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Ranked from LEAST RISK to MOST RISK for the Seller.
When establishing international terms of payment it is a good idea to consult your banker.
|Method||Usual Time of Payment||Goods Available To Buyer||Risk to Seller||Risk to Buyer||Comments|
|CASH IN ADVANCE||Before shipment||After payment||None||Complete - relies on seller to ship exactly the goods expected, as quoted and ordered||Seller's goods must be special in one way or another, or special circumstances prevail over normal trade practices (example, goods manufactured to buyer-only specification).|
|CASH AGAINST DOCUMENTS||After shipment||After payment||If payment not honoured, goods must be returned or resold. Storage, handling, return freight expenses may be incurred||Assures shipment but not content, unless inspection or check-in is allowed before payment||Security to the seller is assured if the transfer of funds is confirmed prior to buyer taking possession of the goods.|
|LETTER OF CREDIT (See next two items.)||Commercial Invoice must match the Letter of Credit exactly. Dates must be carefully headed - "Stale" documents are unacceptable for collection.||Letters of Credit require total accuracy in conforming to terms, conditions, and documentation.|
|Confirmed Irrevocable Credit||After shipment is made, documents presented to the Bank||After payment||Gives the seller a double assurance of payments - Depends on the terms of the letter of credit.||Assures shipment is made but relies on exporter to ship goods as described in documents. Terms may be negotiated prior to letter of credit agreement, alleviating buyer's degree of risk.||The inclusion of a second assurance of payment (usually a "reputable" Bank) prevents surprises, adds assurance that issuing bank has been deemed acceptable by confirming bank. Adds cost and an additional requirement to seller.|
|Unconfirmed Irrevocable Credit||Same as above||Same as above||Seller has single bank assurance of payment and seller remains dependent on foreign bank. Seller should contact his banker to determine whether or not the issuing bank has sufficient assets to cover the amount.||Same as above||Credit can be changed only by mutual agreement, as stipulated in a sales agreement. Becomes open account with buyer's bank as collection agent. Foreign bank may have problems making payment in sum or timeliness.|
|DRAFTS/ BILLS OF EXCHANGE (See next two items.)||Remittance time from buyer's bank to seller's bank may still take one week to one month||Drafts, by design, should contain terms and conditions mutually agreed upon||A draft may be written with virtually any term or condition agreeable to both parties. When determining draft tenor (terms and conditions) consult with your banker and freight forwarder to determine the most desirable means of doing business in a given country.|
|Sight Draft (with documents against acceptance)||On presentation of draft to buyer.||After payment to buyer's bank.||If draft not honoured, goods must be returned or resold. Storage, handling, return freight expenses may be incurred.||Assures shipment but not content, unless inspection or check-in is allowed before payment.||A draft can be a collection instrument used to exchange possession and title to goods for payment. Seller is essentially drawing a check against the bank account of the buyer. Buyer's bank must have pre-approval, or seek approval of the buyer prior to honouring the check. Payable upon presentation of documents.|
|Time Drafts (with documents against acceptance)||On maturity of the draft||Before payment, after acceptance||Relies on buyer to honour draft upon presentation.||Assures shipment but not content, time of maturity allows for adjustments, if agreed to by seller.||Payable based upon the acceptance of an obligation to pay the seller at a specified time. Although a time draft has more collection leverage than an invoice, it remains only a promissory note, with conditions.|
|OPEN ACCOUNT||As agreed, usually by invoice||Before payment||Relies completely on buyer to pay account as agreed||None||All terms of payment, including extra charges and terms should be mutually understood and agreed upon prior to open account initiation. Companies conducting on-going business are candidates for open account terms of payment. Seller must measure not only buyer's credit reliability but the country's as well.|
Receiving payment by cash in advance of the shipment might seem ideal. In this situation, the exporter is relieved of collection problems and has immediate use of the money. A wire transfer is commonly used and has the advantage of being almost immediate. Payment by check, may result in a collection delay of up to six weeks. Therefore, this method may defeat the original intention of receiving payment before shipment.
