Methods of Payment
Prudent Credit Practices
Credit is extended cautiously by experienced exporters. They carefully assess prospective consumers and keep track of existing accounts. If the danger is too significant, you may reasonably deny a customer's request for open-account credit and instead provide payment-on-delivery conditions via a documented sight draft or an irrevocable verified letter of credit—or even payment in advance. You may opt to allow a month or two for payment from a totally creditworthy international customer, or even to prolong open-account conditions. Other excellent credit practices include keeping track of any adverse changes in your clients' payment patterns, abstaining from going beyond standard commercial terms, and working with your foreign banker on how to deal with exceptional conditions or challenging overseas markets. Even if the safest payment methods are utilized, it is always a good idea to verify a buyer's credit.
An International Company Profile (ICP) from the US Commercial Service is important for credit checks. You may get an ICP on corporations in several countries for a cost. The ICP provides financial background on the firm, including not just its size, capitalization, and years in business, but also other relevant information such as the names of other U.S. corporations that do business with it. You can then call those U.S. businesses to inquire about their payment experiences with a certain overseas firm. Because being paid in whole and on time is so important, you should think about how much risk you're prepared to take when offering credit in foreign markets. There are various methods for receiving payment for goods sold abroad; your choice will be determined by how trustworthy you believe the buyer is. Domestic transactions are often conducted on open account if the buyer has strong credit; otherwise, cash in advance is required. Five different payment options are commonly used for export sales.
The basic means of payment are listed in terms of security for the exporter, from most secure to least safe:
• Letters of credit
• Cash in advance
• Open account
• Consignment
• Documentary collections
Cash in Advance
Receiving payment in cash prior to dispatch may appear to be ideal: Your business is free of collection issues and has fast access to funds.
The regularly utilized wire transfer method has the benefit of being practically instantaneous. Payment via check may cause a collection delay of up to 6 weeks, negating the original goal of collecting payment prior to dispatch.
For consumer items and other products with a low monetary value that are sold directly to the end user, many exporters accept credit cards as payment. However, because the regulations regulating credit card transactions in the United States and abroad might often differ, U.S. retailers should contact their credit card processor for further information. Typically, international credit card transactions are performed via phone or fax. Because those techniques are vulnerable to fraud, you should verify transaction legality and get required authorizations before transferring items or performing services.
For modest transactions with importers that want confidence that the items would be supplied in exchange for upfront payment, exporters may use escrow services as a mutually beneficial cash-in-advance solution. In international trade, escrow is a service that lets both the exporter and the importer to secure a transaction by entrusting cash to a trusted third party until certain criteria are satisfied.
Advance payment, on the other hand, tends to cause cash flow issues and increases risk for the buyer. Furthermore, unlike in the United States, cash in advance is not as customary in the rest of the globe. Buyers are frequently anxious that items paid for in advance will not be delivered; another factor to consider is the loss of power with the seller if goods do not satisfy requirements.
Exporters that insist on receiving money in advance as their exclusive manner of conducting business may lose out to competitors who provide more flexible payment terms.
Letters of Credit and Documentary Collections
Letters of credit, also known as documented collections or drafts, are frequently employed to safeguard the rights of buyer and the seller. Payment for these two ways is contingent on the provision of documentation containing the title and demonstrating that required measures have been done. Payments on letters of credit and drafts can be made immediately or later. Sight drafts are drafts that are paid on presentation. Time drafts or date drafts are drafts that must be paid at a later period, usually after the buyer has received the goods.
Because these two means of payment rely on paperwork, you should spell out all payment requirements to avoid confusion and delays. "Net 30 days," for example, should be described as "30 days from acceptance." Similarly, the payment currency should be mentioned as "US $30,000." Other ideas may come from international bankers.
Banks impose costs for managing letters of credit, which are usually based on a percentage of the payment amount, and lesser fees for handling drafts. If both international and domestic bank fees are to be applied to the buyer's account, this should be noted fully in all quotations and the letter of credit.
In most cases, the exporter expects the customer to cover the letter of credit fees. If the customer, on the other hand, refuses to pay the additional cost, you must either absorb the letter of credit fees or risk losing the deal. Letters of credit for lesser sums might be costly due to costs that are excessive in comparison to the sale.
