|
Export
101 – Export Methods of Payment
Introduction
Getting paid for your exports in an accurate and
timely manner is naturally a very important part of the export process. While there are
some other payment methods associated with exporting, the most common types remain: cash
in advance; open account; the use of documentary collections, such as sight and time
drafts; and export letters of credit, which also may be implemented on a sight or time
basis. Most other payments are derived from these fundamental building blocks of export
payments and collections.
Each of these payment methods has certain risks and
costs associated with them, which are often the responsibility of the exporter. These
costs need to be analyzed, evaluated, and negotiated in advance of the shipment, so that
you can price your product accordingly and satisfy both your own and your buyer’s
requirements.
At a minimum, the payment terms that you decide
upon should take the following factors into account:
- The country risk of the buyer. The
buyer’s country has ultimate control over the exchange and release of dollars, which
of course is what you expect to receive in exchange for your goods. Many developing
nations implement import regulations and exchange control mechanisms that can make payment
in a hard currency like the dollar difficult at times. This is because they like to retain
certain minimums of hard currencies, like the dollar, to be able to pay off foreign debts
and obtain other financing.
In addition, the economic and political instability
of a country, or a poor trade relationship with the United States, could slow or impede
your payment. Proper market research on the buyer’s country, and advice from trade
professionals, should help you determine which payment mechanism to use. Our major trading
partners, such as Europe, Canada, and Japan, generally have much freer access to dollars,
making payment much smoother. That doesn’t mean you should avoid the other countries,
but that you should be prepared to get more involved in the payment process.
- The buyer’s banks reputation. If the
payment is by a Letter of Credit, a draft with the bank as the drawee, or any other method
where the buyer or buyer’s bank is obligated to pay you, their reputation and
financial stability is an issue. Again, proper research done on the buyer’s bank, and
advice from your own international banker, can help you decide whether or not to work with
them. Occasionally, an exporter’s strategy includes requiring the buyer to use a bank
recommended by your own bank in order to complete the transaction.
- The credit worthiness of the buyer. In many
cases, international credit reports on foreign firms are vague, difficult to obtain, too
expensive, or non-existent. For this reason you should ask for both trade and financial
references in your potential distributor evaluation form, and insist on adequate credit
and credit history before ever selling on open account. If the buyer has good credit, they
usually are readily able to provide it.
- The competition. It is difficult to compete
for foreign business if others interested in selling similar merchandise are offering more
favorable credit terms. Naturally, most importers are interested in obtaining open account
status if they can. This means that their government is allowing them to pay you in
dollars, and there are few import restrictions. If the business is promising and you can
properly insure your receivable, you might consider it, but if there is any doubt in your
mind about the risk of non-payment, you might hold your ground or even pass on the
business. If the buyer is particularly interested in your products, they might agree to
your terms over the competition. Your international bank can be of great assistance in
guiding you in these types of decisions.
- The volume and value of the shipment. In most
cases, the larger the shipment, the higher the value. That means most of the costs
associated in exporting the goods are also more expensive. Lower value shipments that are
less expensive to ship may call for a more lenient credit position, such as open account
or use of a draft. If delayed payment of a high value receivable is going to have an
adverse effect on your daily operations, you should carefully consider asking for cash in
advance, or at least partial prepayment of the goods.
FAQ’s
What factors tend to complicate negotiating payment
with foreign buyers?
The primary international marketing uncontrollable
is essentially the cultural variable. This is the key element that makes all other factors
a challenge. The culture drives the language and communications, the management styles and
"rules of the game," the political and economic conditions that control the
currency availability and exchange, and the local import regulations of the destination
market.
It is essential that an exporter fully understand
the business environment of the buyer. They face many challenges in managing the price
escalation of the imported goods, including tariff and non-tariff barriers such as import
permits and licenses, in order to be able to resell the goods at a profit. In many cases,
you might request a Letter of Credit for payment, but the potential buyer tells you that
they are obligated to use a Letter of Credit for payment in order to obtain the import
permit and obtain the equivalent amount of U.S. Dollars (U.S.D.) for exchange. Many
governments use the import permit and Letter of Credit to control the importation of
certain goods, and control the outflow of exchange.
When a Letter of Credit is not mandated for import,
the buyer would prefer not to have to pay for one if they can avoid it, since it ties up
their credit line or cash, and is relatively cumbersome and expensive.