Many exporters accept credit cards in payment for exports of consumer and other products, generally of a low follar value, sold directly to the end user. Domestic and international rules governing credit card transactions sometimes differ, so U.S. merchants should contact their credit card processor for more specific information. International credit card transactions are typically done by telephone or fax. Due to the nature of these methods, exporters should be aware of fraud. Merchants should determine the validity of transactions and obtain the proper authorizations.
For the buyer, however, advance payment tends to create cash flow problems, as well as increase risks. Furthermore, cash in advance is not as common in most of the world as it is in the United States. Buyers are often concerned that the goods may not be sent if payment is made in advance. Exporters that insist on this method of payment as their sole method of doing business may find themselves losing out to competitors who offer more flexible payment terms.
T/T payment in advance
T/T means telegraphic transfer, or simply wire transfer. It's the simplest and easiest payment method to use.
T/T payment in advance is usually used when the sample and small quantity shipments are transported by air. The reason why is that the documents like air waybill, commercial invoice and packing list will be sent to you along with the shipment by the same plane. As soon as the shipment arrives, you can clear the customs and pick up the goods with the documents. As it's acknowledged, T/T payment in advance presents risk to the importer if the supplier is not an honest one.
It takes 3-4 days for us to received the wire transfer made from anywhere in the world.
In a foreign transaction, an open account can be a convenient method of payment if the buyer is well established, has a long and favorable payment record, or has been thoroughly checked for creditworthiness. With an open account, the exporter simply bills the customer, who is expected to pay under agreed terms at a future date. Some of the largest firms abroad make purchases only on open account.
However, there are risks to open account sales. The absence of documents and banking channels might make it difficult to pursue the legal enforcement of claims. The exporter might also have to pursue collection abroad, which can be difficult and costly. Another problem is that receivables may be harder to finance, since drafts or other evidence of indebtedness are unavailable. There are several ways to reduce credit risk,through such means as export credit insurance and factoring.
Exporters contemplating a sale on open account terms should thoroughly examine the political, economic, and commercial risks. They should also consult with their bankers if financing will be needed for the transaction before issuing a pro forma invoice to a buyer.
D/P (documents against payment)
The exporter (we) makes shipment and sends the shipping documents to the exporter's bank (the Bank of China) for collection. The Bank of China then sends the shipping documents along with a collection letter to the importer's bank, who then sends a collection notice to the importer. The importer makes payment upon receiving the notice, and only after payment does the importer receive the original shipping documents with which you take the physical possession of the goods.
The major advantage of the use of a cash against documents payment is the low cost, versus using a letter of credit. But, this is offset by the risk that the importer will for some reason reject the documents (or they will not be in order). Since the cargo would already be loaded (to generate the documents), we have little recourse against the importer in cases of non-payment. So, a payment against documents arrangement involves a high level of trust between the exporter and the importer.
D/A (documents against acceptance)
The D/A transaction utilizes a term or time draft. In this case, the documents required to take possession of the goods are released by the clearing bank only after the buyer accepts a time draft drawn upon him. In essence, this is a deferred payment or credit arrangement. The buyer’s assent is referred to as a trade acceptance.
D/A terms are usually after sight, for instance “at 90 days sight”, or after a specific date, such as “at 150 days bill of lading date.”
As with open account terms, there are some inherent risks in selling on D/A:
Documentary Letters of Credit and Documentary Drafts
Documentary letters of credit or documentary drafts are often used to protect the interests of both buyer and seller. These two methods require that payment be made based on the presentation of documents conveying the title and that specific steps have been taken. Letters of credit and drafts can be paid immediately or at a later date. Drafts that are paid upon presentation are called sight drafts. Drafts that are to be paid at a later date, often after the buyer receives the goods, are called time drafts or date drafts.
