One of the most important aspects of your export business is your terms of trade. You must have a clear understanding of the various methods of payment available. This includes costs, risks, marketing implications and, of course, when you will actually receive payment.
It is also important to know that your terms of trade should not be one size fits all; you can and should offer different methods of payment based on a particular circumstance.
Cash in Advance
Cash in advance is the method of payment that will be preferred by your finance people. There is no payment risk. You get paid up front and you can use your client’s money to finance production of the product you are selling.
From your client’s perspective, this is the riskiest and one of the most expensive methods of payment. They have to give up use of their cash and have no assurance that you are going to ship their order.
This can result in negative marketing implications for your business. Still, this can be an acceptable payment method for small, non-repetitive orders including sample sales.
Open Account Terms
Open account terms are the opposite end of the spectrum from cash in advance. You, as the exporter, must finance production with your own available resources and take on the risks of getting paid.
From your client’s perspective, this is the preferred method of payment in terms of costs and risks, and provides positive marketing sizzle. There are tools that allow you to sell on open account terms without taking all of the non-payment risk, including a standby letter of credit or credit insurance.
In today’s global marketplace, open account terms are becoming the norm and a competitive necessity for recurring sales, particularly to representatives and distributors that are creating a market for your products.
Documentary Collections
Documentary collections are a method of payment that involve using the banking channels for something more than handling the movement of funds for your payment. With a documentary collection you are relying on the bank to control your product until payment is made. This is accomplished by sending your receivable and bill of lading needed to claim your shipment through the banking channels along with a bank collection letter.
Your bank sends their collection letter with your documentation to your client’s bank. They contact your client and advise them to make payment so they can release your documents to them. Your most significant risk is your buyer saying they have changed their mind and no longer want the shipped product.
Documentary collection terms can be effective when you wish to have control of your product until it is paid for, and your client does not want to pay for your product until it arrives in port. This can be used effectively for sales to distributors that have the product sold and do not have to offer terms locally.
Letter of Credit
Documentary letters of credit is the method of payment where the banks are actively involved in shifting the payment risk and directly settling the payment. Because of this level of involvement, this is the most expensive method of payment for both the exporter and the importer, and requires the importer to tie up their available credit with their bank.
The primary function of a letter of credit is to shift the credit risk of the importer to the issuing bank. And, if deemed necessary by the exporter, shift the credit risk and the country risk of the issuing bank to a confirming bank.
Payment under a letter of credit is guaranteed by the issuing or confirming bank provided the exporter can comply with all of the requirements specified in the letter of credit and provide all of the required documents in the manner specified. Because of the documentation risk and the costs, letters of credit are best suited to large non-repetitive transactions or transactions involving custom designed products.
If you are an export businesses or looking to export your products, check out out blog post Are You Ready to Export?
