The money is out from the first day of production, not from the invoice date, and it is the cost of goods that is financed, not the price.
Multiply the cost of goods, not the invoice, by your cost of funds and by every day from the start of production to the day the buyer pays, on actual/360. On an illustrative 4,200,000 export order with 3,423,000 of cost, 70 days of production, 26 of transit and 90 days of open-account terms, that is 3,423,000 × 8.4% × 186 ÷ 360 = 148,558, nearly half (48.5 per cent) of the order's 306,600 operating margin. The 90-day payment term is only 48.4 per cent of the days financed.
Worked in full in Trade Finance by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Exporters tend to price the payment term and forget the calendar around it. The money is out from the day production starts, not from the day the invoice is issued, and it stays out through the voyage. Built from its parts, the financing line is the largest single cost on most export orders, and the easiest to understate.
| Input | Value |
|---|---|
| Contract value | 4,200,000 |
| Cost of goods sold, 81.5% of the price | 3,423,000 |
| Selling, general and administrative cost carried by the order, 11.2% | 470,400 |
| Operating margin before finance, 7.3% | 306,600 |
| Production / transit / buyer credit, days | 70 / 26 / 90 |
| Exporter's own cost of funds, actual/360 | 8.4% |
Cost of one day = cost of goods × cost of funds ÷ 360 = 3,423,000 × 8.4% ÷ 360 = 798.70
Days to cash = production + transit + buyer credit = 70 + 26 + 90 = 186
Financing = 798.70 × 186 = 148,558
In Excel: =COGS*CoF*(Prod+Transit+Terms)/360. Keep the three day counts in separate cells, because each is managed by a different team.
| Stage of the calendar | Days | Financing | Share |
|---|---|---|---|
| Production, order to ship-ready | 70 | 55,909 | 37.6% |
| Transit, port to port and inland | 26 | 20,766 | 14.0% |
| Buyer credit | 90 | 71,883 | 48.4% |
| Total | 186 | 148,558 | 100% |
Financing takes 148,558 of the 306,600 operating margin, leaving 158,042: money alone consumes 3.54 per cent of the price. More than half of it, 76,675, is spent before the buyer's credit period even starts. A sales team that thinks of the 90 days as the cost of the deal is looking at less than half of the bill.
This is financing only. On open account the exporter also carries the buyer's default risk for the 116 days from shipment, an expected loss of 34,416 at a 4.1 per cent annual default probability and 62 per cent loss given default. With both counted, the margin left is 123,626, and it reaches zero at 203.3 days of buyer credit. How that loss changes the choice of instrument is worked in open account vs letter of credit.
Use the marginal rate on the facility that actually funds the order, not a blended cost of capital: the order draws on the working-capital line from the day materials are bought, and repays it only when the buyer pays. Expressed on the quotation, 148,558 is 3.54 per cent of the price on 90-day terms, before any allowance for credit risk. That is the figure a commercial team should see beside the margin when it agrees the terms.
| Buyer credit | Days to cash | Financing | Share of operating margin | Margin after financing |
|---|---|---|---|---|
| At sight (0) | 96 | 76,675 | 25.0% | 229,925 |
| 30 days | 126 | 100,636 | 32.8% | 205,964 |
| 60 days | 156 | 124,597 | 40.6% | 182,003 |
| 90 days | 186 | 148,558 | 48.5% | 158,042 |
| 120 days | 216 | 172,519 | 56.3% | 134,081 |
| 180 days | 276 | 220,441 | 71.9% | 86,159 |
Even sold at sight, the order spends a quarter of its margin on financing, because production and transit are financed whatever the terms. Every day of credit costs the same 798.70, so the factory is as much a lever as the contract: cutting production from 70 to 50 days saves 15,974, exactly what 20 days of terms conceded to the buyer cost. The rate is the third lever. At a 6.0 per cent cost of funds the line is 106,113, 34.6 per cent of the margin; at 10.0 per cent, 176,855, or 57.7 per cent.
Financing = cost of goods × cost of funds × (production + transit + terms) ÷ 360: 148,558 on this order, 48.5 per cent of the margin, and only 48.4 per cent of it due to the terms. Build the calendar from its parts before quoting the buyer anything. The order's five-line build-up, the calendar and the six routes to payment are live formulas in the free workbooks for this order.
On the cost of goods, because that is what the exporter has paid out and must fund. On the illustrative order, 3,423,000 of cost at 8.4 per cent for 186 days costs 148,558; the same calculation on the 4,200,000 invoice gives 182,280, overstating the line by 22.7 per cent.
Cost of goods times cost of funds divided by 360. On 3,423,000 of cost at 8.4 per cent that is 798.70 a day of financing, so 30 more days of buyer credit cost 23,961 before any extra credit risk. Days of production and transit cost exactly the same.
It is the funding of an order from the start of production until shipment. On the illustrative order, 70 days of production on 3,423,000 of cost at 8.4 per cent cost 55,909, and the 26 days of transit after shipment another 20,766: together more than the 71,883 of the 90-day payment term.
This article is one calculation from Trade Finance. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: business operations: cost, contracts, pricing and supply chain → · All 1340 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.