Since payment by these two methods is made on the basis of documents, all terms of payment should be clearly specified in order to avoid confusion and delay. For example, "net 30 days" should be specified as "30 days from acceptance." Likewise, the currency of payment should be specified as "US$30,000." International bankers can offer other suggestions.
Banks charge fees - based mainly on a percentage of the amount of payment - for handling letters of credit and smaller amounts for handling drafts. If fees charged by both the foreign and U.S. banks are to be applied to the buyer's account, this should be explicitly stated in all quotations and in the letter of credit.
The exporter usually expects the buyer to pay the charges for the letter of credit, but some buyers may not agree to this added cost. In such cases, the exporter must either absorb the costs of the letter of credit or risk losing that potential sale. Letters of credit for smaller amounts can be somewhat expensive since fees can be high relative to the sale.
Documentary Collection (Draft)
Documentary collections are regulated by the Uniform Rules for Collections issued by the International Chamber of Commerce (URC 522). This document can also be obtained from the International Trade Department of your financial institution or from ICC Australia*.
Documentary Collection or Draft is the term when you ship the goods before the payment is made and then draw a draft on the buyer, not on the bank, like under L/C. Under documentary collections banks have no responsibility for the payment.
There are two types of documentary collections - sight draft, also know as "Documents Against Payment", and time draft, also known as "Documents Against Acceptance".
"Sight draft" is payable by the buyer immediately after notification by the buyer's bank of the receipt of the draft and transport documents.
Under this method of payment you (the Drawer) negotiate the terms with the buyer (the Drawee), specify the documents required for the payment, ship the goods and draw the draft on the buyer. The draft and the documents required for the payment are presented to your bank (Remitting Bank) and after examination are forwarded to the buyer's bank (Presenting Bank). The Presenting Bank holds the title documents (usually the transport documents) and will release them to the buyer only after the payment was made.
Sight draft procedure is shown in the diagram below:
1. The Drawer and the Drawee negotiate terms and conditions of the transaction
2. The Drawer ships the goods
3. The Drawer draws a draft and presents it to the Remitting Bank along with other documents
4. The Remitting Bank examines the documents and the draft and forwards them to the Presenting Bank
5. The Presenting Bank notifies the Drawee of receipt of the documents
6. The Presenting Bank holds the documents until the payment is made by the Drawee
7. The Drawee examines the documents and makes the payment for the supplied goods
8. The Presenting Bank releases the documents to the Drawee
Sight drafts have some similarity with L/C. You deal with documents and through banks, and the buyer cannot take the possession of the goods before the payment is occurred.
However, the payment is not guaranteed. If the buyer for any reason refuses to pay, you have to deal with goods "on the water" or stacked in the customs zone in a foreign country. It can be very costly to ship your goods back or to sell them urgently. In both cases, there are substantial additional expenses (warehousing, cost of transportation to a new destination, significant discount, etc.). In some cases, the buyer who failed to pay was one of the bidders at the resulting auction and had bought the goods for a fraction of the initial price.
is also possible, that the buyer will delay the payment. Although
legally the payment has to be made immediately upon receipt of the
draft by the buyer's bank, the buyer may hold the payment until the
goods are delivered.
Unlike the sight draft, when dealing with time drafts, the buyer may take possession of the goods before the payment. Under the time draft, you agree on a deferring period, ship the goods and draw a draft. For the title documents to be released, the buyer has to accept the draft by issuing written evidence of his willingness to pay on the agreed maturity date (usually by signing and dating the draft).
Dealing with the 'time draft', always draw a draft against the certain date specified in the other document. (For example, "Payable at 60 days after invoice date/bill of lading date/the draft date")
time draft, in fact, is very similar to "open account" terms
– you have no control over the goods, nor over the payment.
The only difference is that, in addition to the contract of sale, you
have the buyer's written guarantee to make a payment on a certain date.
