Methods of Payment in Foreign Trade

Compared to selling in the domestic market, selling abroad can create extra problems. Delivery generally takes longer and payment for goods can take more time. So exporters need to take extra care in ensuring that prospective customers are reliable payers and payment is received as quickly as possible. Payment for export depends on the conditions outlined in the commercial contract with a foreign buyer. There are internationally accepted terms designed to avoid confusion about costs and price (Incoterms). The way exporters choose to be paid depends on a number of factors: the usual contract terms adopted in the buyer's country; what competitors may be offering; how quickly funds are needed; the availability of foreign currency to the buyer and, of course, whether the cost of any credit can be afforded by the importer (the buyer) or the exporter (the seller).

There are several basic methods of payment providing various degrees of security for the exporter and the importer.

Payment in advance (Cash with order)

The best possible method of payment for the exporter is payment in advance. Cash with order (CWO) avoids any risks on small orders with new buyers and may even be asked before the production begins. However this form is rare since it means that the buyer is extending credit to an exporter. In addition the importer may run a risk that the goods will not be despatched in accordance with the contract terms. Nevertheless, provision for partial advance payment in the form of deposits (normally between 10 per cent and 20 per cent of the contract price) or progress payments at various stages of manufacture is often included in the contract terms.

Variation of this form is cash on delivery (COD), where small value goods are sent by Post Office parcel post and are released only after payment of the invoice plus COD charges.

Open account

Payment on open account offers the least security to an exporter. The goods and accompanying documents are sent directly to the importer who has agreed to pay within a certain period after the invoice date - usually not more than 180 days. There are various ways in which the importer can send money to his supplier under open account and he may wish to choose the means to be used, for example payment by cheque, by telegraphic transfer (TT), by International Money Order, etc.

The open account method is increasingly popular within the EEC because it is simple and straightforward.

Documentary Bill of Exchange

This is a popular method as it offers benefits for both the exporter and the importer. The main advantage for the importer is that he does not need to make payment until his exporter has dispatched the goods. The advantage for the expor­ter is that there are legal procedures for recovering money against bill of ex­change and, if the goods are sent by sea, he is able to control them through the documents of title to the goods until the importer has agreed to make payment. Documentary bill of exchange is a demand for payment from the exporter. He will draw it up on a special printed form and forward it to his bank together with the documents relating to the transaction. These may include the transport do­cument proving that the goods have been dispatched. The exporter's bank will send the bill and documents to the importer's bank “for collection”. The impor­ter's bank will notify him of the arrival of the documents and will release them to the importer provided that: a) he pays the amount of the bill in full if it is the sight draft, or b) if the bill is a term draft, the importer “accepts” it, i.e. signs across the bill his agreement to pay the amount in full on the due date.

Documentary Letter of Credit (L/C)

The Irrevocable Letter of Credit is the most commonly used method of payment for imports. The exporter can be sure that he will be paid when he dispatches the goods and the importer has proof that the goods have been dispatched accor­ding to his instructions.

The “letter” is an inter-bank communication. The two banks take full responsi­bility that both shipment and payment are in order. The banks deal only in do­cuments and are not obliged to inspect the actual goods. This is how the system works.

4 The importer and exporter agree a sales contract and the terms of the Documen­tary Credit.

4 The importer asks his bank to open a Documentary Credit in the exporter's favour.

4 The importer's bank (the issuing bank) issues a L/C saying, “We, the bank, promise that we will pay you when you submit certain documents that prove that you have shipped the goods as agreed upon in the sales contract”. The L/C speci­fies the documents to be submitted, the shipping requirements and the expiry date. The issuing bank sends a L/C to a bank in the exporter's country (the advising bank). The issuing bank arranges with the advising bank to pay the exporter after the documents have been presented.

4 The exporter prepares the documents, usually an invoice, a bill of lading, an insurance policy, a packing list and a certificate of origin, then makes a shipment. Then the exporter draws a draft (Bill of Exchange), attaches the documents to it and presents everything to the advising bank for payment.

4 The advising bank examines the documents. If everything is in order the bank pays the draft presented by the exporter and sends the documents to the issuing bank.

4 The issuing bank notifies the importer that the documents are at his dispo­sal. The bank releases the documents as soon as the importer has paid and the importer may receive the goods.

There is a great variety of international trade relations, so there are dif­ferent kinds of L/C. But all have the same function: to provide a safe and trusted method of payment between importer and exporter.