Letters of Credit
Letters of credit are among the most adaptable and secure financial tools available to foreign companies. A letter of credit is an assurance granted by a bank on behalf of an importer (foreign buyer) that buyers are willing and able to the beneficiary (exporter) This confirmation indicates that the confirming bank (the confirming bank) has joined its guarantee to the foreign bank's (the issuing bank's) pledge to pay the exporter. When a letter of credit isn't verified, it's "recommended" through a U.S. bank, and the document is referred to as an advised letter of credit. U.S. exporters may want letters of credit granted by foreign banks vetted through a U.S. bank. Exporters can seek assistance from a US Commercial Service office or an international banker in assessing risks and determining what conditions are acceptable for a given export transaction.
An irrevocable letter of credit is one that cannot be amended unless both parties agree. It can also be revocable, in which case either party can unilaterally amend it.
A revocable letter of credit is not recommended since it exposes the exporter to several dangers.
Wire transfers can be used to speed the receiving of payments. You should inquire about bank fees for such services with your international banker.
A Typical Letter of Credit Transaction
The processes for issuing an irrevocable letter of credit that has been confirmed by a US bank are as follows:
1. Just after exporter as well as the purchaser have reached an agreement on the transaction's terms, the buyer arranges for a letter of credit to be opened with his or her bank, which details the papers required for payment. The buyer is the one who decides which documents are necessary.
2. The buyer's bank issues (opens) an irrevocable letter of credit to the seller, which contains all shipment instructions.
3. The buyer's bank issues an irrevocable letter of credit and demands confirmation from a U.S. bank. The exporter might ask for a specific U.S. bank to act as the confirming bank, or the foreign bank can choose a U.S. correspondent bank.
4. Along with the irrevocable letter of credit, the U.S. bank creates a letter of confirmation to send to the exporter.
5. The exporter carefully reads the letter of credit's terms and conditions. The freight forwarder for the exporter is contacted to ensure that the shipping deadline can be reached. If the exporter fails to meet one or more of the requirements, the client is immediately notified that a modification may be required.
6. The exporter arranges for the items to be delivered to the relevant port or airport with the help of a freight forwarder.
7. The freight forwarder completes the relevant documents once the products are put onto the exporting carrier.
8. The exporter (or freight forwarder) provides the paperwork to the U.S. bank, demonstrating complete compliance with the letter of credit requirements.
9. The documents are examined by the bank. The paperwork are submitted to the buyer's bank for review and then transferred to the buyer if everything is in order.
10. The paperwork are used by the buyer (or the buyer's representative) to claim the items.
11. The letter of credit is accompanied with a sight or time draft. A sight draft is paid on presentation, whereas a time draft is paid over a certain length of time.
Tips on Using Letters of Credit
When making quotes for potential clients, bear in mind that banks will only pay the amount mentioned in the letter of credit—even if additional expenditures for shipping, insurance, or other variables are incurred and verified.
When you receive a letter of credit, carefully compare the terms of the letter to the terms of the pro forma quotation. This stage is critical because if the requirements are not followed precisely, the letter of credit may become invalid, and you may not get payment. If completing the letter of credit's requirements is difficult, or if any of the information is erroneous or misspelled, you should immediately contact the customer and request a document adjustment.
You must produce paperwork demonstrating that the products were dispatched within the letter of credit's deadline; otherwise, you may not be reimbursed. You should verify with your freight forwarders to ensure that there are no unexpected circumstances that might cause a shipment delay.
Documents must be submitted by the deadline. To guarantee that the letter of credit is paid, check with your international banker to see whether there will be enough time to produce the needed payment documentation.
You might ask for a clause in the letter of credit that allows for partial shipments and transshipment. Specifying accepted behaviors can help you avoid last-minute complications.
Documentary Collections
An exporter entrusts the collection of a sale's payment to its bank (remitting bank), which then sends the paperwork requested by the buyer to the importer's bank with instructions to release the documents to the buyer for payment. The importer receives monies in return for these papers, which are then sent to the exporter via the banks participating in the collection. Documentary collections entail the use of a draft that compels the importer to pay the face amount either immediately (document against payment) or at a later date (document against acceptance). The documentation necessary for the transfer of title to the items are specified in the collection letter. Although banks serve as intermediaries for their customers, documentary collections lack a verification procedure and provide no recourse in the case of nonpayment. Letters of credit are often more costly than documentary collections.