You have to rely on the buyer. The consequences of the refusal to pay
are the same as the
are normally issued in a set of two (First of Exchange and Second of
Exchange) or singly (Sola Bill of Exchange). ) Two drafts are usually
drawn to ensure that at least one draft reaches the Drawee when they
are dispatched separately. When two drafts are issued they may be
numbered "1" and "2" and marked "First of Exchange (Second
A draft, sometimes also called a bill of exchange, is analogous to a foreign buyer's check. Like checks used in domestic commerce, drafts carry the risk that they will be dishonored. However, in international commerce, title does not transfer to the buyer until he pays the draft, or at least engages a legal undertaking that the draft will be paid when due.
A sight draft is used when the exporter wishes to retain title to the shipment until it reaches its destination and payment is made. Before the shipment can be released to the buyer, the original ocean bill of lading (the document that evidences title) must be properly endorsed by the buyer and surrendered to the carrier. It is important to note that air waybills of lading, on the other hand, do not need to be presented in order for the buyer to claim the goods. Hence, risk increases when a sight draft is being used with an air shipment.
In actual practice, the ocean bill of lading is endorsed by the exporter and sent via the exporter's bank to the buyer's bank. It is accompanied by the sight draft, invoices, and other supporting documents that are specified by either the buyer or the buyer's country (e.g., packing lists, consular invoices, insurance certificates). The foreign bank notifies the buyer when it has received these documents. As soon as the draft is paid, the foreign bank turns over the bill of lading thereby enabling the buyer to obtain the shipment.
There is still some risk when a sight draft is used to control transferring the title of a shipment. The buyer's ability or willingness to pay might change from the time the goods are shipped until the time the drafts are presented for payment; there is no bank promise to pay standing behind the buyer's obligation. Additionally, the policies of the importing country could also change. If the buyer cannot or will not pay for and claim the goods, returning or disposing of the products becomes the problem of the exporter.
Time Drafts and Date Drafts
A time draft is used when the exporter extends credit to the buyer. The draft states that payment is due by a specific time after the buyer accepts the time draft and receives the goods (e.g., 30 days after acceptance). By signing and writing "accepted" on the draft, the buyer is formally obligated to pay within the stated time. When this is done the time draft is then called a trade acceptance. It can be kept by the exporter until maturity or sold to a bank at a discount for immediate payment.
A date draft differs slightly from a time draft in that it specifies a date on which payment is due, rather than a time period after the draft is accepted. When either a sight draft or time draft is used, a buyer can delay payment by delaying acceptance of the draft. A date draft can prevent this delay in payment though it still must be accepted.
When a bank accepts a draft, it becomes an obligation of the bank and thus, a negotiable investment known as a banker's acceptance. A banker's acceptance can also be sold to a bank at a discount for immediate payment.
Letters of Credit
A letter of credit adds a bank's promise to pay the exporter to that of the foreign buyer provided that the exporter has complied with all the terms and conditions of the letter of credit. The foreign buyer applies for issuance of a letter of credit from the buyer's bank to the exporter's bank and therefore is called the applicant; the exporter is called the beneficiary.
Payment under a documentary letter of credit is based on documents, not on the terms of sale or the physical condition of the goods. The letter of credit specifies the documents that are required to be presented by the exporter, such as an ocean bill of lading (original and several copies), consular invoice, draft, and an insurance policy. The letter of credit also contains an expiration date. Before payment, the bank responsible for making payment, verifies that all document conform to the letter of credit requirements. If not, the discrepancy must be resolved before payment can be made and before the expiration date.
A letter of credit issued by a foreign bank is sometimes confirmed by a U.S. bank. This confirmation means that the U.S. bank (the confirming bank), adds its promise to pay to that of the foreign bank (the issuing bank). If a letters of credit is not confirmed, it is advised through a U.S. bank and thus called an advised letter of credit. U.S. exporters may wish to confirm letters of credit issued by foreign banks if they are unfamiliar with the foreign banks or concerned about the political or economic risk associated with the country in which the bank is located. An Export Assistance Center or international banker can assist exporters in evaluating the risks to determine what might be appropriate for specific export transactions.
