Payments terms in Foreign Exchange

So much has been said about Foreign Exchange aspects of assets held abroad. In most cases, the assets result from inter-company transactions, whereby accounts receivable on the one sid, and accounts payable on the other, are incurred.

Because timing the payment of those accounts is subject to some control, owing to common ownership, it is possible to accelerate or delay payment, and thereby obtain some degree of protection. An account is always payable in a particular currency. When entities in different countries are involved, one of them has either a possible exposure, or a possible advantage, that depends on the relative strengths of the currencies.

To give two examples, suppose a U.S. importer in July 1969 owed, for goods shipped, a German exporter and a French exporter, in Deutsche marks and French francs, respectively. If the importer had delayed payment of the French francs until after August 8, approximately 15 percent fewer dollars would have been required. On the other hand, if the importer had not made payment of the Deutsche marks until after the end of October, approximately 15 percent more dollars would have been required.

Payment terms are generally agreed upon on an arm's-length basis, and normally the importer would not be able to change the timing. However, when an affiliation exists, it is possible to take advantage of the situation to achieve some measure of protection against a possible devaluation or revaluation. In the example given, payment to Germany could have been accelerated, and payment to France delayed.

The principle is simple: payments from countries with weaker currencies should be expedited and payments by countries with stronger currencies should be delayed. This is the phenomenon called leads and lags.

There are, however, a number of practical difficulties that restrict what can be done.

First of all, nonpayment, or prepayment, may result in a financial burden in a particular country, that arises from the availability of funds to finance continued normal operations, and from the additional interest cost on funds borrowed, or interest earnings lost on funds used. Secondly, government exchange regulations often require payment within a specified time.

In the United States, for example, changes in accounts with affiliates are considered as changes in investment abroad, and are covered by the Office of Foreign Direct Investments regulations. Finally, the effect of changing payments transfers the gains from possible protection to a different country.

When profit centers are involved, or there are other ownership interests that can make for difficulties, there is an advantage for the group as a whole, which arises from the fact that the country that delays payment has interest earnings, or savings, from the use of the funds, and also benefits from any change in currency values.