Methods of Payment

Cash in Advance

                Receiving payment by cash in advance of the shipment might seem ideal.  In this situation, your company is relieved of collection problems and has immediate use of the money.  A wire transfer is commonly used and has the advantage of being almost immediate. Payment by check may result in a collection delay of up to six weeks—perhaps defeating the original intention of receiving payment before shipping.

                Many exporters accept credit cards in payment for consumer goods and other products that generally have a low dollar value and that are sold directly to the end user.  Domestic and international rules governing credit card transactions sometimes differ, so U.S. merchants should contact their credit card processor for more specific information.  International credit card transactions are typically handled by telephone or fax. Because those methods are subject to fraud, you should determine the validity of transactions and obtain the proper authorizations before sending goods or performing services. 

                For the buyer, advance payment tends to create cash flow problems and to increase risks.  Furthermore, cash in advance is not as common in most of the world as it is in the United States.  Buyers are often concerned that the goods may not be sent if payment is made in advance so that they will have no leverage with the seller if goods do not meet specifications.  Exporters who insist on advance payment as their sole method of doing business may find themselves losing out to competitors who offer more flexible payment terms.

                Documentary Letters of Credit and Documentary Collections or Drafts

                Documentary letters of credit or documentary collections or drafts are often used to protect the interests of both buyer and seller. These two methods require that payment be made on presentation of the documents conveying the title and showing that specific steps have been taken.  Letters of credit and drafts may be paid immediately or at a later date. Drafts that are paid on presentation are called sight drafts.  Drafts that are to be paid at a later date, often after the buyer receives the goods, are called time drafts or date drafts.  A transmittal letter is used, which contains complete and precise instructions on how the documents should be handled and how the payment is to be made.  

                                Letters of Credit

                A letter of credit adds a bank’s promise to that of the foreign buyer to pay the exporter.  A letter of credit issued by a foreign bank is sometimes confirmed by a U.S. bank.  This confirmation means that the U.S. bank adds its promise to that of the foreign bank to pay the exporter.  If a letter of credit is not confirmed, it is “advised” through a U.S. bank and is thus called an advised letter of credit.  U.S. exporters may wish to have letters of credit issued by foreign banks confirmed through a U.S. bank if they are unfamiliar with the foreign bank or are concerned about the political or economic risk associated with the country in which the bank is located. 

                                Documentary Collections or Drafts

                A draft, sometimes called a bill of exchange, is analogous to a foreign buyer’s check.  Like checks used in domestic commerce, drafts carry the risk that they will not be honored.  However, in international commerce, title does not transfer to the buyer until the buyer pays the draft.

                A sight draft is used when the exporter wishes to retain title to the shipment until it reaches its destination and payment is made. Before the shipment can be released to the buyer, the original “order” for the ocean bill of lading (the document that evidences title) must be properly endorsed by the buyer and surrendered to the carrier.  It is important to note that air waybills do not need to be presented for the buyer to claim the goods.  Risk increases when a sight draft is used with an air shipment. 

                A time draft is used when the exporter extends credit to the buyer.  The draft states that payment is due by a specific time after the buyer accepts the time draft and receives the goods.  By signing and writing “accepted” on the draft, the buyer is formally obligated to pay within the stated time.  When this is done, the time draft is then called a trade acceptance.  It can be kept by the exporter until maturity or sold to a bank at a discount for immediate payment.

                A date draft differs slightly from a time draft in that it specifies a date on which payment is due, rather than a time period after the draft is accepted.  When either a sight draft or time draft is used, a buyer can delay payment by delaying acceptance of the draft.  A date draft can prevent this delay in payment, thought it still must be accepted.

                Open Account

                In a foreign transaction, an open account can be a convenient method of payment if the buyer is well established, has a long and favorable payment record, or has been thoroughly checked for creditworthiness. With an open account, the exporter simply bills the customer, who is expected to pay under agreed terms at a future date.  Some of the largest firms abroad make purchases only on open account.

                However, there are risks to open-account sales. The absence of documents and banking channels might make it difficult to pursue the legal enforcement of claims. The exporter might also have to pursue collection abroad, which can be difficult and costly.  Another problem is that receivables may be harder to finance, because drafts or other evidence of indebtedness is unavailable.  There are several ways to reduce credit risk, including export credit insurance and factoring.

                Exporters contemplating a sale on open-account terms should thoroughly examine the political, economic, and commercial risks.  They should also consult with their bankers if financing will be needed for the transaction before issuing a pro forma invoice to a buyer.

                Consignment Sales

                International consignment sales follow the same basic procedures as in the United States.  The goods are shipped to a foreign distributor, who sells them on behalf of the exporter.  The exporter retains title to the goods until they are sold, at which point payment is sent to the exporter.  The exporter has the greatest risk and least control over the goods with this method. Also, receiving payment may take a while.

                It is smart to consider risk insurance with international consignment sales.  The contract should clarify who is responsible for property risk insurance that will cover the merchandise until it is sold and payment is received.  In addition, it may be necessary to conduct a credit check on the foreign distributor.

                Foreign Currency

                A buyer and a seller who are in different countries rarely use the same currency.   Payment is usually made in the buyer’s or seller’s currency or in a third mutually acceptable currency.

                One of the risks associated with foreign trade is the uncertainty of future exchange rates.  The relative value between the two currencies could change between the time the deal is concluded and the time payment is received.  If you are not properly protected, a devaluation or depreciation of the foreign currency could cause you to lose money. 

                One of the simplest ways for you to avoid such risk is to quote prices and require payment in U.S. dollars.  Then the burden of exchanging currencies and the risk are placed on the buyer.  You should also be aware of any problems with currency convertibility.  Not all currencies are freely or quickly converted into U.S. dollars.  Fortunately, the U.S. dollar is widely accepted as an international trading currency and U.S. firms can often secure payment in dollars.

                If the buyer asks to make payment in a foreign currency, you should consult an international banker before negotiating the sales contract.  Banks can offer advice on the foreign exchange risks that exist with a particular currency.

                Payment Problems

                In international trade, problems involving bad debts are more easily avoided than rectified after they occur.  Credit checks and the other methods that have been discussed in this chapter can limit the risks.  Nonetheless, just as in a company’s domestic business, exporters occasionally encounter problems with buyers who default on their payment. When these problems occur in international trade, obtaining payment can be both difficult and expensive.  Even when the exporter has insurance to cover commercial credit risks, a default by a buyer still requires the time, effort, and cost of the exporter to collect a payment.  The exporter must exercise normal business prudence in exporting and exhaust all reasonable means of obtaining payment before an insurance claim is honored.  Even then, there is often a significant delay before the insurance payment is made. 

                The simplest and least costly solution to a payment problem is to contact and negotiate with the customer.  With patience, understanding, and flexibility, you may often resolve conflicts to the satisfaction of both sides.  This point is especially true when a simple misunderstanding or technical problem is to blame and there is no question of bad faith. Even though you may be required to compromise on certain points—perhaps even on the price of the committed goods—your company may save a valuable customer and profit in the long run.