A letter of credit may either be irrevocable and thus, unable to be changed unless both parties agree; or revocable where either party may unilaterally make changes. A revocable letter of credit is inadvisable as it carries many risks for the exporter.
A change made to a letter of credit after it has been issued is called an amendment. Banks also charge fees for this service. It should be specified in the amendment if the exporter or the buyer will pay these charges. Every effort should be made to get the letter of credit right the first time since these changes can be time-consuming and expensive.
To expedite the receipt of funds, wire transfers may be used. Exporters should consult with their international bankers about bank charges for such services.
A Typical Letter of Credit Transaction
Here are the typical steps of an irrevocable letter of credit that has been confirmed by a U.S. bank:
1. After the exporter and buyer agree on the terms of a sale, the buyer arranges for its bank to open a letter of credit that specifies the documents needed for payment. The buyer determines which documents will be required.
2. The buyer's bank issues, or opens, its irrevocable letter of credit includes all instructions to the seller relating to the shipment.
3. The buyer's bank sends its irrevocable letter of credit to a U.S. bank and requests confirmation. The exporter may request that a particular U.S. bank be the confirming bank, or the foreign bank may select a U.S. correspondent bank.
4. The U.S. bank prepares a letter of confirmation to forward to the exporter along with the irrevocable letter of credit.
5. The exporter reviews carefully all conditions in the letter of credit. The exporter's freight forwarder is contacted to make sure that the shipping date can be met. If the exporter cannot comply with one or more of the conditions, the customer is alerted at once.
6. The exporter arranges with the freight forwarder to deliver the goods to the appropriate port or airport.
7. When the goods are loaded, the freight forwarder completes the necessary documentation.
8. The exporter (or the freight forwarder) presents the documents, evidencing full compliance with the letter of credit terms, to the U.S. bank.
9. The bank reviews the documents. If they are in order, the documents are sent to the buyer's bank for review and then transmitted to the buyer.
10. The buyer (or the buyer's agent) uses the documents to claim the goods.
11. A draft, which accompanies the letter of credit, is paid by the buyer's bank at the time specified or, if a time draft, may be discounted to the exporter's bank at an earlier date.
Example of a Confirmed Irrevocable Letter of Credit
The example of a confirmed irrevocable letter of credit in (see below) illustrates the various parts of a typical letter of credit. In this sample, the letter of credit was forwarded to the exporter, The Walton Building Supply Company (A), by the confirming bank, Megabank Corporation (B), as a result of c letter of credit being issued by the Third Hong Kong Bank, Hong Kong (C), for the account of the importer, HHB Hong Kong (D). The date of issue was March 8, 1997 (E), and the exporter must submit the proper documents (e.g., a commercial invoice in one original and three copies) (F) by June 23, 1997 (G) in order for a sight draft (H) to be honored.
Tips on Using a Letter of Credit
When preparing quotations for prospective customers, exporters should keep in mind that banks pay only the amount specified in the letter of credit - even if higher charges for shipping, insurance, or other factors are incurred and documented.
Upon receiving a letter of credit, the exporter should carefully compare the letter's terms with the terms of the exporter's pro forma quotation. This step is extremely important, since the terms must be precisely met or the letter of credit may be invalid and the exporter may not be paid. If meeting the terms of the letter of credit is impossible or if any of the information is incorrect or even misspelled, the exporter should contact the customer immediately and ask for an amendment to the letter of credit.
The exporter must provide documentation showing that the goods were shipped by the date specified in the letter of credit or the exporter may not be paid. Exporters should check with their freight forwarders to make sure that no unusual conditions may arise that would delay shipment.
Documents must be presented by the date specified for the letter of credit to be paid. Exporters should verify with their international bankers that there will be sufficient time to present the letter of credit for payment.
