Methods of Payment in International Trade

In international trade procedures, the seller and buyers want to make business under the best conditions for themselves. In apparel trading it is quite critical for both buyer and seller to settle how the payment will be made as buyer and seller both are like to optimize their advantage and risks in trade. 
Therefore, it is necessary for merchandisers to have sufficient information about the different methods of payment available to them. The main payment methods in foreign trade are 

1. Cash in advance
2. Open account
3. Consignment
4. Documentary collection
5. Letter of credit (L/C)

A brief discussion of each payment method are explained here with the advantages and risks that a merchandiser enable to choose the best method for the transaction.

1. Cash-in-Advance

With the cash-in-advance payment method, exporters receive payment before the ownership of the goods is transferred. It is most secure method of trading for exporters and, consequently the least attractive for buyers as it gives the greatest protection for the seller and puts the risk on the buyer. Wire transfers is the most commonly used cash-in-advance options available to exporters.

Advantages and Risks

The advantages and risks for both the buyer and seller are illustrated below

Parties	Advantage	Risks
Buyer	None	No control over the goods Use of the funds is lost Seller may refuse to ship goods Political risk in the seller country
Seller	Goods shipped when convenient Use of buyer’s funds	None

Application

Cash-in-Advance method may be applicable under the following circumstances, where;

• The importer is a new customer and/or has a less-established operating history
• The importer’s creditworthiness is doubtful, unsatisfactory, or unverifiable
• The political and commercial risks of the importer’s home country are very high 
• The exporter’s product is unique, not available elsewhere, or in heavy demand.

2. Open Account

With the open account payment method, goods are manufactured and delivered before payment is made. It is most secure method of trading for importer and, consequently the least attractive for exporter as it gives the greatest protection for the buyer and puts the risk on the seller. In this method goods are produced and shipped, documents are remitted directly to the buyer, with a request for payment immediately, or at an agreed future date, which is usually 30 to 90 days.

Advantages and Risks

The advantages and risks for both the buyer and seller are illustrated below

Parties	Advantage	Risk
Buyer	Control over the goods Payment when convenient	None
Seller	None	No control over the goods or payment and buyer may refuse to pay.

Application

Open account method may be applicable under the following circumstances, where;

• The buyer and the seller has long-term relationship
• The seller is sufficiently confident that payment will be received
• The seller is under pressure to sell his goods
• The buyer has a very good reputation and is well-known in the market
• The buyer is credit worthy
• The buyers’ country is politically and economically stable.

3. Consignment

With the consignment sales, seller ship the goods to importer while retains legal ownership of the merchandise until they are re-sold by the importer. In the consignment method, the importer is called the consignee and he/she is responsible for paying for the goods when they are sold. Consignment sales are very risky and there is no control available to the exporter. Obtaining sales proceeds or return of the merchandise if it is not sold can be difficult.

Advantages and Risks

The advantages and risks for both the buyer and seller are illustrated below

Parties	Advantage	Risk
Consignee	Payment only when goods are sold.	None
Seller	Retains ownership of the goods. Consignee is the intermediary for the resale of goods to buyer.	Limited control of goods. No control over the consignee’s willingness to pay for the goods.

Application

On Consignment payment method may be applicable under the following circumstances, where; 

• The consignee is reliable
• The consignee has a good credit history
• The consignee’s country has economic and political stability
• The consignee is the branch office of the main company.

4. Documentary Collection

With the documentary collection method bank on both sides act as intermediaries in processing of shipment documents and the collection of payments. In this method seller ships the merchandise and entrusts the collection of a payment to the remitting bank (exporter’s bank), which sends documents to a collecting bank (importer’s bank) along with instructions for payment. Funds are received from the importer and remitted to the exporter through the banks involved in the collection in exchange for those documents. Under collection, title to the goods is not passed to the buyer until the draft (bill of exchange) is paid or accepted by the buyer. There are two types of documentary collection regarding draft, which are usually determined by the payment terms agreed within a commercial contract.

1.   Documents against payment (D/P)

If shipment is made under a sight draft, the exporter is paid when the draft is presented to the buyer for payment. The buyer’s bank will not release the shipping documents to the buyer until the buyer has paid the draft. This is known as documents against payment. It provides the exporter with some protection, since the banks will release the shipping documents only according to exporter’s instructions.

2.   Document against acceptance (D/A)

If a shipment is made under a time draft, the exporter instructs the buyer’s bank to release the shipping documents against acceptance (signing) of the draft. This method is known as document against acceptance. By accepting the draft, the buyer is promising to pay the exporter at the specified future date usually 30 to 90 days. It provides the exporter with no protection as buyer is able to obtain the merchandise prior to paying for it.

Advantages and Risks

The advantages and risks for both the buyer and seller are illustrated below

Parties	Advantage	Risk
Buyer	Control over the goods. Payment when convenient	None
Seller	None	No control over the goods or payment Buyer may refuse to accept draft.

Application

Documentary collection method may be applicable under the following circumstances, where; 

• The buyer and the seller has long-term relationship
• The seller is sufficiently confident that payment will be received 
• The buyer has a very good reputation and is well-known in the market 
• The buyer is credit worthy 
• The buyers’ country is politically and economically stable 
• The buyers’ country has no foreign exchange control policy.

5. Letter of Credit (L/C)

With the letter of credit payment method a bank on behalf of the importer promising to pay in favor of an exporter upon presentation of shipping documents in compliance with the terms set by the buyer. In this payment method the seller will not ship merchandise without a bank's assurance of payment. It is one of the most secure instruments available to international traders. Having assurance from buyer’s bank seller prepares and ships the goods and presents shipping documents   through his bank to buyers’ bank for payments. The seller receives the payment for supplied goods before the goods are available to the buyer. A key principle underlying letter of credit is that banks deal only in documents but not in goods.

Advantages and Risks

The advantages and risks for both the buyer and seller are illustrated below

Parties	Advantage	Risk
Buyer	Payment is made by the bank upon the seller’s fulfillment of the terms and conditions of the credit	Relies on seller to ship goods as ordered
Seller	Assurance of payment before shipment Payments are made against document but not in goods.	None or very little

Application

Documentary credit method may be applicable under the following circumstances, where;

• The buyer and seller has not long-term relationship
• The seller will not ship without a banks' assurance of payment
• The buyer has not  a very good reputation and is new in the trade
• The buyers’ credit information is difficult to obtain
• The buyers’ creditworthiness is doubtful
• The buyers' like to enhance creditworthiness with a bank 
• The buyers’ country is not politically and economically stable 
• The buyers and sellers both are in numerous risks