Documents against Payment Collection
When the exporter wants to keep title to the shipment until it arrives at its destination and payment is completed, a document against payment collection, also known as a sight draft, is employed.
Before the shipment may be transferred to the buyer, the original "order" for the ocean bill of lading must be duly endorsed by the buyer and handed to the carrier. It is vital to remember that the buyer does not need to submit air travel invoices in order to claim the items. When using a sight draft with an air freight, the risk increases.
In practice, the exporter signs the ocean bill of lading and the exporter's bank sends it to the buyer's bank. When the foreign bank receives these documents, it notifies the buyer. The foreign bank hands over the bill of lading to the buyer as soon as the draft is paid, allowing the buyer to collect the shipment.
When a sight draft is utilized to regulate the transfer of title of a shipment, there is still some risk.
Between the time the items are sent and the time the drafts are submitted for payment, the buyer's capacity or willingness to pay may change. Furthermore, the buyer's responsibility is not guaranteed by a payment guarantee from the bank. There's also the potential that the importing country's policies will alter. Finally, if the buyer is unable or unwilling to pay for and claim the items, the exporter is responsible for returning or disposing of the commodities.
Document against Acceptance Collection
When the exporter gives credit to the buyer, a document against acceptance collection, also known as a time draft, is employed. Payment is required by a certain date after the buyer has approved the time draft and received the goods, according to the draft.
The buyer is technically bound to pay within the stipulated time frame by signing and writing "accepted" on the draft. The time draft is then referred to as a trade acceptance after this is completed. The exporter might keep it till maturity or sell it at a discount to a bank for quick cash.
A date draft varies from a time draft in that it specifies a payment due date rather than a time period following the draft's acceptance. When a buyer uses a sight draft or a time draft, he or she might postpone payment by delaying acceptance of the draft. A date draft can help avoid payment delays, but the document must still be accepted.
Escrow
As an online alternative to traditional ways of payment, a variety of online escrow services have been developed. The third party takes the buyer's payment and retains it until the products are delivered.
Open Account
If the buyer is well-established, has a lengthy and good payment history, or has been properly examined for creditworthiness, an open account might be a handy way of payment in a foreign transaction. With an open account, the exporter simply invoices the consumer, who is expected to pay at a later period according to agreed-upon conditions. This approach is obviously beneficial to the importer in terms of cash flow and cost, but it is a dangerous decision for an exporter. Foreign purchasers frequently demand exporters for open-account conditions due to tight competition in export markets. Furthermore, the seller's granting of credit to the buyer is more typical in other countries. As a result, exporters that are hesitant to issue financing risk losing a sale to their rivals.
Open-account sales, on the other hand, come with certain dangers. The lack of papers and financial systems, for example, might make pursuing legal enforcement of claims problematic. The exporter may also have to seek collection outside of the United States, which can be difficult and expensive. Another issue is that receivables may be more difficult to finance due to the lack of drafts or other proof of obligation. Using trade finance practices such as export credit insurance and factoring, it is feasible to significantly reduce the risk of nonpayment associated with open-account trading. Exporters may also seek export working capital finance to guarantee that they have the funds they need for production and credit while they wait for payment.
Exporters considering an open-account transaction should carefully consider the political, economic, and commercial risks involved. Exporters that require financing prior to the issue of a pro forma invoice to a buyer should speak with their bankers.
Consignment
In international trade, consignment is a version of the open-account payment technique in which money is provided to the exporter only after the items have been sold to the final customer by the overseas distributor. An international consignment transaction is based on a contractual agreement in which the exporter receives, manages, and sells the goods for the foreign distributor, who retains title to the goods until they are sold. Only those things sold need payment to the exporter. The selling of heavy machinery and equipment on consignment is a common application of consignment in exporting, as the foreign distributor typically requires floor models and inventories for sale. Unsold goods may be returned to the exporter at cost if they are not sold within the agreed-upon time frame.
