Different Methods of International Trade Payments
In international trade, methods of payment could take any of the following forms:
1. Cash in Advance.
2. Open Account. ,
4. Documentary Credit.
The first three are the traditional trade payment methods, which view the bank’s role as an agency for transmitting or receiving funds or documents. The ordering of the payment and delivery of goods depends upon the situation and convenience of the buyer and seller Under documentary credit, on the other hand, the bank assures payment subject to the completion of documentary conditions.
1. Cash in Advance:
Under this system the buyer puts funds at the disposal of the seller prior to shipment of goods or provision of services, i.e., the exporter may receive the value of export in advance from the importer before the actual shipment of goods. This may be done by cheque, draft or T.T. favoring the exporters. The exporter collects the remittance and subsequently export goods as per terms of the contract.While this system is advantageous to the’ seller as be can use the funds immediately, the buyer is not only tying up his capital but also has no assurance that goods contracted for would be received in time and of the quality and quantity ordered.
This practice though expensive and risky is resorted to in cases where either the buyer’s creditworthiness
is doubtful or where there is an unstable political or economic environment in the buyer’s country or where manufacturing process or services delivered are specialized and capital intensive. These require the parties to agree to fund the operation by partial payment in advance or by progressive payments.
2. Open Account:
An open Account method is an arrangement between the buyer and the seller whereby the goods are manufactured and delivered before payment is made. Unlike cash in the Advance method, the Open Account payment is obviously more advantageous to the buyer as he pays for the goods only after receiving them and satisfying hirnsçif about delivery time, quantity and quality.
The risk element for the seller is, however, very high. He must, therefore, check the credit the worthiness of the buyer before agreeing to open account terms.
One of the examples of Open Account system is Consignment Sales. Under this system, seller ship goods to his agent who receives and sell the same and remit sales proceeds to the seller after deduction of commission and other charges. The seller retains title to the goods shipped. In consignment sale, the seller must have sufficient knowledge regarding the financial status of the agent. Generally, no bill of exchange (draft) is required, as a result, the seller is not protected against possible default.
Under Open Account method, since payment has to be made at some stated future date and there is no negotiable instrument in evidence of the buyer’s commitment to pay the seller faces the risk of release of goods without assurance of payment. Political or economic developments may lead to new regulation to defer or block his own capital until the goods are received and/or inspected by the buyer or the services are found to be acceptable and payment is made.
The collection is a method under which goods are shipped and the bill, of exchange (Draft), is drawn by the seller on the buyer. The documents are sent to the bank with clear instructiOn for collection through one of its correspondent bank located in the buyer’s county-y. The documents are to be delivered only after the payment has been made or Draft is accepted.
There are two examples of Collection method are D/P and D/A bills.
Documents against Payment (D/P Bill)
This is one of the most widely used methods of trade payment. The seller ships the goods and draws a sight bill of exchange (draft) on the buyer and the same is presented to the drawee (buyer or importer) along with the shipping documents for payment. Drawee pays the draft and takes delivery of documents. Banks in buyers country gives delivery of, documents to the buyer only against payment.
Documents against Acceptance (D/A Bill)
In this method usance bill of exchange is drawn on the buyer by the seller which is presented to the drawee for acceptance by a bank on his own country (collecting bank). Drawee accepts draft and tx up a date of payment (date of maturity). The collecting bank holds the accepted draft and releases documents to the drawee. On the due date, the accepted draft is presented to the drawee for payment.
The Collection system is less risky for the seller as compared to Open Account trading, but the seller is still dependent on the buyer to take delivery of documents and pay or accept the Draft(s).The buyer is still in an advantageous position for his payment liability is deferred until goods arrive.
The buyer may refuse or unable to pay or accept the raft. In case of non-payment or refusal of sight draft and non-acceptance of usance draft not only the question of warehousing of the goods arises hut also the sale of goods to a third party possibly at a low rate or possibility of bringing back the shipment is to be considered. The position of seller could be worse when the accepted draft of a usance bill is dishonored on the due date as the buyer have taken possession of goods. This may lead to expensive litigation abroad.
Another variant of the collection is clean collection under which the seller draws only a draft on the buyer for the value of goods/services and present the draft to his bank whiçh sends the draft along with a collection letter to a correspondent bank usually in the buyers country.
4. Documentary Credit:
In international trade, the seller wants to make sure that the buyer is able to pay in time once the goods have been šhipped and that risk of non-payment is minimised. He, therefore, wants to find out how a third party i.e., the bank can help him in the practical arrangements for these transactions. Similarly, the buyer is interested that he gets possession of goods before he pays for them and he is able to make sure that the goods are exactly those he ordered.
It is important to decide in advance how the seller is going to get payment before handing over possession of goods and how the buyer is going to get constructive possession of the goods before making payment. This is more so because the parties are located in two different countries separated by distance, with the different political, legal, monetary and trading system and possibly without knowing each other well. The two trading partners wish to reconcile the conflicting interests and converging them into one acceptable solution. This object led to research for a system which is mutually convenient, reliable and safe, taking into account their own individual problems, apprehensions, and requirements.
The solution resulted in the evolution of the Documentary Credit method where a bank acts as a fiduciary agent to safeguard the interest of both the parties, namely, ensuring constructive delivery of goods by the seller to the buyer and payment being made by the buyer on presentation of documents complying with the terms and conditions of the Credit.
Documentary credit, therefore, a conditional bank undertaking of payment. It is a conditional the undertaking was given by a bank (Issuing Bank) at the request of a customer (Applicant) or on its own behalf to paý a seller (Beneficiary) against stipulated documents provided all the terms and conditions of the Credit are complied with.
These stipulated documents are likely to include those required for commercial, regulatory, insurance or transport purposes, such as commercial invoice, certificate of origin, insurance policy or certificate and a transport document of a type appropriate to the mode(s) of transport used.