The terms of payment are a critical part of any export transaction. They can determine if you are successful in making the sale, if you make a profit, and the associated financial risk.
(Please read-on, or if you prefer click here for a video on the subject.)
What are the best payment terms?
That depends on a several factors, including:
- How much you can trust your buyer?
- Is this the first transaction?
- How much risk are you prepared to take?
- How much risk is your buyer prepared to take?
- How big is the transaction?
What are my payment options?
- cash in advance – where the buyer prepays some or all of the money in advance of a shipment
- letters of credit – where banks oversee and/or guarantee the payment
- documentary collections– where you ship your goods but retain some control over them until you receive payment. (There are several types of documentary collections)
- open account – where you deliver your goods with an invoice requesting payment on a specific date after delivery
Generally the first options are safest, but your buyer may not accept the safest terms. You should contact your bank for advice about which option is best for your particular situation.
Methods of payment
The following methods of export payment are listed in order of risk from lowest to highest.
Cash-In-Advance: Also known as Pre-Payment, Upfront Payment, or Cash Sale, the buyer pays you before a shipment. This method of payment is often used for new customers and for internet trades, but is not very customers-friendly. Cash-in-advance greatly limits your risks as the exporter, but it has the opposite effect on the buyer. The buyer has to trust that you will deliver quality products on time.
Letters of Credit: In a Letter of Credit, the importer’s bank issues a document stating that they will pay the exporter when the terms of the Letter of Credit are fulfilled. Terms that could be specified include quantity, description and documentation. The onus is on the exporter to ensure that the documents and quantities shipped are correct; otherwise the exporter risks non-payment. A Letter of Credit also locks the importer in to the contract and ensures that they cannot renege or pull out of the deal.
Letters of Credit, a form of Documentary Collection, have been a cornerstone of international trade since the early 1900s.
They offer security, particularly when you are dealing with new customers and have not had the time to build a relationship of trust.
With a Letter of Credit you know that you will be paid, and don’t have to worry about your buyer’s willingness or ability to pay because a Letter of Credit guarantees payment for an export against receipt of specified documents.
As the exporter, you must make sure that you get the Letter of Credit before you start the production phase of the transaction: you definitely should have the Letter of Credit in place before you ship any products.
• The Letter of Credit must reflect the agreement you made with your buyer.
• You must be sure that you can adhere to all the requirements listed in the agreement such as latest shipping date and mode of transport, and that all documentation requested can be provided.
• Wording of the documentation is important, and all wording, descriptions, weights, etc., on documents must match.
• Once your products are shipped, lodge all the necessary documents with your bank. The bank will check that the documents meet the requirements in your Letter of Credit. Your documents must be in strict accordance with the Letter of Credit, otherwise your bank will not be able to claim payment from the issuing bank.
• Your bank will credit your account when they receive the funds from overseas. There may a slight time lag because the documents need to be checked by your bank, then sent via courier to the issuing bank overseas, and then to the customer. This means you will need to get the documents to your bank quickly, as soon as the shipping documents are available, otherwise your customer will incur demurrage charges at the port or airport for delays in picking up the goods.
• You may want to have your Letter of Credit confirmed or guaranteed by an Australian bank or take out export credit insurance. The cost of confirming a Letter of Credit depends on the risk associated with the market and bank overseas.
• If an American bank does not confirm your Letter of Credit and you do not have export credit insurance, you could run the risk of a foreign bank not performing and making payment to you.
When you use the Documentary Collection payment method, you entrust the handling of your trade documents to your bank:
• You, as exporter, produce and ship the goods, passing all the necessary documents to your bank along with a ‘Draft’ or ‘Bill of Exchange’ drawn on your buyer.
• Your bank passes the documents on to their agent bank in the buyer’s country.
• If the Draft is drawn ‘At Sight’ or ‘On Demand’, the buyer’s bank releases the documents – and therefore title to the goods – once the buyer makes payment.
• If the draft is drawn to mature at some future time, such as ’60 days After Sight’, the buyer will accept the bill of exchange agreeing to make the payment at an agreed, future date.
Documentary Collections are governed by International Chamber of Commerce rules. There are two main types:
- Documents against payment using a sight draft
- Documents against acceptance using a term draft.
Documents against acceptance’ is considered riskier than ‘Documents against payment’ because it relies on the customer making payment after the agreed time.
Your customers may ask you to offer credit terms or you may find that you need to match your competitors in this way.
The demand for your product, your price and how badly you need to do the business will all affect what terms you decide to offer. An Open Account, with an agreed payment period, is increasingly required by buyers.
Extending credit terms will have an impact. However, extending credit terms will have a real cost impact on your business because it impacts cash flow, so it is important to estimate the cost of the time it takes to receive payment at the end of the credit period and to build this cost into your price.
Open Account is the most inexpensive payment method and is commonly used in intra-company trading, or where the exporter and customer know each other well and wish to cut the cost of having Letters of Credit or Bills of Exchange.
The Open Account option is often requested by buyers but it should only ever be considered where you know a lot about the buyer and have absolute confidence in the integrity of the people involved.
The risk with Open Account is that the buyer can receive your goods and then not pay you, leaving you totally exposed to buyer credit risk, as well as possible country and currency risk.
Export Credit Insurance can help here, and may protect you from non-payment. Well-known names include Atradius and QBE Trade Credit. Export credit insurance needs to be arranged prior to shipping and can generally not be taken out once your customer has a track record of not paying or paying late.
Undertake your own due diligence on buyers
Part of the due diligence you undertake before doing business with a new customer should include credit checks, especially if you are considering offering credit terms. You can obtain these from companies like Dun & Bradstreet and Coface. In locations where commercial credit checks are unavailable, you may be able to get such service from the USCS through their International Company Profiles.