Exporting on consignment is clearly dangerous, as the exporter is not assured payment and the items are in the hands of an independent distributor or agency in a foreign nation. Consignment, on the other hand, might help exporters become more competitive by increasing the supply of goods and allowing for speedier delivery. Exporters can also save money by selling on consignment since it lowers the direct expenses of inventory storage and management. Partnering with a reputable and trustworthy foreign distributor or third-party logistics provider is the key to success when exporting on consignment. To protect consigned products in transit or in the ownership of a foreign distributor, as well as to limit the risk of nonpayment, appropriate insurance should be in place.
Exchange Rate Risk
When a buyer and a seller are from different nations, they almost never use the same currency. Payment is often done in either the buyer's or seller's currency, or in a third currency that is mutually accepted.
The unpredictability of future exchange rates is one of the dangers involved with international trading. The native currencies of the counterparties. This strategy might lead to nonpayment by a foreign buyer who is unable to satisfy agreed-upon commitments due to a severe depreciation of his native currency versus the US dollar. While export credit insurance may cover losses due to nonpayment, such "what-if" protection is useless if export possibilities are missed in the first place owing to a "payment in US dollars only" policy. Selling in foreign currencies can be a realistic alternative for U.S. exporters that want to reach the global market if foreign exchange risk is adequately handled or hedged.
You should also be aware of any currency conversion difficulties. Not all currencies can be changed into US dollars easily or fast. Fortunately, the United States dollar is generally acknowledged as an international trading currency, and American businesses may frequently obtain payment in dollars.
Before negotiating the sales contract, you should consult an international banker if the buyer requests payment in a foreign currency.
Banks can provide guidance on any foreign exchange risks that come with a certain currency.
A forward contract, which allows an exporter to sell a specified quantity of foreign currency at a pre-determined exchange rate with a delivery date ranging from three days to one year in the future, is the most direct form of hedging foreign exchange risk.
U.S. Department of Commerce Trade Finance Guide
The U.S. Department of Commerce's Trade Finance Guide: A Quick Reference for U.S. Exporters (export.gov/tradefinanceguide) will help you learn more about international payment methods, foreign exchange risk, and other relevant issues.
This succinct, clear, and easy-to-understand handbook was created to assist small and medium-sized U.S. businesses who are new to exporting discover the most efficient way to receive paid from export sales.
Payment Issues
It is simpler to avoid bad debt issues in international trade than it is to correct them once they have occurred. Credit checks and the other procedures outlined in this blog can help to mitigate risks, but the exporter must use standard business caution.
However, much as in a company's domestic operation, exporters occasionally run into issues with non-paying customers. Obtaining payment when these issues arise in international trade may be both difficult and costly. Even if the exporter has commercial credit insurance, a buyer's default still necessitates the spending of both time and money to collect. The relative values of the two currencies may fluctuate between the time the agreement is signed and the time payment is received. A devaluation or depreciation of the foreign currency might lead you to lose money if you are not properly safeguarded. If a customer has agreed to pay €500,000 for a cargo and the euro is worth $0.85, you could expect to get $425,000. If the euro fell in value to $0.84, your payment would be $420,000 at the new rate, resulting in a $5,000 loss for you. However, if the value of the foreign currency rose, you would get a windfall in additional income. Nonetheless, most exporters choose to minimize risk rather than speculate on foreign exchange changes.
One of the simplest methods to minimize the hazards of fluctuating exchange rates is to quote pricing in U.S. dollars and request payment in that currency. The buyer is thus responsible for both the cost of currency exchange as well as the risk. However, such a strategy might backfire. Even when all of the insurer's requirements are completed, the exporter sometimes faces a lengthy wait for payment.
Contacting and negotiating with the client is the easiest and least expensive answer to a payment problem. You can typically resolve problems to the satisfaction of both parties if you use patience, understanding, and flexibility. This is especially true when the cause is a simple misunderstanding or technical issue with no evidence of malicious faith.
Even if you have to make some concessions—perhaps even on the price of the contracted goods—your firm may be able to save a key customer and benefit in the long term.
If discussions fail and the amount involved is large enough, your organization should seek the help and guidance of your bank, legal counsel, and the United States Commercial Service, which can often resolve payment issues informally. Arbitration is typically speedier and less expensive than legal action when everything else fails. Most international arbitration is handled by the International Chamber of Commerce (ICC); ICC arbitration is often accepted by foreign corporations since it is not linked with any specific government. Visit iccwbo.org for additional information.
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