Methods of payment in foreign trade

The flow of money across national borders is complex and requires the use of special documents. Foreign trade usually is financed on credit. Exporters rarely get paid right away because of collection and foreign-exchange problems.

The basic methods of payment for exports are:

- Cash in advance

- Letter of credit

- Documentary collection or draft

- Open account

- Other payment mechanisms, such as consignment sales or countertrade.

If payment is to be made by a documentary collection or draft, also known as a commercial bill of exchange, the drawer (exporter) instructs the drawee (importer) to transfer the face amount of the bill of exchange at a given time. The transfer is made to a designated payee, possible to the exporter’s bank at which the drawer has an account, or directly to the exporter. If the exporter requests payment be immediately, the exchange instrument is called a sight draft. If payment is to be made later, the instrument is called a time draft. These drafts generally contain a significant amount of information about the shipment. With a bill of exchange it is always possible the importer will not be able to make payment to the exporter at the agreed-upon time.

A letter of credit, however, obligates the buyer’s bank in the importing country to accept a draft (a bill of exchange) presented to it, provided the draft is accompanied by the prescribed documents. A documentary letter of credit stipulates that payment will be made by the bank on the basis of the documents, not on the terms of the sale. A letter of credit denominated in the exporter’s currency means the exporter incurs no risk of loss as a result of possible exchange-rate fluctuations.

A letter of credit transaction may involve a conforming bank in addition to the parties mentioned above. With a confirmed letter of credit, the exporter has the guarantee of a bank in the exporting country as well as the guarantee of the importer’s bank.

An exporter may sell on an open account. An exporter receives the greatest security of payment from cash with order or from cash on delivery. At the other extreme payment an open account offers the least security to an exporter. The goods and accompanying documents are sent directly to an overseas buyer who has agreed to pay within a certain period after the invoice date – usually not more then 180 days. The buyer undertakes to remit money to the exporter by an agreed method.

A variation of open account payment is the consignment account where an exporter supplies an overseas buyer in order that stocks are built in quantities sufficient to cover continual demand. The exporter retains ownership of the goods until they are sold, or for an agreed period of time, after which the buyer remits the agreed price to the exporter.

Clearly the best possible method of payment for the exporter is payment in advance. Cash with order avoids any risks on small orders with new buyers and may even be asked for before production begins. However, this form of payment is extremely rare in exporting since it means that an overseas buyer is extending credit to an exporter – when the opposite procedure is the normal method of trade.

Variations in this form of payment are cash on delivery where small value goods are sent by Post Office parcel post and are released only after payment of the invoice plus charges.

However, a large proportion of export contracts cannot be settled by payment in advance or by open account, particularly with sales outside the EEC. So parallel with the development of international trade throughout the world, the trading community has developed methods of payments which involve the transfer of documents for exported goods using the international banking system – with the aim of speedily settling export transactions at minimum risk to exporters and to overseas buyers.