International Payment of Goods-Terms of Payment

There are five basic methods of obtaining payment for export orders, and according to the order of the exporter's preference they are:
1.Cash in advance
2.Documentary letter of credit
3.Documentary collection
4.Open account
5.Payment against goods on consignment

1.Cash in Advance
Cash in advance means that the exporter is paid either when the importer places his order or when the goods are ready for shipment. Cash with order or cash payment before shipment is the exporter's dream,it rarely occurs,although in certain circumstance it is wise and even customary to ask for it.This state of affairs may be only likely in a seller's market as it is naturally very unpopular in the eyes of importers.
Nevertheless,it may be essential to ask for at leat part of the purchase price with the order or before shipment in case where orders are from politically unstable countries or financially unstable customers, or where goods are specifically custom made for a new customer who has no long-term "good faith" relationship with you,or where the exporer may be looking up considerable capital in the preparation of the goods. In practice,compromise are often sought.For example, the exporter might arrange to receive one-third of the purchase price with the order when the contract is signed, one-third when the consignment is ready for shipment and the balance when the goods have arrived.
When cash in advance is used, the importer usually remits the payment to the exporter. Remittance means the transfer of money through banks from one party to another. Of course, remittance is not confined to cash in advance.It also applies to "open account","installment",and "deposit payment " etc. There are three ways of remitting the money: mail transfer (M/T),telegraphic transfer (T/T), and demand draft (D/D).
M/T refers to the transfer made between banks by mail,with the advantage of low charges.T/T means the transfer made by telecommunication system such as telex or telegraph.It is faster than M/T,but more expensive.Under D/D ,the importer buys a check from a bank in the importing country, called a banker's demand draft, and send it to the exporter (the payee) so that the exporter can get money by presenting the demand draft to a bank (drawee) in the exporter's country.D/D is transferable,which is different form M/T and T/T.

2. Documentary Letter of Credit
Frequently,in international trade an exporter is,for some reason, not entirely satisfied with the credit or reputation of a foreign buyer.Foeign credit reports are often sketchy and do not give sufficient ( adequate) information for the seller to assess his chances of ultimate payment.This applies particularly to the vast majority of foreign companies that are small-and medium-sized and,therefore,not internationally known.Additionally,the country in which the foreign importer is located may be in a weak financial position with limited hard exchange to meet foreign exchange requirements.Thus,even if the importer is financially strong and reputable,conditions beyond his control may prevent him from fulfulling his foreign obligation.Sometimes,even an importer with a good credit standing may be tempted not to accept a shipment if there has been a significant drop in the price of the merchandise involved.
To make sure that an obligation will be met, a seller or other beneficiary may wish a large financial institution with superior credit standing to stand between him and a buyer or other party who is expected to perform obligations.This can be done by means of a documentary letter of credit.
A documentary letter of credit is defined as an instrument by which a bank promises to pay the seller for his goods providing the seller conforms exactly to the conditions laid down in the letter of credit. Apart from requiring 'cash with order', the most satisfactory method of obtaining payment is by means of a documentary letter of credit.It provides security of payment to exporter and enables the buyer to ensure that he receives the goods as ordered and delivered in the way he requires.Specifically, it is an arrangement whereby the banks requires a bank to establish a credit in favor of the seller.The buyer's bank undertakes, or authorize its correspondent bank in the exporterer's country, to pay the exporter a sum of money (normally the invoice value of the goods) against presentation of specified shipping documents.
(1) Parties involved
The parties involved in a letter of credit transaction include: applicant,opening bank,advising bank,beneficiary,negotiating bank,paying bank and confirming bank.
*Applicant is the party who applies for the opening of a letter of credit ,that is ,the importer.
*Opening bank is the bank located in the importer's country that opens a letter of credit on behalf of the importer.By issuing a credit, the bank assumes full responsibility for payment after the proper drafts and documents have been presented.
*Advising bank is the bank located in the exporter's country who informs the exporter that a letter of credit has been opened in his favor and transfers the L/C to the exporter.It is usually the correspondent of the issuing bank.
*Beneficiary is the part in whose favor the letter of credit is issured, and who is entitled to receive the payment,that is , the exporter.
*Negotiating bank is the bank who buys an exporter's draft submitted to it under a letter of credit and then forward the draft and documents to the opening bank for reimbursement.Usually the advising bank is also the negotiating bank.
*Paying bank is the bank that makes payment to the beneficiary against presentation of stipulated documents. It is usually the opening bank but can also be a third designated bank.
*Frequently,an advising bank is requested to add its own commitment to the letter of credit .In this case, it is called the comfirming bank.

