Whether you are importing goods from abroad or selling to international buyers, the payment issue is critical and must be addressed as soon as possible. However, due to the frequently complicated nature of international trade, payment in these circumstances is not always simple.
What payment methods should you be aware of, and how do they compare? This guide delves deeply into payment terms in international trade, including their meaning, how they work, and how to choose the best option for you.
Why are payment methods important when exporting?
A payment method is an agreement between you and your buyer that specifies when and how they will pay you. Setting up how you will receive payment in your export business is more complicated than selling to domestic customers.
To reduce risk and simplify the process, various types of payments are made available to importers and exporters so that they can enter into mutual agreements. Some payment methods are more advantageous to the buyer, while others are more advantageous to the supplier.
As you gain experience as an exporter and enter more complex markets, the payment method you select may change.
5 Payment Methods in International Trade
To compete in today's global marketplace and win sales, exporters must offer customers attractive sales terms backed up by appropriate payment methods. Today, JOG International shares the 5 standard and most common payment methods.
Cash in Advance
Letter of Credit (L/C)
Documentary Collections (D/C)
Open Account (O/A)
Consignment
Cash in Advance
Cash in advance is also known as 'advance payment' or 'cash with order.' It means exactly what it sounds like. For the exporter, this is by far the safest and best mode of payment in international trade.
An exporter can avoid credit risk with cash-in-advance payment terms because payment is received before ownership of the goods is transferred. You are paid in advance for this option, and you can use your client's money to fund the production of the product you are selling. Wire transfers and credit cards are the most commonly used cash-in-advance options for international sales. Escrow services are becoming another cash-in-advance option for small export transactions as the Internet evolves.
However, requiring advance payment is the least appealing option for the buyer because it results in an unfavorable cash flow. Foreign buyers are also concerned that if payment is made in advance, the goods may not be delivered. Exporters who insist on this payment method as their sole mode of operation risk losing business to competitors who offer more appealing payment terms.
Letter of Credit (L/C)
Letters of credit (L/Cs) are among the safest tools available to international traders. International letters of credit are a commitment made on behalf of the foreign buyer by a bank that payment will be made to the beneficiary (exporter) if the terms and conditions stated in the L/C are met, as evidenced by the presentation of specified documents.
An importer must be able to satisfy the bank of their creditworthiness in order to obtain a letter of credit. When the bank completes the payment on behalf of the importer, they will seek reimbursement from the importer. This is usually determined by the terms agreed upon by the importer and the bank.
However, this payment term has some drawbacks. For one thing, it is widely regarded as very expensive, as the banks involved typically charge significant fees. The fees will vary depending on the importer's credit rating and the transaction's complexity.
Documentary Collections (D/C)
Documentary collections fall somewhere between Letters of Credit and Open Accounts. Documentary collection is a very balanced payment term that exposes the exporter and importer to nearly equal risk.
This method is only used between banks acting on behalf of both parties. The process begins when the exporter ships the goods and sends the documents required to claim the goods to the importer. The Bill of Lading is typically included in these documents. This is then passed on to the buyer, whose payment causes the collecting bank to transfer the funds to the remitting bank. Finally, the amount is received by the exporter from the remitting bank.
This payment term includes two major methods. They are documents against payment (DAP) and documents against acceptance (DA).
Documents Against Payment (DAP)
The bank will release payment to the exporter upon sighting the documents under this agreement. There will be no delay in payment, and once the documents are presented (and found to be in order), payment must be completed.
Documents Against Acceptance (DA)
The documents will be delivered to the importer's bank once a firm commitment to pay on a specific date is made under this agreement. This means that payment is not received immediately, but rather at a mutually agreed-upon date.
Open Account (O/A)
In international trade, an open account transaction is a sale in which the goods are shipped and delivered before payment is due, which is typically in 30, 60, or 90 days. There is a delay between the receipt of the purchase order and the receipt of payment, with activities such as production and shipping to be completed in the interim.
You should only consider this option if you have a low-risk trading relationship with the importer. Another option is where there is very little demand or where you want to win important customers.
Consignment
In international trade, the consignment method of payment is a variation of an open account in which payment is sent to the exporter after the goods have been sold to the end customer by the foreign distributor.
This payment term is frequently used by exporters who have distributors or third-party agents in other countries. This situation may be more uncommon in normal seller-buyer relationships.
Also, this payment term is uncommon for one simple reason: the enormous risk it poses to exporters. The costs of producing, shipping, and delivering the goods to the importer are all borne by the exporter. The exporter also bears the risk of the importer failing to pay or paying late. It is the riskiest of the most common methods of payment.
Checklist in choosing the right payment method
Setting your payment methods and terms is critical to the survival of your business. It is critical to conduct research and seek advice from industry experts and professionals.
Perform due diligence and research to learn everything you can about a buyer before doing business with them.
Conduct credit checks through reputable international agencies, especially if you plan to offer credit terms.
Consider carefully how you will fund any new contracts without incurring debt. Your current clients or suppliers may be able to assist you.
Consider your cash flow and risk management strategies.
Inquire with your bank about a secured loan or commercial bill facility to assist you in financing your exports.
Final Thoughts
Payment terms are an important aspect of international trade. Although setting these terms can be difficult, the positive trade-off is that you can reduce the risks of the trade, which is always a good thing.
Want to learn more about how JOG International can assist you in sourcing products and expanding your business in China? Contact us now.
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