To succeed in today’s global market place and win sales against foreign competitors, exporters must offer their customer attractive sales terms supported by appropiate payment methods. because getting paid in full and on time is the ultimate goal for each export sale , an apropiate payment method must be chosen carefully to minimize the payment risk while also accommodating the needs of the buyer.
With cash-in-advance payment terms, the exporter can avoid credit risk because payment is received before the ownership of the goods is transferred. Wire transfers and credit cards are the most commonly used cash-in-advance options available to exporters. However, requiring payment in advance is the least attractive option for the buyer, because it creates cash-flow problems. Foreign buyers are also concerned that the goods may not be sent if payment is made in advance. Thus, exporters who insist on this payment method as their sole manner of doing business may lose to competitors who offer more attractive payment terms.
Letters of Credit:
Letters of credit (LCs) are one of the most secure instruments available to international traders. An LC is a commitment by a bank on behalf of the buyer that payment will be made to the exporter, provided that the terms and conditions stated in the LC have been met, as verified through the presentation of all required documents. The buyer pays his or her bank to render this service. An LC is useful when reliable credit information about a foreign buyer is difficult to obtain, but the exporter is satisfied with the creditworthiness of the buyer’s foreign bank. An LC also protects the buyer because no payment obligation arises until the goods have been shipped or delivered as promised.
A documentary collection (D/C) is a transaction whereby the exporter entrusts the collection of a payment to the remitting bank (exporter’s bank), which sends documents to a collecting bank (importer’s bank), along with instructions for payment. Funds are received from the importer and remitted to the exporter through the banks involved in the collection in exchange for those documents. D/Cs involve using a draft that requires the importer to pay the face amount either at sight (document against payment) or on a specified date (document against acceptance). The draft gives instructions that specify the documents required for the transfer of title to the goods. Although banks do act as facilitators for their clients, D/Cs offer no verification process and limited recourse in the event of non-payment. Drafts are generally less expensive than LCs.
An open account transaction is a sale where the goods are shipped and delivered before payment is due, which is usually in 30 to 90 days. Obviously, this option is the most advantageous option to the importer in terms of cash flow and cost, but it is consequently the highest risk option for an exporter. Because of intense competition in export markets, foreign buyers often press exporters for open account terms since the extension of credit by the seller to the buyer is more common abroad. Therefore, exporters who are reluctant to extend credit may lose a sale to their competitors. However, the exporter can offer competitive open account terms while substantially mitigating the risk of non-payment by using of one or more of the appropriate trade finance techniques, such as export credit insurance.
Payment Risk Ladder Exporter:
Least Secure ? Less Secure ? More Secure ? Most Secure Importer: Most Secure ? More Secure ? Less Secure ? Least Secure Open Account Bills for Collection Documentary Credits Advance Payment.
There are 3 standard ways of payment methods in the export import trade international trade market:
- Clean Payment
- Collection of Bills
- Letters of Credit L/c
- Clean payments:
In clean payment method, all shipping documents, including title documents are handled directly between the trading partners. The role of banks is limited to clearing amounts as required. Clean payment method offers a relatively cheap and uncomplicated method of payment for both importers and exporters.
There are basically two type of clean payments:
In advance payment method the exporter is trusted to ship the goods after receiving payment from the importer.
In open account method the importer is trusted to pay the exporter after receipt of goods.
The main drawback of open account method is that exporter assumes all the risks while the importer get the advantage over the delay use of company’s cash resources and is also not responsible for the risk associated with goods.
2. Payment collection of bills in international trade:
The Payment Collection of Bills also called “Uniform Rules for Collections” is published by International Chamber of Commerce (ICC) under the document number 522 (URC522) and is followed by more than 90% of the world’s banks.
In this method of payment in international trade the exporter entrusts the handling of commercial and often financial documents to banks and gives the banks necessary instructions concerning the release of these documents to the Importer. It is considered to be one of the cost effective methods of evidencing a transaction for buyers, where documents are manipulated via the banking system.
There are two methods of collections of bill :
Documents Against Payment D/P
In this case documents are released to the importer only when the payment has been done.
Documents Against Acceptance D/A
In this case documents are released to the importer only against acceptance of a draft.
- Letter of credit L/c:
Letter of Credit also known as Documentary Credit is a written undertaking by the importers bank known as the issuing bank on behalf of its customer, the importer (applicant), promising to effect payment in favor of the exporter (beneficiary) up to a stated sum of money, within a prescribed time limit and against stipulated documents. It is published by the International Chamber of Commerce under the provision of Uniform Custom and Practices (UCP) brochure number 500.
Various types of L/Cs are :
Revocable & Irrevocable Letter of Credit (L/c)
A Revocable Letter of Credit can be cancelled without the consent of the exporter.
An Irrevocable Letter of Credit cannot be cancelled or amended without the consent of all parties including the exporter.
Sight & Time Letter of Credit
If payment is to be made at the time of presenting the document then it is referred as the Sight Letter of Credit. In this case banks are allowed to take the necessary time required to check the documents.
If payment is to be made after the lapse of a particular time period as stated in the draft then it is referred as the Term Letter of Credit.
Confirmed Letter of Credit (L/c)
Under a Confirmed Letter of Credit, a bank, called the Confirming Bank, adds its commitment to that of the issuing bank. By adding its commitment, the Confirming Bank takes the responsibility of claim under the letter of credit, assuming all terms and conditions of the letter of credit are met