(2) Procedures
The procedure leading to opening a letter of credit starts with the foreign buyer agreeing with the exporter that payment will be by a documentary credit.The buyer then instruct his bank at his place to open a documentary credit of the exporter on the terms and conditions agreed upon by the buyer and the exporter.This issuing bank,not being exporter in the product, will require very detailed instructions covering product decriptions:quantities,agreed unit prices and total shipment values,terms of trade,date payment is due after presentation of the correct documents,packing,shipping period and so on.It is very common for a buyer to clearly specify a period of validity of the letter of credit.
After issuing the L/C,the issuing bank sends it to the advising bank,usually his correspondent bank in the exporter's country and asks the bank to advise the exporter of the establishing of the L/C and pass the credit to the exporter for study prior to release of the goods.If the seller requires a confirmed letter of credit ,them the correspondent bank may be asked to confirm the L/C opened by the issuing bank,and a fee will be charged to the buyer for this service.After the seller receives the L/C and is satisfied with the stipulations he will be in a position to load the goods.
After shipment of the goods,the seller will send the draft accompanied by all the necessary documents to the negotiation bank for negotiation within the validity of the L/C.If the documents are full and correct,the bank will pay,or accept the draft and then send the documents to the paying bank(issuing bank).After careful checking of the documents,and no problems are found,the paying bank will reimburse the money to the negotiating bank in accordance with the terms of the credit.The issuing bank (paying bank) then presents the documents to the buyer for payment or acceptance.Documents will be handed over to the buyer upon buyer's payment of the amound due or acceptance of the draft.With the documents,the buyer can take delivery f the goods.

(3)Types of L/C
Letters of credit can be classified into different types:
*Revocable L/C and Irrevocable L/C
Revocable L/C, as the name suggests,means that it can be canceled or modified by the issuing bank usually at the will of the buyer without prior approval of the exporter at any time before the documents have been paid or accepted. The exporter's losses could be substantial if the credit were revoked halfway throught the manufacturing process or just before shipment.As it does not provide adequate security for the exporter,revocable L/C is not used very frequently.They are,however,used effectively for shipments between affiliated companies and in other instances when there is no doubt concering creditworthiness and mutual trust between the parties.
Irrevocable L/C is the one that cannot be modified or rescinded by the opening bank without express permission of all parties,including the exporter,importer and intermediary banks.The opening bank is irrevocably committed to honor the exporter's drafts provided all the stipulations of the credit are met. Most credits are of the irrevocable type.
*Confirmed and Unconfirmed L/C
Comfirmed L/C represents the obligation of the confirming bank in the exporter's locality,usually the advising bank. It means the confirming bank guarantees payment if the issuing bank in exporter's country is often is often requested by a seller who has little confidence in or does not know the financial strength of the foreign opening bank.
Unconfirmed L/C means that the L/C doesn't have any payment guarantee by a bank in the exporter's country.It contains the obligation of the issuing bank only.This type is usually used when the opening bank of the undoubted reputation and financial strength or the transaction is small.
*Sigh L/C and Usance L/C
Sigh L/C means payment is immediately made to the beneficiary on presentation of the stipulated documents and on condition that all the terms of the credit have been complied with. It is advantageous to the exporter as he can get the payment quickly.
Usance L/C or Time L/C implies that the seller is paied in a specified number of days after the presentation of the stipulated documents. It can be further divied into:Banker's acceptance credit and Deferred payment credit.
Banker's acceptance credit calls for usance drafts to be drawn on and accepted by the opening paying bank.Under this type,the paying bank guarantees to make payment in a specified number of days after its acceptance of the time draft.
Deferred payment credit doesn't call for a time draft drawn on and accepted by the paying or opening bank.Under this type, a period of credit is agreed by buyer and seller.When documents are presented " in order " by the seller,the bank does not accept a bill of exchange,but instead gives a letter of undertaking to the seller advising him when he will receive his money.It is similar to banker's acceptance credit except that under deferred payment credit the seller cannot make use of discounting facilities and therefore cannot get poayment in advance.
*Transferable and Non-transferable L/C
Transferable credits arise where the exporter is obtaining the goods form a third party,say the actual manufacturer,and, as the middleman,does not have the resources to buy outright and await payment from his overseas customer.The credit is established in favor of the middleman (the prime beneficiary) and authorizes the advising bank to accept instructions from the prime beneficiary to make the credit available in whole ,or in part,to one or more third parties (the secondary beneficiaries).No letter of credit is transferred unless specifically authorized in the credit and this kindof credit can be transferred only for one.When the credit is transferred,all confitions must remain as in the original credit except that the amount of the credit ,quantity of goods called for and the unit price may be reduced,or the period of validity and/or shipment may be shortered.
Non-transferable credit is one that can not be transferred. If a letter of credit is not indicated with "Transferable",it is a non-transferable credit.