Exporters may request that the letter of credit specify that partial shipments and transshipment will be allowed. Specifying what will be allowed can prevents unforeseen last minute problems.
Letter of Credit
An irrevocable Letter of Credit is also an often used payment method. It is often referred to an L/C. Letters of Credit are formal payment methods that offer a lot of protection to the parties.
Simply put, a letter of credit is a letter written by the importer's bank to the exporter. It verifies that the payment will be guaranteed when the bank is presented with the concrete documents (bill of lading, and freight documents). Most letters of credit are "irrevocable" once the importer has had them sent.
A letter of credit usually includes applicant (you, the importer), beneficiary (our I/E agent), opening bank, negotiating bank, specification and quantity of the goods, amount of money, loading port and destination port, shipment date, the validity date of the L/C, terms and conditions agreed by both the importer and seller, and the documents required by the importers (bill of lading, commercial invoice, packing list, insurance certificate, etc.)
The L/C payment procedure is usually as follows:
You (the importer) applies to open the L/C to us (the seller) through a
bank who can open the L/C in your country.
The typical L/C scenario takes 14-21 days to complete.
Letter Of Credit (L/C)
is the most used payment term in International Trade and I'll be fairly
specific on this topic. L/C is a perfect procedure to equally protect
your interests and your buyer's interests. Using L/C as a term of
payment, you risk almost nothing and at the same time it
Before choosing L/C as a term of trade, you must understand what it is, how it works and what you can do to minimise risks involved in the L/C payment process.
L/C, its Forms and Types
Letters of Credit are regulated by International Chamber of Commerce under the Uniform Customs and Practice for Documentary Credits (UCP 500). I strongly recommend you obtain this document from the International Trade Department of your financial institution or from ICC Australia* and read it very carefully. Sometimes it's difficult to understand what it means, as the document is drafted for the banking professionals and its language is very technical. Do not hesitate to call your bank and ask questions. Any mistakes, unclear or incorrectly stipulated terms, even typos in a L/C may cost you dearly.
In "plain English", L/C is a conditional bank guarantee of payment for supplied goods. "Conditional" means that to get paid you have to present the bank-guarantor with documents, which strictly comply with the terms and conditions specified in the L/C.
There are different forms and types of L/C, which you may (or should not) use in your operations, viz
Revocable and Irrevocable L/C
Agree that the L/C is irrevocable before you go any further in your L/C negotiations. Although UCP 500 requires that L/C should indicate whether it is revocable or irrevocable (Article 6, b), it also says "in the absence of such indication the Credit shall be deemed to be irrevocable." (Article 6, c)
"can be transferred only if it is expressly designated as
"transferable" (UCP 500, Article 48, b). Transferable L/C must
correspond with the original L/C, "with the exception of:
L/C payable at sight
L/C payable on the maturity date
The payments under L/C are usually made by the bank upon receipt of the documents stipulated in the L/C and a bill of exchange issued by you.
The bill of exchange (the draft) is an unconditional order in writing, signed and addressed by the drawer (you) to the drawee (the paying bank), requiring the drawee to pay the drawer a certain sum of money according to the terms of the L/C.
Under L/C, always draw the draft on the bank, not on the buyer.
How L/C works
diagram below shows how participants are involved in the process of
payment under L/C:
Another party, which may be involved in the L/C procedure, is the Nominated Bank.
The Advising Bank is not necessarily a bank where you usually banking. Shop around. Try to find a bank, which has a corresponding bank in your buyer's country and can offer you a better deal in terms of charges involved in the payment under L/C.
The Issuing Bank
If the Advising Bank does not have a corresponding bank in the buyer's country, ask the bank to recommend you a well-known bank with high credit rating and insist your buyer has the L/C issued by this bank. The Advising Bank will be able to provide you with the information on financial status and credibility of the Issuing Bank.
