Payment Methods in import and export transactions

Payment Methods in import and export transactions

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Payment Methods in import and export transactions

In import and export transactions, sellers and buyers do not necessarily know each other and are taking many more risks than in domestic trade. How can sellers ensure that they will be paid? Should the currency in which they will be paid drop against their own currency, how can they make certain that this drop will not eat into their profit margins? How do buyers ensure that they will obtain delivery of the goods they have ordered, on time and in accordance with specifications? Unless buyers and sellers know and trust each other they will need to resort to trade payment and financing mechanisms through third parties such as banks or specialized financial institutions.

In the sections that follow, the most frequently used payment methods for international trade are explained briefly, together with the various financing techniques that can be employed. The sort of questions you will be asking yourself, when deciding which payment method and corresponding financing technique to choose, are:
If you are the seller:

What is the risk of not getting paid? Do I know the buyers well? Can I trust them? Are they financially solid, or are they likely to default?
Do I really need to give them credit? For how long?
How do I manage if I do not get paid right away?
What if the dollar (or franc or other currency) drops in value by the time I am paid?
The transaction looks very profitable but I do not have the funds to buy the raw materials and pay production costs. Who do I turn to for credit?

If you are the buyer:
Will my suppliers deliver? What if the goods arrive late, or are substandard, or do not arrive at all?
Will my suppliers give me three or even six months’ credit? Can I pay them for their raw materials after I have produced my goods and exported them?

What if my currency devalues and I find that the goods I have to pay for have become too expensive?
If you are the seller, it helps to put yourself in the buyer’s shoes, and vice versa. The best transactions are those that satisfy both parties because they lead to further business.

Various means of payments are being used for receiving export proceeds by our exporters. These are: cash in advance, open account, documentary collection, and documentary credit. Among these, documentary credit and documentary collections have been observed to be used mostly by our existing exporters. From the point of view of an exporter (relatively new exporter), the advantages, disadvantages, and procedures of each of the payment methods have been discussed in the sections that follow.

1. Cash in Advance

In this method of payment, the buyer places the funds at the disposal of the seller (exporter) prior to the shipment of goods. If you are unsure about the buyer’s credit or there are other circumstances which cast doubt on the certainty of getting paid, the last resort is to ask for cash in advance. This may be acceptable to a first-time buyer who trusts you to deliver the goods. In the long run, however, it may not be competitive and buyers will not want to continue importing your goods if they can turn to other suppliers offering better terms.

On the other hand, your buyers may also be a source of credit if they understand that your lack of funds prevents you from supplying them with the goods they need. Obviously, there will have to be some solid basis of trust for the transaction. The buyers may require you to offer them more competitive prices. They may also disburse the funds direct to your suppliers rather than to you. But it is useful to remember that you can turn to sources other than financial institutions if you need working capital to complete an export order.

Since this method of payment is expensive and contains a lot of risks on the part of the buyer (because they have no assurance that what they contracted for will be supplied and received inappropriate manner), they may not be willing to accept such terms of payments.
Thus it is rarely used in Bangladesh.

2. Open Account System

At the other end of the range of payment methods is the open account system. This is an arrangement between the buyer and seller whereby the goods are manufactured and delivered before payment is required. Open account provides for payment at some stated specific future date and without requiring the buyer to issue any negotiable instrument evidencing his legal commitment. The seller must have absolute trust that he will be paid at the agreed date. Though the seller can avoid a lot of banking charges and other costs, but he has no security that he will be receiving payment in due course. For this reason the exporter may not be willing to accept this sort of mode of payment. This system is also uncommon in Bangladesh.

3. Documentary Collection
This is an arrangement whereby the goods are shipped and the relevant bill of exchange (B/E)/(draft) is drawn by the seller on the buyer and documents are sent to the seller’s bank with clear instructions for collection through one of its correspondent banks located in the buyer’s domicile. In this method, you hand over the shipping documents to your bank and ask it to forward the documents to the buyer’s bank, with instructions to release them to the buyer on payment of your invoice. This is called cash against documents (CAD). You can also give your buyers trade credit by drawing a bill of exchange on them and requiring them to accept the bill when they collect their documents. This is called documentary collection against acceptance, or documents against acceptance (DAA) because the buyer accepts your bill of exchange.

Though the documentary collection is inexpensive and simple to arrange, the exporter is required to ship the goods without an unconditional guarantee or promise of payment by the buyer. However, as compared to cash in advance and open accounts, the documentary collection is a much more common means of payment by exporters.

4. Documentary Credits
The documentary credit or letter of credit is an undertaking issued by a bank to the buyer’s account (or for its own account), to pay the beneficiary (exporter) the value of the draft and/or documents provided that the terms and conditions of the credit are complied with.

This is the most frequently used method of payment for imports. Although one of the costliest, it is often considered the most secure because the buyer is assured that the seller will be paid only when the documents representing goods have been delivered. Conversely, the seller is assured that the buyer will receive the documents for the ultimate delivery of the goods only when payment has been made. The security of the transaction is assured by one or more third parties. This is normally the buyer’s bank (issuing bank),which issues the letter of credit (L/C) and the seller’s bank (advising/confirming bank), which informs the seller that the L/C has been issued and perhaps adds its confirmation to the L/C (in other words, guarantees the payment if the seller wants to be sure the issuing bank will not default).

In addition to the commitment of making payment by a bank to the exporters, the documentary credit provides legal security to the involved parties as it may operate within the framework of ICC’s (International Chamber of Commerce) Uniform Customs and Practice for Documentary Credits (UCP- 600). UCP-600 is an international codification of actual business practices, based on the experience of bankers, exporters and importers. It should be emphasized that the UCP rules apply when they have been incorporated by the parties in the documentary credit application forms. Because of the above-mentioned advantages, documentary credit is the most popular mode of payment in international trade.

In Bangladesh also, documentary credit is the most acceptable mode of payment in export and import trade.

The documentary credit operates as follows

The seller and the buyer first agree that a documentary letter of credit will be the method of payment. This agreement is usually spelt out in the sales contract. The buyer instructs his or her bank to issue the L/C, specifying the conditions that have to be fulfilled before payment is released. The issuing bank asks a local bank in the seller’s country to advise the seller and possibly also to confirm the L/C. In some cases, the advising bank may arrange for another institution to pay the seller. When the seller has fulfilled all the conditions set out in the L/C, he or she submits the appropriate shipping documents to his or her bank (or the bank agreed on) and collects payment. (See Box-3).