*Revolving L/C
Frequently, in internatonal trade a buyer will purchase regularly from a foreign supplier. To facilitate such repeat shipments between the same buyer and seller, a revolving letter of credit may be used, Instead of issuing several letters of credit,the bank issues only one,with a fixed amount available for each defined calendar period.When a shipment has been made and documents presented and paied for,the credit is automatically renewed in its original form so that another shipment can be made. This eliminates the need to establish a new credit for each shipment.Such credits can be revocable or irrevocable,and are usually subject to a time limitation. They can also be cumulative or non-cumulative.With a cumulative revolving credit,any amount unused during a given preiod can be carried forward to the next period.When a credit is noncumulative,any amount not used during a given period is automatically canceled at the end of that period.

*Back to Back Credit
Back to back credit arise in circumstances similar to those of the transferable credit.It means that the middleman receives a credit in his favor from the buyer and ask his bank (usually the advising bank of the primary credit) to establish a second credit in favor of his supplier against the security of the credit in his own favor.The second credit is similar to the first except that the amount may be lower and it will have a shorter validity to allow time for substitution of invoices and other contingencies.The opening of the second credit should be based on an irrevocable L/C.Since there are two separate credits instead of one as in the case of a transferable credit,there may appear some problems in the matching of documents and credit terms.

*Red Clause Credit
Red clause credits are also called anticipatory credits.this instrument similar to a normal letter of credit axcept that it contains a clause (originally typed or printed in red) authorize the negotiating bank to make clean advances of a certain percentage or the total amount of the L/C to the exporter.The clean advances are based on the guarantee of the opening bank and the importer,which means that the opening bank or the importer is liable for repayment plus interest in cases where no shipment is made unter the letter of credit or when the loan is not repaid by the beneficiary.Due to the high risk or the importer,before permitting red clause advances,the importer must have a considerable amount of confidence in capacity and integrity of the beneficiary.In addition to assuming a credit risk,the importer also takes on the exchange risk,since red clause advances are usually in the local currency.

*Standby L/C
This type is different from other types in that the buyer and seller hope it will never be drawn upon.They are ofter used as a kind of "back up" in the event of the buyer not paying for the goods.They normally require the issuing bank to make payment to the seller upon presentation of documents evidencing non-payment by the importer.Standby L/C can only be used when the applicant fails to fufill it payment obligation.