If the Issuing Bank is not internationally recognised and your banker or you have any doubts that the Issuing Bank, for any political or economical reason, may fail to make a payment under the L/C, I would strongly recommend that the L/C be confirmed by another bank.
The Nominated Bank
Confirmation of L/C
The best-case scenario is when the Advising Bank confirms the L/C. If the Advising Bank does not agree to confirm the L/C, ask the bank to recommend you another bank to be the Confirming Bank.
Keep in mind that "Branches of a bank in different countries are considered another bank." (UCP 500, Article 2). That means that Citibank in Poland, for instance, is an independent financial institution and has its own financial status and credit rating, which is very different compared with the rating of Citibank in Australia.
If you are dealing with a buyer from a country with an unstable political or economical situation, always ask for the confirmation of the L/C.
There are additional charges for the confirmation of the L/C, which depend on the risk involved in dealing with the particular country. The responsibility to pay for the confirmation is negotiable and usually is paid by the buyer. However, if it wasn't agreed prior to the issuance of the L/C, you are the one who will pay for this service.
When L/C is to be confirmed the payment process is different and is shown in the following diagram:
There is another advantage in using confirmed L/C. Assume that after long negotiations your potential buyer is ready to strike a deal, which is very profitable for you. The only condition you are not comfortable with is the deferred payment of 90 days after the shipping date. You feel that you may have some problems with cash flow, because you have to pay for the freight, packaging and so on. Well, with the confirmed L/C you won't.
A confirmed L/C may be used not only for securing the payment under the L/C but also as a security to obtain additional funds from the Advising Bank. Generally, the Advising Bank can discount the L/C in your favour as soon as the documents stipulated in the L/C are presented to the bank and checked. The funds will be considered as a loan, which will be automatically reimbursed by the Confirming Bank on the maturity date indicated in the L/C.
Information that an
- Full Applicant's name and address
Documents that may
be stipulated in
I would like to underline that there is a difference between the documents you have to present under the L/C and the documents you have to supply according to the contract. It is not necessary to mention all documents required by the contract in the L/C.
Most likely, you will be required to present a commercial invoice, a transport document and an insurance policy (certificate).
list of additional documents depends on the agreement made between you
and the buyer. Usually the buyer will include documents needed for the
customs clearance. The list may include:
- Certificate of origin
The detailed explanation of the above documents is given in the "Export Documentation" section of these tutorials.
relation to L/C, there are several issues about the documents you
should keep in mind:
- Specify how many original documents and how many copies are to be presented.
Delays cause troubles
- the latest date for shipment,
When negotiating the date of shipment, be sure that you are able to ship the goods before this date. Always allow extra time for the amendments of the L/C. If the L/C contains any errors or you cannot fulfill all terms and conditions stipulated in the L/C do not ship the goods until all necessary amendments are made. Do not forget to include the amendment allowing "later shipment".
Try to obtain all possible documents before the shipment. If the document can be issued only after the goods are shipped (e.g. transport documents), be sure that you'll get it before the date stated in the L/C. If L/C does not indicate the date of presentation of the documents, "banks will not accept documents presented to them later than 21 days after the date of shipment". (UCP 500, Article 43, a)
The expiry date of the L/C should allow you not only to assemble and check all documents but also to correct errors, which might be identified by the bank. The bank has up to 7 days to examine the documents and inform you if there are any discrepancies. These discrepancies must be corrected and the documents must be resubmitted to the bank prior to the expiry date. "In any event, documents must be presented not later than the expiry date of the Credit." (UCP 500, Article 43, a)
If the agreed delivery terms include freight (e.g. CFR, CIF, CIP), then the L/C will require that the transport document clearly indicate that freight has been paid or prepaid and the words "Freight Prepared" appear on the transport document.
"The words "freight prepayable" or "freight to be prepaid" or words of similar effect, if appearing on transport documents, will not be accepted as constituting evidence of the payment of freight" (UCP 500, Article 33, c)
If the agreed delivery terms do not include freight (e.g. EXW, FCA, FAS, FOB), then the L/C will require that the transport document indicate that freight is to be paid by the buyer and the words "Freight Collect" appear on the transport document.