When would I request cash in advance to be the
only payment option?
Cash in advance, either by a wire transfer or a
bank draft, is often used when the value of the shipment is low by export standards.
International open account averages nearly 90 days on a worldwide basis. If the value of a
shipment was under $5,000.00, for example, the business might not be worth it, given the
fixed costs of your company’s operations.
In other cases, the value of the goods may be much
higher ($25,000.00 or more), especially if you are custom making the product to a
buyer’s specifications. In this case, when reselling to another buyer might be
difficult or even impossible, you should at least require a significant deposit to cover
the cost of raw materials and labor in order to protect yourself. If you are selling stock
items that you can resell, are comfortable with the buyer, or you can control the title of
the goods, then you might consider other payment options such as a collection, Letter of
Credit, or open account.
Why would anyone use open account payment terms?
Open account is not that uncommon between
international traders. It actually represents nearly 70% of all transactions, according to
a recent estimate. It is important to understand, however, that most companies don’t
start out using open account payment terms with their overseas customers; the trust that
is necessary for this type of agreement to work must be built up over time.
As an exporter, you first have to decide which
payment methods should be implemented, taking into account the many variables involved,
including the various countries and buyers, and the amounts of credit being implied. You
will also need to decide how your payment methods should be managed after your initial
relationship is built and you have experienced good payments from your customers.
Many firms may start out by mandating cash in
advance or letters of credit, and then move to a more flexible form of payment, such as
the use of a collection, before ultimately moving the business to open account. The key is
in using a "consignment controlled" payment method until you are comfortable
working with the buyer on open credit. You might even change payment methods between
shipments, based on the size and value of the goods, the method of shipment, or even the
time of season.
What is a "consignment controlled
shipment"?
Basically, it means keeping the export documents
(which are title to the goods) out of the hands of the buyer until you have either been
paid, or have the assurance from the buyer’s bank or your bank that you will be paid.
This may be obtained through cash in advance, but also by other means, such as use of a
collection, a "sight" or "time" draft, or by using a Letter of Credit
(which also uses a draft, either on a "sight" or "time" basis).
These payments involve the relay of the title
documents between the international banks involved. Depending on the type of payment used,
these banks are obligated under International Chamber of Commerce guidelines to collect
the monies for you, or to make other arrangement to pay you at a later date. This would
involve the difference between "sight" and "time", and it basically
means that the banks will not turn over the documents to the buyer until the arrangements
have been executed. Without title documents, your buyer is unable to recover the goods and
clear them through customs.
How do you use a sight or a time draft?
This payment method is most often used in
international trade for the exchange of merchandise for money. With this method, the goods
are shipped to the foreign country either consigned to the buyer, or in many cases, the
buyer’s bank. The buyer’s bank will release possession of the documents once the
buyer has made payment arrangements (sight), or signed a promise to pay at a later date
(time). The exporter, their bank, or a freight forwarder prepares a draft drawn on the
buyer or their bank, and submits the draft together with the documents and instructions to
the buyer’s bank. If drawn on the buyer, the buyer’s bank notifies the buyer to
come to the bank to either pay or accept the draft. Once that is completed, the documents
are turned over and the buyer can make clearance arrangements. If it is a sight draft, the
remitted amount would be wired to your bank, who will credit your account after collecting
their small fee.
This method of payment is not too expensive, but
leaves the seller at risk if the buyer refuses to honor the draft. The exporter’s
advantage with a sight draft is that the bank still controls the documents and notifies
you of the nature of any problems, while waiting for your instructions. Your options then
include renegotiating with the buyer to accept the draft, locating another possible buyer
in that country or one nearby, or having the goods returned to you at your expense.
The only thing worse than an unaccepted draft is
one that is accepted on a time basis, and then is left unpaid when it "matures"
or becomes due. In this case, your recourse for collection is only an endorsed draft from
the buyer, so it is quite similar to open account. That is why many experts in this field
recommend that you never draw a time draft directly on the buyer, but rather on the
buyer’s bank, with their approval. They also recommend avoiding the consignment of
the bill of lading directly to the buyer, but rather to their bank or "to order of
shipper," thus making it negotiable.