3.Documentary Collection
Documentary collection is a method by which the exporter authoriazt the bank to collect money from the importer. Title documents are only handed over to the buyer when the amount of draft is paid or when the draft is accepted by a specified date.
When such payment terms are used,the exporter obtains the usual shipping documents,such as a bill of lading,insurance policy,commercial invoice,inspection certificate and so on. Simultaneously,he draws a draft on the importer for the total amount due which was previously agreed in the sales contract.After the draft and all documents are properly assembled,the exporter attaches the documents to the draft and submits everything to his bank,accompanied by detailed instructions as to how the bank is to proceed in obtaining payment from the importer.The bank,acting as agent for the exporter,checks to make sure all the documents are in order and are complete as stated in the instructions.Then,based on the customer's instruction,the bank types his own collection letter and sends it,together with the drafts and documents,to one of its foreign correspondents in the importer's country.The foreign correspondent,again acting as agent,notifies the importer that it has title documents available for his to be picked up provided he either pays the draft if it is a sigh draft or accepts it if it is a time draft.After a sight draft has been paid,the money is remitted back to the exporter's bank.The latter either credits the exporter's account or send him a check for the proceeds.An accepted time draft generally remains with the overseas correspondent,who will present it to the acceptor for payment as maturity.
The parties concerned in a documentary collection transaction are principal (usually the exporter),remitting bank in the exporting country as the agent of the exporter,collecting bank in the importing country and drawee(usually the importer).
There are two types of the documentary collection:Documents Against Payment (D/P) and Documents Against Acceptance(D/A).
*Documents Against Payment
Documents against payment means documents can only be handed over to the buyer when he paid the amount of the draft. It can be further divided into Documents Against Payment At Sight and Documents Against Payment After Sight.
D/P at sight means that the buyer shouls pay the draft amount as soon as he is presented the sight draft by the bank
D/P after sight means the buyer will pay the draft amount in a specified number of days after the time draft drawn by the seller is presented and accepted.Still the documents can be released to the buyer when payment is made.
*Documents Against Acceptance
D/A means that the title document will be handed over to the buyer once the buyer has accepted the usance draft drawn by the seller.Payment will be made when the usance period is due.Under this term, as the importer gets the goods before making payment,the importer's credit standing is important to the exporter.It is therefore not as secure as D/P since the seller might not be paid at all.
Although banks are involved in documentary collection, they just act as agents and offer no bank guarantee to either the buyer or the seller,which is different from L/C payment terms.

4.Open Account
The open account system is one of the principal methods of settlement in international trading practice.This mechanism has the advantage of simplicity.There is no special procedure.The exporter dispatches goods,sends teh appropriate documents of title,e.g. bills of lading,together with an invoice,and then has to wait for payment.The goods thus pass into the customer's possession before the payment is made and the exporter has only the protecton of the particular contract of sale.Due to the high risk to the exporter,open account is usually adopted when the exporter is well acquainted with the financial status of the buyer and has no doubt about his solvency,or when the exporter sells goods to his own overseas branch or subsidiary.
Sales on this basis are usually settled by periodic remittances. With open account,the actual mechanics and speed of remitting money is of vital importance.Funds might be transfered by T/T,M/T or D/D.etc..

5.Payment Against Goods on Consignment
Consignment sales are usually used as a way of expanding overseas sales and especially opening up markets for new products.Goods shipped on consignment enable the exporter to place stocks in the importing country without actually giving up the title of ownership.The consignee sells the goods on behalf of the consignor and gets a certain percentage of commission.Normally,the exporter will not receive any payment until sales are made in the overseas country and the goods may alsways be sent back without liability on the part of the importer/consignee.Stocks therefore might represent a considerable amout of capital locked up in the overseas market and exposed to all the normal commercial,plus political and climatic risks.Due to the hign risk,the exporter should have a clear understanding of the credit of the agent before using the method and be fully aware of the risks involved.Such consignment operations are best based on a consignee who is well known and committed to the exporter.Under this item,the exporter gets the money after the goods have been sold out. The consignee would render monthly accounts of sales and sent the consignor the payments due after deducting expenses,and an agreed rate of commission.
The above methods of payment including cash in advance,L/C,documentary collection,open account and so on are all used in exporting and all have their drawbacks and advantages.From the exporter's point of view,the ideal method of payment whould be by cash,either on confirmation of order or when the goods are ready for shipment.The other extreme is presented by the methods of open account and payment against consignment and these are the most favorable methods from the point of view of the importer.But these two extreme are rarely adopted in international trade because of the high risks involved. So far documentary L/C and documentary collection are the most common ways.Exporters favor L/C because of the guarantee it offers while importers would prefer D/A or D/P payment terms. In many cases,tow or more methods are adopted for on transaction.For example,collection may be combined with remittance,L/C with collection etc.Sometimes,under installments or deferred payment for large equipment transactions, a combination of payment methods including L/C,remittance and collection is used.