Mekong Sole: Financing a First Order Without an LC
Mekong Sole Co., a Vietnamese footwear exporter, has a $480,000 order from Trailmark, a new U.S. retailer. Trailmark refuses a letter of credit and proposes open account at 60 days. Mekong's production cost is $374,400, giving a 22% gross margin. Its bank offers four options: a confirmed irrevocable LC at 1.15% of invoice value plus a $350 advising fee; documentary collection at 0.35% plus $200; export factoring with an 80% advance, a 2.4% discount on invoice value, and a 0.6% service fee; or credit insurance at 0.45% of insured value, covering 90% of a loss after a $5,000 deductible, available only for open-account sales. Trailmark's credit rating is moderate, and two references report payments 15–30 days late. Mekong has $120,000 of liquidity and a $250,000 operating line at 7.5% annual interest. The buyer will not accept a 30% deposit.
1. Calculate the all-in cost and net cash position for each option. State your assumptions, especially the financing period.
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Assume Mekong must finance the $374,400 production cost for 90 days and that the invoice is paid at day 90 under open account. Interest = $374,400 × 7.5% × 90/360 = $7,020.
| Option | Direct cost | Financing cost | Net cash if paid | Key risk |
|---|---|---|---|---|
| Confirmed LC | $5,520 + $350 = $5,870 | $0 if sight | $474,130 | Buyer refuses; demanding it may lose the order |
| Documentary collection | $1,680 + $200 = $1,880 | $7,020 if 90 days | $471,100 | No payment guarantee; buyer can refuse documents |
| Factoring | 2.4% × $480,000 = $11,520; 0.6% = $2,880; total $14,400 | Included in advance | $465,600 | Cost is about 3.0% for 60–90 days; recourse terms matter |
| Open account + insurance + line | Premium 0.45% × $480,000 = $2,160 | $7,020 | $470,820 | Retains credit risk after 90% cover and $5,000 deductible |
If Trailmark defaults completely, insurance recovery = 90% × ($480,000 − $5,000) = $427,500. After $9,180 of premium and interest, net cash is $418,320, which still covers the $374,400 production cost but leaves only about $43,920 before other overheads. Factoring gives certainty but is the most expensive option. The LC is cheapest in risk terms but is not available commercially.
2. Recommend a payment and financing structure. Explain why the cheapest nominal option is not automatically the right one.
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Recommend open account at 60 days with credit insurance and the operating line, subject to conditions. The all-in cost is $9,180, below the $14,400 factoring cost and far below the lost margin if Mekong insists on an LC and loses the order. The insurance does not eliminate risk, but it converts a catastrophic $480,000 default into a manageable residual loss. The operating line covers production, and the $120,000 liquidity buffer covers the deductible and timing gaps.
The lowest nominal cost is documentary collection at $1,880, but it is not the right choice: under URC 522 the buyer can refuse to pay or accept documents, leaving Mekong with goods stranded in the U.S. and no insurance cover. The confirmed LC is the strongest instrument, but Trailmark has refused it; insisting would likely end the negotiation. Factoring is attractive if Mekong cannot tolerate any credit risk, but it costs about $5,220 more than the insured open-account structure and may still be recourse.
Structure the deal in two shipments. Release the first $240,000 only against insured open account with a credit limit; make the second shipment conditional on payment of the first within 75 days. This limits exposure while preserving the buyer relationship.
3. What commercial terms should Mekong propose to Trailmark to share the risk and preserve the order?
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Mekong should not simply absorb the risk. It should propose a package that gives Trailmark the open account terms it wants while creating incentives for timely payment.
- Price the risk: add 0.45% for insurance and a financing charge of about 1.5% to the unit price, or offer a 1.5% discount for payment at 30 days. This makes the cost visible without demanding an LC.
- Split the order: first shipment on insured open account, second shipment after the first payment clears. If Trailmark refuses any split, reduce the first order to $300,000 and require a standby LC for the balance.
- Use a late-payment charge: 1.5% per month on overdue amounts, plus suspension of future shipments. This is more enforceable than a vague warning and gives Mekong a contractual lever.
- Ask for a personal guarantee or parent-company guarantee if Trailmark is a subsidiary; alternatively, ask for a bank comfort letter. These are weaker than an LC but stronger than open account alone.
- Keep the relationship: offer to revisit 30-day terms after six months of clean payment history. This gives Trailmark a path to better terms and gives Mekong a reason to monitor performance.