Although the consignment is controlled and the
costs are less than a Letter of Credit, the banks’ ability to protect you with this
method is limited, unless the drafts are drawn on them. Unlike with a Letter of Credit,
they are under no obligation to pay you, and these processes are governed by their own
International Chamber of Commerce guidelines on the matter. Before using these
instruments, you should become familiar with the specifics, or obtain consultation on the
details.
Where do I find the rules for the use of sight
and time drafts?
The rules are published by the International
Chamber of Commerce, located in Paris, but with an office in New York. The title of the
rules is "The Uniform Rules for Collection," publication number URC 522, revised
January 1, 1996. These rules are periodically revised, so exporters who use drafts need to
keep abreast of these rule changes.
Your international banker can provide you with a
synopsis, or you can visit the organization’s web site directly at www.iccwbo.org.
When would an exporter use a Letter of Credit?
If not required by the foreign government as an
import regulation for currency exchange, the Letter of Credit (L/C) is commonly used when
the buyer is unwilling to pay up front, and the risk of non-payment is too great to allow
any other form of payment (except for cash in advance). The Letter of Credit is really not
a letter, but more of a contract between the buyer’s bank and your company. With this
method, the buyer’s bank is substituting the credit of the buyer with their own, at a
fee and with a set of instructions for you to accomplish in order to have them secure
payment.
Prior to the Letter of Credit being issued, it is
important for you to send a clear set of instructions on what elements should be included
with regard to your ability to perform your responsibilities. You should send this along
with your pro forma invoice if you can, which stipulates the payment method. Since the
most frustrating part of using letters of credit are the "surprises" discover
upon your review of the document, you need to be as clear as possible about what you can
and cannot do. If possible, you should be clear about which bank you would like to receive
the Letter of Credit. Also, it is probably to your advantage to work with a local bank in
your region rather than one in another time zone.
After issuance, the buyers bank then sends the L/C
to either their branch office in the United States, a correspondent bank, or another bank
per your instruction, and asks them to either advise the Letter of Credit to the seller in
the U.S. or to add their confirmation. When the U.S. bank adds their confirmation, the
U.S. bank agrees to pay the beneficiary even if they are unable to collect from the
issuing (buyer’s) bank. The drawee on the draft becomes the confirming bank, rather
than the buyer or their bank. The most important aspect of a Letter of Credit is that the
banks involved will have no obligation to pay in the event that there are discrepancies on
the documents supplied by the beneficiary (seller).
How do I find the rules for using letters of
credit?
The ICC also writes the guidelines for using
letters of credit. The most current publication of these rules is the "Uniform
Customs and Practice for Documentary Credits," revised January 1, 1993, publication
UCP 500. It is the exporters’ responsibility to understand these rules and to prepare
documents in accordance with them. For this reason, most exporters receive outside
assistance from those with experience in this area, including freight forwarders,
international departments of banks, and export assistance agencies.
What happens when I submit my documents to the
bank, and there are discrepancies?
Discrepancies usually come in two forms. Those you
can fix before they are sent to the overseas bank, and those you cannot possibly remedy.
The most common discrepancy in the United States is the description of the merchandise.
That is why the commercial invoice needs to be prepared in strict accordance with the
Letter of Credit. It is always required first as the primary document for payment and
reviewed the most carefully. For example, if the L/C has indicated it is "covering:
500 cases of Bold & Brave Meat Snack Stix," and your invoice says
"Sticks," then you may be found discrepant. For a slight delay in payment, and a
discrepancy fee, you can repair that and resubmit. On the other hand, if the L/C indicated
shipment was arriving by air transport, and you shipped the goods by sea freight, then you
may have violated the terms of the contract. In this case, the issuing bank reserves the
right not to pay you, even though your goods are already on the way. You would most likely
have to renegotiate the price in order to complete the transaction and receive payment.
Keep in mind that Letters of Credit are not
actually a "guarantee" of payment. Instead, they are an assurance of payment, if
you have properly shipped the goods (i.e., in the right amount, at the right time, by the
right mode of transport, etc.), and you can prove it in your documentation. As an
exporter, you should always: 1) Send clear instructions for issuance; 2) Analyze the L/C
carefully when you receive it; and 3) Prepare all of your documents exactly as the L/C
states, sometime even when it makes no sense to you. Banks pay on the strength of the
documents, not on your good word. The best advice is to never guess and to ask questions
until you clearly understand the process. Don’t forget that all export service
providers are available to assist you in this process.
Export Methods of Payment Links
|
|
