With increased globalization, many companies see the benefits of engaging in international trade; there’s opportunity to earn more revenue and to place your products and services in front of a wider audience. However, a business should also weigh in the risks associated with international trade.
While one can mitigate most of these risks, certain risks can never be fully mitigated, so for things like sanctions, a company must be adequately prepared in order to overcome them.
Here are the major risks that multinational companies face while trying to expand internationally:
Foreign exchange risk
Multinational companies face the risk of currency value fluctuations, where in appreciation of a currency relative to other currency can negate the economic gains made. It’s important for businesses to identify foreign exchange risks and have adequate policies in place to effectively deal with them. Businesses must identify adequate tools available to hedge these risks and carry out a regular comparative analysis to select the most effective tools.
Parties in international trade make payment in foreign currencies and are subjected to exchange rate fluctuations. For example, if the Chinese currency becomes stronger against the Euro, imports from China would be expensive thus decreasing the profit margin for the German company.
It’s quite possible that a country might change certain policies that could negatively affect a business. Trade barriers, sanctions, ban on certain products, are common examples. Companies need to be adequately prepared to deal with such scenarios.
This refers to counterparty or credit risk wherein the other side may not be able to pay the money once the delivery is done. Taking payment in full or taking letter of credit are some ways to manage this risk.
A letter of credit (LC) is a bank guarantee that a buyer’s payment will be received by the seller for the correct amount and on the time specified; If the buyer is unable to make the payment on the purchase for some reason, the bank will reimburse that amount to the seller. A letter of credit is seen as a more secure mode of payment.
However, letter of credit also carries risks – country risk and bank risk. Financial markets of a country can go into a turmoil, so country risk assessment is important in international trade transactions.
Similarly, the Bank issuing the LC should also be trustworthy and creditworthy. Will the bank really be able to cover the payment if the need arises?
So, it’s important for businesses engaged in international trade to identify foreign exchange risks and have adequate policies and hedging options, such as getting into forward foreign exchange contracts to protect their profit margin, asking for Letter of credit, etc. to deal with those risks effectively.
Shipments could be delayed due to several reasons – seizure, accident, theft, breakage. This is where having sufficient insurance helps. It is also a good idea to work with a forwarding agent.
Frequent economic swings
Inability to predict or prepare for changes in the local economic environment can create risks domestically.
Intellectual property risk
Third parties can make unauthorized use of a business’s intellectual property. When doing international trade, it becomes difficult for businesses to defend their rights to their intellectual property. Businesses can mitigate such risks by registering their corporate names and trademarks before signing any agreement.
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