Payment methods in International Trade

The conditions on which parties in international trade agree on to complete payment are known as Payment methods or payment terms. These are the methods of payment that can be utilized by exporters and importers to finalize their trade deal. Payment terms deal with important issues related to the trade deal including when to make the payment, who retains ownership of the goods before delivery, and how payment will be made.

A profitable trade can be made by using Payment methods whether you are exporting or importing goods. The payment terms can also play an important role in attracting good trades in the first place, especially for sellers. Generally, buyers want to delay payment as much as possible, until they receive or even sell the goods, whereas sellers want to collect payment as early as possible, often before they send the goods or immediately upon receipt. The right payment terms acts as a balancing act for all these circumstances.

There are five major types of payment methods that is often adopted by parties in international trade. These include cash in advance, letter of credit, documentary collections, open account, and consignment.

Cash in advance, also called advance payment or cash with order is a straightforward payment method in which the  buyer pays for the goods upfront. It is paid before shipment. The payment may be completed either by wire transfer, international cheque, or payment by debit card between the exporter and the importer.

This payment term favors the exporter because they receive payment while still in possession of the goods. Parties using this method may agree to pay a set percentage of the price before production starts. Either all or most of the outstanding price will be paid after production and before shipment. Any amounts left will be paid after receiving the goods by the importer.

A lot of risk for the importer is involved in cash in advance as it puts them in a position where the exporter has already received payment for the goods, but still has ownership and possession of the goods. An unfavorable cash flow situation is created for the importer because they have to pay all of the price upfronts and in cash which is generally avoided by most buyers.

This payment option will only be suitable in rare situations such as where the order size is very small, or where the exporter is in a very strong negotiating position such as where the goods are scarce. It can also be an option for exporters where the importer completely trusts the seller or who are not convinced of the credit-worthiness of importer.

Cash in advance payment term is very rarely offered by exporters because it include so much risk for the buyer. However, you will need to be more flexible with your payment methods if you want to attract more sales or a higher caliber of buyers.

One of the most well-known terms of payment and the most secure payment methods in international trade is Letter of credit (L/C). A payment process is involved in this which is conducted by a bank on behalf of the importer. The letter of credit is a document that is used as a guarantee by the bank stating that the exporter will be paid for the goods once certain terms and conditions are fulfilled. Typically, these terms and conditions are included in the letter of credit, and mostly deal with inspecting the documents accompanying the goods, rather than the goods themselves.

The importer must be able to satisfy their bank of their credit-worthiness to obtain a letter of credit. The bank will turn towards the importer for reimbursement after they complete the payment on behalf of the importer which  is usually based on terms agreed between the bank and the importer.

Letters of credit is mostly suitable for situations where the exporter and importer have a new trade relationship. This can also be a good option where the exporter is not satisfied with the importer's credit-worthiness or is unable to confirm this. There is less risk for the exporter in a letter of credit since they have a solid guarantee of payment.

The main disadvantages of this payment term is that it is generally considered to be very expensive, as significant fees is typically charged by the banks involved in it. The fees will vary depending on the complexity of the transaction and credit rating of the importer. There may be no provision to establish the quality of the goods in the process as generally these are not inspected by the bank.

Documentary collection method is a very balanced payment term in which almost equal risk exposure exist for exporter and importer. It is completed exclusively between banks that acts on behalf of both parties. The process begins when the exporter ships the goods and sends documents required to claim the goods to the importer. Usually, the Bill of Lading is included in these documents.

Payment is put forward by the importer with their bank with the instruction that payment should be made only upon confirmation of the documents. The documents will be released to the importer once confirmed, enabling him to claim the documents. This collection of documents lets you lodge payment with a third party pending the completion of the agreement.

Documents against payment (DAP) and documents against acceptance (DA) are two major methods within this payment method.

Documentary collection does not expose too much risk for either party as this payment method is relatively balanced. The ownership and possession of the goods is transferred from the seller after receiving payment or a firm commitment to pay. The payment is made by the buyer only after they see the documents for the goods, or sometimes even after taking physical delivery. It can be set up in less time and less overall cost is also involved in this method than letter of credit.

It may be harder to discover any problem with the quality of the goods before payment is made in this case also, as the focus of both banks is on documents, and not necessarily on the goods themselves. Very little recourse is also provided by the payment method for the exporter in case the importer fails to pay for the goods.

A trade deal is involved in this payment method where the exporter is agreed to deliver the goods to the importer without receiving payment until a later date which is typically 30, 60, or 90 days after delivery. Therefore, the goods on credit will be essentially received with payment to follow at a later date by the importer.

This payment method is favorable for the importer as they can take delivery of the goods without making payment. Their operating expenses can be reduced as they can simply order the goods and sell completely before they have to pay the exporter. Their need for working capital can also be reduced, as they don't have to worry about freeing up funds to complete payment before taking delivery of the goods.

Importers often prefer those exporters who provide open account payment terms due to these advantages. Open account terms is the dominant mode of payment in a buyers' market where there are more goods and less demand. These terms are mostly offered by exporters who also want to show trust in a valued customer or who want to attract a valuable account.

Open account is also very risky for exporters as the risks of late payment, bankruptcy, non-payment, and other unexpected events are very high in this transaction. Also, exporters essentially have to produce the goods and ship them without receiving any payment. Exporters may have the chance to be in a very delicate position in this payment term.

Exporters often try to protect their position by exploring trade finance options for these reasons. The exporter will be able to protect themselves against loss, pending when they receive full payment from the importer from these essential mechanisms including export credit insurance and factoring. 

However, this option should be explored in situations where you have a low-risk trading relationship with the importer or where you are looking to win important customers or where there is very low demand.

The goods are produced, shipped, and delivered and also the payment is collected by the exporter to the buyer only after the goods have been sold in Consignment. This payment method is generally used by exporters who have third-party agents or distributors in foreign countries. This situation is rare to found in normal seller-buyer relationships because of the incredible risk it poses to exporters.

All of the costs of producing, shipping, and delivering the goods to the importer is bear by the exporter. Typically, the goods continue to be the property of the exporter while the goods are in possession of the importer, which means the loss will be bear by the exporter in case of an event like theft, fire, storm, or other damage.

The risk of non-payment or late payment by the importer is also bear by the exporter. There is also a risk that the goods may not even sell as expected and as a result of that, exporters are understandably reluctant to accept these terms from buyers.

The payment term is most suitable for the situation where there is an existing good relationship between the importer and exporter. The goods must have been shipped to a country that is commercially secure and the importer needs to be reputable and trustworthy. In addition, proper insurance measures and advantage of trade financing options must be taken where available.

Consignment can also be an advantage where the exporter is able to protect themselves well. Exporters can have a great advantage to enter new markets, reduce the costs of maintaining inventory and thereby allowing for lower prices. Goods can be made available much faster leading to competitive advantages.

Some other terms that have evolved apart from the major payment terms, over the years include:

Bank payment obligation: Bank payment obligation is one of the newer payment terms in which two banks are involved in the process. An obligor bank that acts on behalf of the importer, and a recipient bank which acts on behalf of the exporter. An irreversible undertaking will be signed by the obligor bank to pay the price of the goods to the recipient bank on an agreed date. The payment is made once the electronic data relating to the trade deal matches successfully.

Confirmed letter of credit: Confirmed letter of credit is a type of letter of credit, but with an important difference. The letter of credit issued by the bank of importer is confirmed by another bank of the choice of exporter. The confirmation is to see if the bank of importer is solvent and capable of paying. The bank of exporter also agrees to pay the exporter if the bank of importer fails to pay.