Payment methods in international trade
There are various ways in which payments in international trade transactions for the goods exported are effected, each carries its own inherent risk, some major to the exporters while some are slightly lesser, while there is one particular method – not very popular though – where there is no discernible risk at all to exporter.
The first method of payment in international trade transaction is called Open Account trading, where the buyer will make payments to the seller after the goods have been received. Both parties would have had to agree earlier when the payment is to be effected, after the buyer has received the goods, whether immediately or, if the seller allows credit period to the buyer, some days or months later1. This method is very favourable to the buyer where he retains complete control of whether or when he wants to make payments for the goods that he has received from the seller. Because of the obvious risks of default by buyer, most sellers seldom want to engage in the business using this method except for those deemed trustworthy and of long-standing business relationship.
Another method that is in use to settle for payment in an international trade transaction is called Collection, where the documents of the goods being shipped are routed through banks with instruction to be exchanged with payment from the buyer, or in cases where credit period is granted by the seller to the buyer, against buyer’s signed acceptance and undertaking to pay for the goods when they fall due. Under Collection method, the seller is slightly better off, for several reasons. Firstly, there is now an involvement of third parties in the transaction, making it a little bit difficult not to pay up. Secondly, without the shipping documents, the buyer cannot go to the shipping company to clear goods. So, in order to get the goods he has to pay first or provide a legally binding written acceptance undertaking. Therefore, in terms of risk profile, Collection method is better to the seller than the Open Account trading.
However, the seller must not be carried away in terms of thinking that he is now on safe ground. Even under Collection, the fact remains that the buyer holds total discretion with regards to the payment for the goods and the seller relies entirely on the buyer’s willingness or ability to make payment. If, for whatever reason, the buyer does not pay up, the seller is totally unprotected, except for the contract that he may have signed with the buyer, which is legally difficult and costly to be enforced, especially if the seller is a small or medium size company and the buyer is in faraway countries.
Then there is another method of payment in international trade, one where would take away some of the payment risks faced by the seller, which is called Documentary Credit. Under this method, the responsibility to make payments to the seller for the goods and services that he has sold to buyer lies with the buyer’s banker. Under this method, by issuing the Documentary Credit, the bank assumes the liability to effect payment. This method is much preferred by the seller because it takes away the risk of non-payment, dispute, delinquency from the buyer. The seller no longer needs to worry whether the buyer can pay or not for the goods as the buyer’s banker will now make the payment.
However, there is a catch. The Documentary Credit issued by the buyer’s banker is neither a guarantee of payment nor an absolute way of getting paid. The Documentary Credit comes with terms and conditions that the seller needs to fulfill and comply with, before he can expect to be paid. If he cannot comply to the terms and conditions stipulated by the bank in the Documentary Credit, the seller will not get paid as well.
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