Method
of Payment in International Trade
To
succeed in today’s global marketplace, exporters must
offer their customers attrac¬tive sales terms supported
by the appropriate payment method to win sales against foreign
competitors. As getting paid in full and on time is the primary
goal for each export sale, an appropriate payment method must
be chosen carefully to minimize the payment risk while also
accommodating the needs of the buyer. As shown below, there
are four primary methods of payment for international transactions.
During or before contract negotiations, it is advisable to
consider which method elow is mutually desirable for you and
your customer.
Key
Points
•
International trade presents a spectrum of risk, causing uncertainty
over the timing of payments between the exporter (seller)
and importer (foreign buyer).
•
To exporters, any sale is a gift until payment is received.
•
Therefore, the exporter wants payment as soon as possible,
preferably as soon as an order is placed or before the goods
are sent to the importer.
•
To importers, any payment is a donation until the goods are
received.
•
Therefore, the importer wants to receive the goods as soon
as possible, but to delay payment as long as possible, preferably
until after the goods are resold to generate enough income
to make payment to the exporter.
Cash-in-Advance
With
this payment method, the exporter can avoid credit risk, since
payment is received prior to the transfer of ownership of
the goods. 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, as this method creates cash flow problems.
Foreign buyers are also concerned that the goods may not be
sent if pay¬ment is made in advance. Thus, exporters that
insist on this method of payment as their sole method of doing
business may find themselves losing out to competitors who
may be willing to offer more attractive payment terms.
Letters
of Credit
Letters
of credit (LCs) are among 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 have been met, as verified
through the presentation of all required documents. The buyer
pays its bank to render this service. An LC is useful when
reliable credit information about a foreign buyer is difficult
to obtain, but you are satisfied with the creditworthiness
of your buyer’s foreign bank. An LC also protects the
buyer since no payment obligation arises until the goods have
been shipped or delivered as promised.
Documentary
Collections
A
documentary collection is a transaction whereby the exporter
entrusts the collection of a payment to the remitting bank
(exporter’s bank), which sends documents to a collectingbank
(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. Documentary collections involve the use of
a draft that requires the importer to pay the face amount
either on sight (document against payment—D/P) or on
a specified date in the future (document against acceptance—D/A).
The draft lists instructions that specify the documents required
for the transfer of title to the goods. Although banks do
act as facilitators for their clients under collections, documentary
collections offer no verification process and limited recourse
in the event of nonpayment. Drafts are generally less expensive
than letters of credit.
Open
Account
An
open account transaction means that the goods are shipped
and delivered before pay¬ment is due, usually in 30 to
90 days. Obviously, this is the most advantageous option to
the importer in cash flow and cost terms, but it is consequently
the highest risk option for an exporter. Due to the intense
competition for 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 face the
possibility of the loss of the sale to their competitors.
However, with the use of one or more of the appropriate trade
finance techniques, such as export credit insurance, the exporter
can offer open competitive account terms in the global market
while substantially mitigat¬ing the risk of nonpayment
by the foreign buyer.
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