According to the International Monetary Fund’s predictions, the global economy is at risk of losing up to $430 billion by 2020 if the ongoing trade war intensifies.

The question then is, what could credit teams do to mitigate risks from these tariffs? This blog answers frequently asked questions about tariffs/import duties and the role of the credit department.

Tariffs, Explained

Tariffs are taxes imposed by countries, making imports more expensive. Tariffs are usually imposed by countries to make local manufacturing more competitive. They are also used to cut trade deficits with countries (when a country imports more than it exports).

Industry-specific Impact

As the team setting credit policies, credit teams have multiple ways of dealing with import duties and trade tariffs. This blog is focused on dealing with the recent tariffs imposed by the United States and their impact on various industries.

The following table summarizes tariffs across the industries in the US:

Industry Average Tariff Rate
Apparel & Clothing 1.4% on clothing and 11% on travel goods & footwear
Chemicals 2%
CPG 25%
Food & Beverage 10%
Health Care 25%
Electronics 25%
Insurance Direct credit exposure
due to increased credit risks.
Manufacturing 10% on Aluminum & 25% on Steel
Pharmaceuticals Granted an exemption status

Use-cases for Dealing with Tariff Costs

Hypothetical Case Study:  US Government has imposed a tariff on Steel and Aluminum goods imported from China. The duties levied will be remitted to the United States Customs Services by the domestic buyer. ABC Automobiles, in this case, is an American buyer doing business with XYZ Steelworks, a Chinese supplier.

So, who is going to pay the extra cost?

Scenario One: Pass this cost to the end consumer, without losing competitive advantage in the market

This is the overall best-case scenario where ABC Automobiles could pass this charge onto their end consumers. As a result, the price of steel/aluminum products (such as cars and beverages) will increase for the American consumer. In this case, despite the increase in cost, the demand stays the same or increases. Companies that deal with premium products which are relatively price-insensitive could fall into this scenario.

But whether ABC Automobiles could pass this cost on to their customers or not depends on the contracts that they already have with the customers. This is especially the case in business to business transactions where there are certain legal clauses that prevent changes in the pricing structure.

Scenario Two: Apply for a tariff exemption

To apply for the exemption, ABC Automobiles would need to fill out this tariff exemption application.

The criteria for qualifying for the exemption are based on various factors – such as the category of the imported goods, the impact of tariff on ABC Automobile’s business, and whether there is an alternative market for sourcing the product.

Scenario Three: Absorb the cost to prevent loss of competitive advantage

To maintain a constant price point, especially in wholesale markets that work by margins – ABC Automobiles would have to absorb this cost to maintain the constant price point of their products and maintain their market share.

This could lead to a significant dent in their bottom-line and directly affect the workers and key stakeholders. In case you want to further understand the legal and competitive issues related to tariff/duties, read this CRF article by Blakeley LLP.

Trade tariff impact on businesses

Action Items for Credit Teams to Minimize Impact from Tariffs

Here’s what credit teams across industries need to think about today for regulating exposure from bankruptcies, M&As, and global trade relations.

● Consider qualifying for trade tariff exemptions

Before filling out your application, here are four points that will help you qualify for the exemption:

  1. Determine whether your import goods are in scope of the Harmonized Tariff Schedule of the United States.
  2. Identify US suppliers of the product, analyze the quantity and quality of the domestic supply capacity, and make a detailed argument in case there are any shortages.
  3. Analyze the national security impacts of the product for exclusions under this clause.
  4. Appeal for an exemption, using robust and unequivocal arguments that are based on evidence.

●  Establish a framework for evaluating and passing on tariff costs to maintain profitability

Your credit team, working with other departments, should establish a framework for assessing and passing on tariff costs in order to maintain margins.

If you are paying for the supplier’s tariff costs, then you should adopt a disclosure protocol. This may be through email notification to your customer base or even a portal disclosure.

●  Consider Credit Insurance schemes to combat bad-debt

Macroeconomic conditions are outside the credit team’s sphere of influence, so the only thing that they could do is to opt for risk-mitigating measures such as credit insurance.

Credit insurance could compensate for up to 85% to 95% of net outstanding debt and is becoming more common among credit teams for global businesses. These strategies help to monitor customer portfolios and recover unpaid debt through litigation or court procedures.

You must; however, customize and negotiate the principal terms of your contract, as they might involve certain obligations in managing your debts – failure to do so could remove the benefit of the guarantees secured by your insurer.

●  Review your working capital strategy – to cut economic costs and optimize cash flow

One of the biggest impacts of tariffs for the industries listed above is the disruption in the global supply chain and the impact on working capital. While cash conversion/working capital is dependent on DSO, DPO, and DIO, credit teams are the ones who drive improvements to DSO through credit policy.

In periods of economic turbulence, the finance leadership would appreciate any steps taken by the credit department to ease working capital challenges. In a sense, the import duties could be a blessing in disguise for the credit department.  Creating an airtight credit policy and leveraging technology for effective collections could solve some working capital challenges and elevate the credit department in the eyes of the finance leadership.