Why a confirmed usance credit that costs 5.53 per cent on a large export order costs more than the whole operating margin on a small one, and how to find the line for your own terms.
There is no legal minimum, but there is an economic one: the order size below which the credit's fixed fees and minimums cost more than the margin the order earns. On the illustrative export order of Trade Finance, a confirmed 120-day usance credit carries 3,695 of charges that do not scale and variable costs of 4.57 per cent of the price, so against a 7.3 per cent operating margin the minimum order is 135,281. Below it, the instrument turns the order into a loss before anyone defaults.
Worked in full in Trade Finance by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Most of what a documentary credit costs is a rate on the amount: the confirmation, the bank discount, the financing of the goods, the expected loss. Those scale with the order and stay a fixed share of it. The rest does not scale. The advising fee, couriers and legalisation, and the amendment are flat, and the examination and confirmation fees have minimums that bite on small drawings. On a 4.2 million order those charges are a rounding error. On 100,000 they are most of the margin.
Harrowgate Instruments, the book's exporter, sells instrumentation at an 81.5 per cent cost of goods and 11.2 per cent of selling and overhead, leaving an operating margin of 7.3 per cent before any finance. The buyer gets 120 days on a usance credit confirmed and discounted without recourse. Money on actual/360. All rates are illustrative.
| Input | Value |
|---|---|
| Operating margin before finance, share of price | 7.3% |
| Gross margin, share of price | 18.5% |
| Exporter's cost of funds, on the cost of goods | 8.4% |
| Days to cash (production 70, transit 26, documents 9, bank 5, discrepancies 6.82) | 116.82 |
| Confirmation, a year, over 155 days; minimum | 1.85%; 1,500 |
| Bank discount on the face, a year, 120 days | 6.90% |
| Document examination; minimum | 0.125%; 425 |
| Advising, couriers and certificates, amendment | 350, 1,180, 240 |
| Buyer PD, LGD; refusals 62%, of which waived 94% | 4.1%, 62% |
Step 1: the fixed block. On a small order both minimums bind: the examination minimum until the drawing reaches 340,000 and the confirmation minimum until 188,317.
Fixed = advising 350 + examination 425 + couriers 1,180 + amendment 240 + confirmation 1,500 = 3,695
Step 2: the variable rate, as a share of the price.
Financing = 81.5% × 8.4% × 116.82 ÷ 360 = 2.22%
Discount = 6.9% × 120 ÷ 360 = 2.30%
Expected loss on documents = 62% × 6% × PD over 180 days × 62% = 0.047%
Variable rate = 4.57%
Step 3: set the margin equal to the cost and solve for the order size.
Minimum order = Fixed ÷ (margin rate − variable rate)
= 3,695 ÷ (7.3% − 4.569%) = 3,695 ÷ 2.731% = 135,281
Excel: =Fixed/(Margin-(COGS*CoF*DaysToCash/360+Disc*Term/360+EL))
The formula holds only while the minimums bind, which they do at this size. Measured against the 18.5 per cent gross margin instead, the floor is 26,523, 5.1 times lower. The book's companion workbook solves both by bisection and carries both, because the gross figure is the tempting one and the operating figure is the one that matters: the selling and overhead the order carries have to be paid whether or not a bank is involved.
| Order | Financing | Confirmation | Discount | Other fees | Total cost | Cost, % of price | Margin after finance |
|---|---|---|---|---|---|---|---|
| 50,000 | 1,111 | 1,500 | 1,150 | 2,195 | 5,979 | 11.96% | −2,329 |
| 100,000 | 2,222 | 1,500 | 2,300 | 2,195 | 8,264 | 8.26% | −964 |
| 135,281 | 3,005 | 1,500 | 3,111 | 2,195 | 9,876 | 7.30% | 0 |
| 250,000 | 5,554 | 1,991 | 5,750 | 2,195 | 15,608 | 6.24% | 2,642 |
| 500,000 | 11,108 | 3,983 | 11,500 | 2,395 | 29,221 | 5.84% | 7,279 |
| 1,000,000 | 22,215 | 7,965 | 23,000 | 3,020 | 56,672 | 5.67% | 16,328 |
| 4,200,000 | 93,304 | 33,454 | 96,600 | 7,020 | 232,358 | 5.53% | 74,242 |
Expected loss is included in the totals but too small to show. The curve is steep at the bottom and flat at the top: the credit costs 11.96 per cent of a 50,000 order and 5.53 per cent of the book's 4.2 million one, where it still spends 76 per cent of the operating margin.
| Case | Minimum order |
|---|---|
| At sight, confirmed | 72,985 |
| 60 days | 94,818 |
| 90 days | 111,492 |
| 120 days (base) | 135,281 |
| 180 days | 526,803 |
| 120 days, operating margin 10% | 68,031 |
| 120 days, operating margin 15% | 35,422 |
| 120 days, operating margin 5% | none |
The term moves the floor because the discount and the confirmation grow with it and leave less margin to absorb the fixed block. At 180 days the room left is so thin that the floor jumps to 526,803. At a 5 per cent operating margin there is no floor at all: even on a very large order the variable costs alone, 5.49 per cent, exceed the margin. That order cannot carry this credit at any size.
The common mistake is to judge the instrument by its rates. A 1.85 per cent confirmation and a 0.125 per cent examination fee look like the same small charges on every order, and on large ones they are. The second mistake is to test the cost against the gross margin, which gives a floor of 26,523 and waves through every order between that and 135,281 that the credit actually makes loss-making. Fee schedules, minimums and the break-evens are live in the free workbooks for this order; how each fee is computed is set out in how letter of credit fees are calculated, and the cheaper alternative for small tickets is priced in letter of credit vs documentary collection.
No. UCP 600 sets no minimum, and banks will issue small credits. The practical minimum is economic: the fixed charges and fee minimums cost the same on a small order as on a large one. On an illustrative confirmed 120-day credit they come to 3,695, which consumes the whole 7.3 per cent operating margin of any order below 135,281.
It depends on size more than on rates. On an illustrative confirmed 120-day usance credit, financing, confirmation, discount, fees and expected loss come to 5.53 per cent of a 4,200,000 order, 6.24 per cent of 250,000 and 8.26 per cent of 100,000, because the minimums and flat fees are spread over less.
Something with a lighter fee floor: documentary collection, credit insurance on open account under a whole-turnover policy, or advance payment. Each keeps more buyer risk than a confirmed credit. On an illustrative 100,000 order the confirmed credit costs 8,264 against 7,300 of operating margin, so the credit would turn the order into a loss before any default.
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.
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