and exchangerate risk. However, I amnot sure if this increaseis the right amount. Whatshould the percentageincrease be? How do Idetermine an accurateand fair amount?

PROPER MARKUP TO COVERLATE PAYMENTS

How does the CFO deter-mine the cost of late payments?How does he then build this costinto the price of the product?Does it make any difference ifthe customer is overseas?

Many firms typically under-take pricing on a cost-plus basis.The question that arises there-fore is: by how much must thecompany’s margin be increasedto cover the late payments?

The first step is to determinethe cost of the late payments.This determination, along withthe computation of the propermarkup, is illustrated in Exhibit 2.

The procedure that should beused is a present value analysis

(Brigham & Ehrhardt, 2005). InExhibit 2, the cost of the productis assumed to be $100. Assum-ing the markup for the domesticmarket is 39 percent, the result-ing price is $139. Assuming thefirm’s cost of capital is 11 percent,and assuming a one-year delayin receiving payments, then themarkup that includes the costof the delayed payments is54.29 percent. The price chargedshould be $154.29 � $139 � .11($139) � $154.29.

Now, the company won’tcare if it receives $139 today or$154.29 in one year. The markupreflects the fact that the com-pany does not have the use ofthe $139 for one year. Stateddifferently, the company couldearn 11 percent by paying offliabilities and retiring equity,which combined have a cost of11 percent. This “opportunitycost” must be added to theoriginal markup.

The process used to deter-mine the proper markup to coverthe cost of delayed payments is apresent value analysis, which issummarized in Exhibit 3. Forillustrative purposes, calculatorentries are given for a 15-daydelay period. This process isused regardless of whether thesource of the delayed paymentsis from a domestic or interna-tional customer. The cost of thedelayed payments to the companyis the same.

MARGIN ADJUSTMENT FOREXCHANGE-RATE RISK

The process described ear-lier to adjust margin for latepayments gets more complicatedwhen the payments are made inforeign currencies. Consider forinstance, that the American firmis due to receive Canadian(CAD) $100,000 on net-30 terms.However, the customer typically

40 The Journal of Corporate Accounting & Finance / September/October 2009

DOI 10.1002/jcaf © 2009 Wiley Periodicals, Inc.

Key Tips for Managing Late Overseas Payments

• Neglecting accounts receivable policy, including late payments, canadversely affect corporate profitability

• A strategic margin adjustment to cover late payments should be basedon time value of money techniques and the firm’s cost of capital.

• Late foreign currency payments can be managed with a put optionstrategy to hedge losses from unpredictable currency movements.

• The put option strategy works best for “soft” foreign currencyreceivables and when markets are volatile; it is less effective whenthe foreign currency is expected to gain value.

Exhibit 1

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pays in 45 days. Furthermore,consider that the exchange ratewas $1.00/CAD when the salewas made, $0.90/CAD 30 dayslater, and $0.85/CAD whenpayment was received 45 daysafter the sale.

In this case, the firmreceived $85,000 (i.e., CAD$100,000 � $0.85/CAD) whenthe payment was received(ignoring any transactionscosts of converting CAD toU.S. dollars).

Note, however, that had pay-ment been received on time, thefirm would have received$90,000 from the sale. This is aclassic case of the firm beinghurt by having an unhedgedexchange-rate position. Here, the“loss” is a quantifiable $5,000(i.e., $90,000 � $85,000).

PUT OPTION HEDGINGSTRATEGY

A popular approach to hedg-ing risks related to foreign cur-rency receivables is via the useof currency put options. Such anoption gives the buyer the right,but not the obligation, to sell acurrency at a specific exchangerate (exercise price) during aspecified time period (Hull,2002). This option allows thefirm to guarantee an acceptableexchange rate yet still have thechoice to participate in anyfavorable exchange-rate move-ments. Additionally, premiumspaid for the options can beincorporated in product margins.

