Payment term in any business is a major part of sales contract. Terms of payment in exports and imports plays an important role in international business. For an exporter getting paid on time and in full is the ultimate goal of his business. On the other hand, importers want to choose those methods which contain minimum risk for them. So, in international trade an appropriate method must be chosen carefully which accommodate the needs of both exporter and importer.
The Major methods of payment in international trade are given below:
Clean payments are characterised by mutual trust between importer & exporter. In the clean payment method, all shipping documents, including title documents, are handled directly by the trading parties. Clean payment method is inexpensive and uncomplicated method for both parties because the role of banks is limited to clearing funds as required. There are basically two types of clean payments:
Advance Payment Method
In this method level of risk for exporter is lowest as they get paid before they ship the goods. It has the highest risk for importer.
Open Account Method
In open account method, the goods are shipped and delivered to importer before payment is due, usually in 30 to 90 days. This is the most advantageous method for the importer in cash flow and cost terms, but it is consequently the highest risk option for an exporter.
In this method of payment, the exporter entrusts the handling of commercial and often financial documents to banks and gives the banks all the necessary instructions concerning the release of these documents to the Importer. Collections are subject to the Uniform Rules for collections published by the International Chamber of Commerce under the document number URC 522. However, the banks involved do not provide any guarantee of payment.
There are two methods under documentary collection method:
a.) D/P or Documents against Payment: In this method, the documents are delivered to the importer only after collecting payment of goods by the importer’s bank.
b.) D/A or Document against Acceptance: In this method, the document are delivered to the importer only against acceptance of drafts.
L/C is another method of payment in international trade. A Letter of Credit is a written undertaking by the Importer’s bank, known as the issuing bank, on behalf of the Importer, promising to effect payment in favour of the exporter up to a stated sum of money, within a prescribed time limit and against stipulated documents. However, the banks deal only in documents and not in goods. The International Chamber of Commerce (ICC) publishes internationally agreed-upon rules, definitions and practices governing Letters of Credit, called “Uniform Customs and Practice for Documentary Credits” (UCP) under UCP 600.
a. Revocable & Irrevocable Letter of Credit
A revocable L/C can be amended or cancelled without the consent of the exporter. On the other hand, an irrevocable L/C cannot be cancelled or amended without the consent of all parties including exporter.
b. Sight & Term Letter of Credit
When payment is to be made at the time that documents are presented, this is referred to as a sight Letter of Credit. On the other hand, when the payment is to be made at a future fixed time from the presentation of documents, this is referred to as a term Letter of Credit.
c. Confirmed Letter of Credit
Under this type of L/C, the Issuing Bank may request the Advising Bank to add its confirmation on the LC. When Advising Bank agreed to add the confirmation, then it will become the Confirming Bank and undertakes to pay the beneficiary (exporter) if all the terms and conditions of the LC are met. Such Undertaking from the Confirming Bank is separate and in addition to the undertaking given by the Issuing Bank.
Under this method, the exporter receives the payment only after the goods have been sold by the importer to the end customer. An international consignment transaction is based on a contractual arrangement in which the importer receives, manages, and sells the goods for the exporter and the exporter retains the title to the goods until they are sold. If these goods are not sold then the same is returned to the exporter. Consignment Sale is considered the most risky and time taking method of payment for the exporter.