The global market is growing at an incredible pace with the countries recognizing the importance of globalization and open economies that facilitate easy trade between countries. At this point in time where the export and import between traders across borders is at its peak, it is essential to understand the array of options available with the buyer and seller as regards the payment for the goods so imported or exported. This blog talks about the available Payment Systems in international trade- options for Importers and Exporters.
Some of the most widely options have been discussed briefly below:
- Cash in Advance: this is the most common and traditionally used method. Usually, wire transfers, immediate bank transfers etc. While it ensures that the seller is absolutely secure, the factor of security as regards the quantity, quality and time of delivery of goods is not in favor of the buyer and also cause a liquidity problem as regards the cash flow. Accordingly, negotiating these terms with the buyer is usually tricky if the whole payment is demanded prior to the execution of the contract. A token payment is therefore resorted to as an advance payment while the balance is paid after the goods have been delivered.
- Letters of Credit: This option is relatively better in terms of security of payment to the traders as a third party guarantee is involved. The buyer, in this case approached a bank to provide the seller a guarantee of payment in case the buyer fails to do so. The bank after analysing the credit worthiness of the client, presentation of the required documents to the satisfaction of the bank grants him a letter of credit that is forwarded by the buyer to the seller. This option not only protects the seller as regards the payment for his goods but also provides him/her with an assurance about the party that he/she is transacting with. On the other hand, it is also a viable option for the buyer as he agrees the effect the payment for the goods only after the goods have been received as per the terms of the Contract between them.
- Open Account: This is another system whereby the seller allows the buyer to avail the credit facility and make the payment for the sale of the goods at a later date after they have been delivered to the buyer. Usually, this period runs in multiples of 30 days such as 30, 60 or even 90 days’ worth of credit as may be negotiated by the parties to the contract. Like Letters of Credit, Open Account also provides the benefit of liquid of cash to the buyer; although, it is riskier for the seller of the goods. However, the risk may be mitigated by employing appropriate techniques such as insurance, financing the transaction with the help of an export credit agency etc.
- Documentary Collections: This method has recently become very popular amongst the trading class and is gradually overtaking the other forms of payments in international trading. One of the most striking features that is facilitating the use of this method is the uniform method by the International Chamber of Commerce (“ICC”) with is being followed in most of the countries. These principles have been codified under the Uniform Rules for Collections, 1995 Revision, ICC Publication No. 522 and apply to all collections as defined in Article 2. Article 2 defines Collections as the handling by banks of documents, in accordance with instructions received, in order to - obtain payment and/or acceptance, deliver documents against payment and/or against acceptance, or deliver documents on other terms and conditions.
There are two main instruments that may be drawn in accordance with these rules depending upon the facts and circumstances of each and every case. Before we delve into the kinds of instruments available as options to the traders, it is critical that we understand the role of each of the parties that are involved in the transaction and thereby, also understand the process that is followed in securing the payment.
The exporter sells the goods who draws the instrument and approaches the bank (“Remitting Bank”) for the purpose of sending it to the importer’s bank as per the instructions of the exporter along with the documents required to take possession of the goods. The bank of the importer (“Collecting Bank”) receives this instrument on behalf of the importer. The importer then approaches the Collecting bank to honour the terms of the instrument and accordingly collect the documents so as to take possession of the goods so delivered. The payment or the bill of exchange as the case may be is then transmitted to the Remitting Bank that then transfers the same to the Exporter.
Finally, coming to the kinds of instruments that are available as options are:
- Documents against Payment (“DP”): The DP terms of payment provide that the documents for obtaining the goods that have been delivered are handed over to the Importer only upon the entire payment having been made by him. For this reason, this draft is also often referred to as a ‘Sight Draft’ as the documents are made available after the actual payment is received on sight of the importer. It is, therefore, one of the most secure options available with the seller.
- Documents against Acceptance (“DA”): The DA terms of payment, on the other hand, allow the buyer of the goods to procure the credit facility for the goods. Under these terms, the documents for securing the goods so transported to the importer’s country by the seller are handed over to him against his assurance that the payment will be made in the decided number of days. Usually, this period also runs in multiples of 30, according to the terms of the agreement such as 30, 60, 90 or even 180 days. Accordingly, a DA is also more commonly known as a ‘time draft’.
While the options are many, an informed decision by the parties to the trade contract should be made. They both should take into consideration various factors such as the security of payment, credit worthiness of the buyer, laws of the countries where the parties are located, whether the payment is being made in lump sum or is it deferred etc.