In Exhibit 4, we consider aput option on CAD 100,000trading on the Chicago Mercan-tile Exchange (CME) with anexercise price of 92 cents perCAD and a premium of 10cents per CAD. The firm couldbuy the right to sell CAD at$0.92 each for a premium (orcost) of $0.10 per CAD. The

The Journal of Corporate Accounting & Finance / September/October 2009 41

© 2009 Wiley Periodicals, Inc. DOI 10.1002/jcaf

Margin Increase for Late Payments

Cost of product $100Markup for domestic market 39%Price of product for domestic market $139Company’s cost of capital 11%Delay period for receiving payment 1 yearFuture value of $139 at 11% for one year $154.29The company would be indifferent between receiving

$139 today or $154.29 in one year.Therefore, the markup to include the cost of late payment is: 54.29%

Exhibit 2

Formula and Calculator Approach

Cost of producing the product xMarkup percentage for domestic market yPrice of product for domestic market x (1 � y)Cost of capital kDelay period for receiving payment n

Calculator: Texas Instruments BA II PlusPresent Value x (1 � y)I/Y kN nCompute FV

Assume delay period is 15 daysSet I/Y � 360Assume x � $100Assume y � 39%Assume k � 11%Therefore, domestic price � $100 (1 � .39) � $139

Then, enter:PV � $139I/Y � 11N � 15FV � $139.64Therefore, if a 15-day delay occurs, the markup to the internationalcustomer is 39.64%.

Exhibit 3

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total cost of this option wouldbe $1,000 (i.e., $0.10 � CAD100,000). Now, if the exchangerate on the date that the customermade payment was $0.85/CAD,the firm could exercise theoption and net $91,000 (i.e.,$92,000 � $1,000). Conversely,if the exchange rate on the datethat the customer made paymentwas $0.95/CAD, the firm wouldlet the option expire and convertCAD 100,000 in the open mar-ket for $95,000. The firm wouldnet $94,000 after accounting forthe cost of the option.

The (sunk) cost of the option(i.e., $1,000) could be built intothe margin. Consider, forinstance, that the firm had sold720 units of product at $139 perunit for a total sale of close to$100,000. The cost of the optionwould be $1.39 per unit (i.e.,$1,000/720). The price chargedthe customer would be $139 �$1.39 � $140.39, for a markupof 40.39 percent.

In the event that the cus-tomer paid late, in line with thediscussion in Exhibit 1, the pricecharged would be $155.83 �

$139 � $1.39 � .11 ($139 �$1.39) � $155.83. The exchange-rate hedge would add 1.54 per-cent to the margin charged alate-paying domestic customer.

WHEN DOES THE PUT OPTIONHEDGE WORK BEST?

The put option strategy islimiting when the foreign cur-rency is expected to appreciateor gain value relative to thefirm’s currency (U.S. dollars inour example). Such currenciesare commonly referred to as“hard” currencies. Receivablesin such “hard” currenciesshould most likely be leftunhedged. That way, the firmstands a better chance of bene-fiting from currency marketmovements by convertingreceivables on receipt into dol-lars at the spot market price.

In recent times, the U.S.dollar has shed significant valuerelative to several leading for-eign currencies. This is a func-tion of domestic and globaleconomic conditions. The firsttwo panels of Exhibit 5 reflectthe decline in the dollar relativeto the Euro and Canadian dollarsince the turn of the new mil-lennium. The third panel in thechart reflects the case of anArab country that pegs thevalue of its currency to the U.S.dollar. In such cases too, theput option has limited valueunless geopolitics suggest theincreased likelihood that theforeign currency will come offthe peg in the foreseeable future.

The put option strategyworks especially well when theforeign currency is expected todepreciate in value. Such curren-cies are frequently referred to as“soft” currencies. In such cases,the firm benefits from locking ina favorable exchange rate via the



Put Option Strategy for Foreign Currency Receivables

Purchase CAD put option (100,000) Exercise Price $0.92Premium $0.10

Total cost of put option on 100,000 CAD $1,000

Profit scenarios at receipt of CAD from customer:

Scenario 1CAD market exchange rate � $0.85/CADDecision: Exercise put option Net proceeds $91,000

Scenario 2CAD market exchange rate � $0.95/CADDecision: Do not exercise put option. Convert at market rate.Net proceeds $94,000

Incorporating the cost of the option into the margin:

Per unit cost of the put option (on 720 units sold) $1.39Price of product for domestic market $139

Price charged to customer (40.39% markup) $140.39

Incorporating the cost of the option into the margin for late payments:

Per unit cost of the put option (on 720 units sold) $1.39Future value of $139 at 11% for one year $154.29

Price charged to customer (54.29% � 1.54% � 55.83% $155.83markup)

Exhibit 4

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Exhibit 5

Appreciating Foreign Currencies

Source: Pacific Exchange Rate Service.

