|                                                                                                                                                             |  | BARTER  IN  RUSSIA:  HOW TO PROTECT YOUR  INVESTMENT                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  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|**BISNISHome PageSearchBISNISEmbassyReportsCountryReportsIndustryReportsPublicationsSourcesof FinanceLeadsand EventsExchangeRatesState ExportsOtherSources** |  | May 1998by Thomas TironeBarter, the non-cash trading of goods and services between firms, is a common feature of business
in Russia today.  A recent survey of Russian businesses found that more than four-fifths of
companies questioned use barter, and more than one-third of the dollar value of all Russian sales
may take place through barter.  For an American company in Russia, barter can be either a boon
or a bane, depending on the structure of its business relationships.  While some Russian
companies use barter to profit handsomely, for the unwary investor, barter can mean very low
returns on an investment.An "Invisible Transaction"
Barter is one of several techniques Russian companies use to do business in a highly illiquid
economy (see: "Using Russian Promissory Notes," BISNIS Bulletin, December 1997/January
1998, Page 1).  Barter is an "invisible transaction"   it never appears on a Russian company's
income statement. Swapping goods is simply an inventory transaction not reported on the balance
sheet.  As a result, barter transactions cannot be detected without a detailed audit.  Barter strips
off the value-added-tax, corporate tax, and creditor obligations that accompany a normal cash
sale.  Therefore, barter sales may be up to 150 percent more profitable for a Russian company
than straight cash sales. Additionally, the proceeds can be directed towards specific individuals,
and not the business.Invisible or not, barter captures value.  Imagine, for example, a firm that produces pencils. 
Suppose that it cost this firm $80 to produce $100 worth of pencils.  If the firm swaps the pencils
for oranges, the swap occurs nominally at market prices: $100 worth of pencils for $100 of
oranges.  The pencils, however, were carried on the books at their $80 product cost.   For a
completely invisible transaction, the oranges (worth $100) can be entered into inventory at $80.
Yet there is $20 of unrecorded value in inventory, which can easily be diverted to tax-free cash in
a separate, off-the-books sale.  Since the extra $20 worth of oranges were never on the books to
start with, selling them does not disrupt the accounting.Barter has clear advantages for the profitability of a Russian company.  The pencil manufacturer
captures $20 "off-the-books" by selling the extra oranges.  The proceeds are tax-free and not
subject to creditors' claims.  Alternately, the manufacturer could have sold the pencils directly for
cash and had $20 to share with the tax authorities, its creditors, and its investors. After paying
value-added and corporate taxes alone, the firm might net $8 or so from the direct cash sale.
Barter is better for profits, especially for company insiders.What are the larger consequences of barter? One immediate consequence is that  inventory
accounts swell uncontrollably.  Finished goods go into inventory, but on the books they never
leave as sales.  The value of inventory just keeps growing, while the unrecorded value from barter
(in our example, the extra $20) keeps leaving in off-the-books transactions. The tax authorities,
the creditors, and the unwary investor go begging for cash that officially isn't there.Protecting Your Interests
The most direct way to protect your interests from the debilitating effects of barter is a full audit
of a Russian firm. This is difficult, expensive, and poses the secondary problem of what to do with
the results.  Should you find your interests are being damaged, recourse can be difficult.Another alternative is to actively monitor inventory values.  This isn't as hard as it seems, since
one telltale sign of barter is the burgeoning of inventories.  Inventory monitoring is much less
expensive than a detailed audit, but generally provides adequate results. Those who structure a
deal with restrictions on inventory growth can protect themselves from barter "leakage" to a large
degree.Better solutions are "piece-of-the-action" deals, where payment is taken in product.  While this
leaves you the problem of distribution and later sale, at least you get something tangible for your
interest.  With the appropriate structuring, this also results in a significant amount of leverage
over the firm, since you always have the option of "dumping" your product on the market at much
less than the production cost, hurting the firm badly in both their cash and barter trades.  In
essence, piece-of-the-action deals give you counterparty leverage to keep the barter trade from
destroying your interest.The logical extension of piece-of-the-action arrangements is in closing the other end of the
transaction   arranging countertrades with suppliers to Russian firms. With the aid of a barter
broker, this strategy enables you to shed the difficult tasks of distribution and resale, while
capturing a larger portion of the returns from your share of the output.Perhaps the best protection for preventing diversion due to barter is choosing an appropriate
Russian firm with which to deal. Many Russian firms, especially those which are very profitable,
don't use barter transactions.  For those firms, barter sales are more trouble than they are worth. 
Careful choice requires a bit more due diligence in the front end of a deal, but can pay off
handsomely in rewards which more than justify the extra expense.  For information on doing
business in Russia, visit BISNIS Online at www.mac.doc.gov/bisnis/country/rusfed.htm.Tom Tirone is President of Tirone Corporation of Champagn, Illinois.This report is provided courtesy of the Business Information Service for the Newly
Independent States (BISNIS)