Knowledge Base

In order to create a new export business and succeed in today’s global marketplace as well as to struggle against foreign competitors, exporters must offer their customers attractive sales terms supported by appropriate payment methods. Getting paid in full and on time is the most important goal for each export business. In order to eradicate payment risks and accommodate the needs of international customers, the exporter has to choose an appropriate and convenient method of payment for both parties.

There are four methods of payment to assure an export procedure and consider any international transaction completed. During or before export contract negotiations, the parties should consider which method is mutually desirable for both seller and customer. 

1. Cash In Advance

Cash in advance means that the customer must pay the exporter in cash before the shipment of products is made. The benefit of such a method is that if an exporter ships a product to an importer and the customer does not pay for the item after its arrival, the exporter has the chance to return the product and have profit in one and the same time. As for the customer, cash in advance assures that the product is going to be send in a short period of time. 

Due to such payment terms, the exporter can overcome credit risk because payment is received before the ownership of the goods is transferred. Wire transfers and credit cards are the most popular cash-in-advance options available to exporters. However, requiring payment in advance is the least attractive option for the buyer, because it creates cash-flow problems. Foreign buyers are concerned that the goods may not be sent if payment is made in advance. Thus, exporters who insist on this payment method may lose to competitors who offer more attractive payment terms. 

This term can be used in a variety of businesses, but it is most common in the import/export industries.

2) Letters of Credit 

A letter of credit represents a guarantee from a bank that a particular seller will receive a payment due from a definite buyer. The bank guarantees that the seller will receive a specified amount of money within a specified time. In return for guaranteeing the payment, the bank will require that strict terms are met. It will want to receive certain documents as shipping confirmation. 

By asking for an appropriate letter of credit a seller is reassured that they will receive their money in full and on time. This is one of the most secure methods of payment for exporters as long as they meet all the terms and conditions. The risk of non-payment is transferred from the seller to the bank. An LC also protects the buyer because no payment obligation arises until the goods have been shipped or delivered as promised. 

3) Documentary Collections

Documentary collections are the best alternative to letters of credit. This way of payment offers  protection to the importer and exporter, insuring their business deal. Banks act as intermediaries to the exchange of title documents for payment. It is important to know that the banks are not obliged to pay as is the case under a letter of credit. 

DC is one of the transactions where the exporter entrusts the collection of a payment to the remitting bank (exporter’s bank), which sends documents to a collecting bank (importer’s bank) together with  additional instructions for payment. Money are received from the importer and remitted to the exporter through the banks involved in the collection in exchange for those documents. 

The two most common conditions for release of documents are:

• Documents Against Payment (D/P): Documents may be released only if the importer makes immediate payment according to the contracted agreement between the exporter and the importer. Also known as sight collection.
• Documents Against Acceptance (D/A): Documents may be released only if the importer accepts the accompanying draft, thereby incurring an obligation to pay at a specified future date. In this arrangement the exporter is exposed to the credit risk of the importer and the political risk of the country. Also known as a term collection. 

4) Open Account

This kind of transaction is beneficial for both seller and buyer as this is the sale where the goods are shipped and delivered before payment occurs. This method of payment is considered to be the most advantageous for the customer in terms of cash flow and cost. As contrast, it represents highest risk options for the seller as he has no guarantees that the customer is going to pay after the product is finally exported. Due to intense competition on export markets, foreign buyers often require exporters to use open account terms. 

The products, together with all the required documents, are shipped directly to the customer who has agreed to pay the exporter's invoice at a specified date. Before making the deal, the exporter should be confident about customer’s sincerity and professionalism as well as about his/her readiness to pay at the agreed time. Open account terms may help win customers in competitive markets and can be used with one or more of the appropriate trade finance techniques that mitigate the risk of non-payment.