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put option rather than riskingcurrency depreciation at the timepayment is received. Exhibit 6shows examples of two such“soft” currencies.

DO GENERAL ECONOMICCONDITIONS MATTER?

The value and efficacy ofany corporate policy ought tobe evaluated relative to generaleconomic conditions. Forinstance, during recessionary

times, delayed payments gener-ally increase (Isberg, 2004).Therefore, at such times, hav-ing a policy that adjusts marginto cover late payments becomeseven more important. More-over, in global economic down-turns such as the one we arecurrently experiencing, cur-rency markets tend to becomemore volatile. Option-basedhedging strategies are espe-cially beneficial when marketvolatility increases.

STRATEGIC IMPLICATIONS

The application of a highermarkup to chronically late-payingcustomers is the primary solu-tion being considered here. Thissolution is predicated on two keyassumptions:

• that the company is willingand able to charge differentcustomers different prices, and

• that the company knows inadvance that a particular



Exhibit 6

Depreciating Foreign Currencies

Source: Pacific Exchange Rate Service.

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customer will (chronically)pay late.

There are, however, at leasttwo popular alternative approachesto addressing the problem of latepayments. They are:

• Assessing a late fee. Suchfees tend to be flat amountsand are typically viewed aspunitive measures. Here, it isassumed that this approachwill not work for competitive/strategic reasons.

• Adjusting credit terms. Thefirm could build cash dis-counts into terms so that itcould be expensive for a cus-tomer to not pay on time. Forexample, if the credit termswere adjusted to “2/30, net45” (i.e., the customer couldpay the full amount [$100] in45 days, or receive a 2 percentdiscount [$98] for paying in30 days), then the cost to thecustomer, on an annual basis,

of not taking the cash discountwould be about 49 percent(i.e., [{$2/[$100(1 � .02)]} �(360/15 days)]. From thefirm’s perspective, however,the discount represents a costthat could be built into theprice charged such chroni-cally late-paying customers.Here, we assume that adjustingcredit terms will not work withsome international customersdue to competitive pressuresand cultural differences.

MANAGING INTERNATIONALLATE PAYMENTS

Firms must routinely dealwith customers who make pay-ments beyond the agreed-uponcredit terms. It is important thatsenior management understandthe unique issues related todeveloping and implementingpolicies relative to late paymentsfrom international customers,and how to communicate these

policies to these customers. Tothe extent that adjusting themargin is feasible, such adjust-ments should be a function ofthe firm’s cost of capital. Whensuch customers are overseas,additional adjustments to mar-gin must be made to accommo-date currency hedging costs.While only slightly increasingprice, an option hedge couldoffer the firm significantprotection from uncertainexchange-rate movements.

REFERENCES

Brigham, E. F., & Ehrhardt, M. C. (2005).Financial management: Theory and prac-tice (11th ed.). Mason, OH: ThomsonSouth-Western.

Hull, J. C. (2002). Fundamentals of futuresand options markets (4th ed.). UpperSaddle River, NJ: Prentice Hall.

Isberg, S. C. (2004). Outsourcing collectionof delinquent accounts: Experiences dur-ing recession and growth [Electronicversion]. Retrieved July 30, 2008, fromhttp://findarticles.com/p/articles/mi_qa3857/is_200407/ai_n9470566/pg_1



Bento J. Lobo, PhD, is currently the UC Foundation Associate Professor of Finance at the University ofTennessee at Chattanooga. Dr. Lobo’s areas of expertise are policy effects on financial markets and assetvaluation. Christi Wann, PhD, is currently the UC Foundation Assistant Professor of Finance at theUniversity of Tennessee at Chattanooga. Dr. Wann’s areas of expertise are corporate finance and invest-ments. John G. Fulmer Jr., PhD, is currently First Tennessee Professor and Associate Dean of the Collegeof Business at the University of Tennessee at Chattanooga. He has taught in the finance area over 35 years,consulted widely, and published more than 50 articles in professional journals.

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managing late payments for international sales

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