Minimising the risks
- Prior to the issuance of the L/C, negotiate exactly what documents must be presented to the bank.
Other Payment Mechanisms
International consignment sales follow the same basic procedures as in the United States. The goods are shipped to a foreign distributor who sells them on behalf of the exporter. The exporter retains title to the goods until they are sold, at which point payment is sent to the exporter. The exporter has the greatest risk and least control over the goods with this method. Additionally, receiving payment may take quite a while.
It is wise to consider risk insurance with international consignment sales. The contract should clarify who is responsible for property risk insurance that will cover the merchandise until it is sold and payment is received. In addition, it may be necessary to conduct a credit check on the foreign distributor.
International countertrade is a trade practice whereby one party accepts goods, services, or other instruments of trade in partial or whole payment for its products. This type of trade fulfills financial, marketing, or public policy objectives of the trading parties. For example, a firm might trade by bartering because it or its trading partner lacks foreign exchange.
Many U.S. exporters consider countertrade a necessary cost of doing business in markets where U.S. exports would otherwise not be sold. One consideration for smaller firms is that this type of trade may cause cash flow problems. Therefore, many smaller exporters do not consider this an option as they wish to do business in U.S. dollars.
There are several types of countertrade, including counterpurchase and barter. Counterpurchase is quite common. In this situation, exporters agree to purchase a quantity of goods from a country in exchange for that country's purchase of the exporter's product. These goods are typically unrelated but have an equivalent value. Another form of this practice is contractually linked, parallel trade transactions that each involve a separate financial settlement. For example, a countertrade contract may provide that the U.S. exporter will be paid in a convertible currency as long as the U.S. exporter (or another entity designated by the exporter) agrees to purchase a related quantity of goods from the importing country.
Barter arrangements in international commerce are not as common, because the parties' needs for the goods of the other seldom coincide and because valuation of the goods may be problematic. This type of countertrade occurs without money exchanging hands as merchandise is traded directly for other merchandise or services. Barter might occur by swapping (one good for another) or by switching (using a chain of buyers and sellers in different markets to barter).
U.S. exporters can take advantage of countertrade opportunities by trading through an intermediary with countertrade expertise, such as an international broker, an international bank, or an export management company. One drawback to this type of exporting is that there are often higher transaction costs and greater risks than with other kinds of export transactions.
The Department of Commerce can advise and assist U.S. exporters on countertrade requirements. The Financial Services and Countertrade Division of ITA's Office of Finance, monitors countertrade trends, disseminates information (including lists of potentially beneficial countertrade opportunities), and provides general assistance to enterprises seeking barter and countertrade opportunities. For more information, contact the Financial Services and Countertrade Division/Office of Finance, International Trade Administration, U.S. Department of Commerce, Washington, D.C. 20230; telephone 202-482-4471.
A buyer and a seller who are in different countries rarely use the same currency. Payment is usually made in either the buyer's or the seller's currency or in a third mutually agreed-upon currency.
One of the risks associated with foreign trade is the uncertainty of the future exchange rates. The relative value between the two currencies could change between the time the deal is concluded and the time payment is received. If the exporter is not properly protected, a devaluation or depreciation of the foreign currency could cause the exporter to lose money. For example, if the buyer has agreed to pay 500,000 French francs for a shipment and the franc is valued at 20 cents, the seller would expect to receive US$100,000. If the franc later decreased in value to be worth 19 US cents, payment under the new rate would be only US$95,000, a loss of US$5,000 for the seller. On the other hand, if the foreign currency increases in value the exporter would get a windfall in extra profits. Nonetheless, most exporters are not interested in speculating on foreign exchange fluctuations and prefer to avoid risks.
If the buyer asks to make payment in a foreign currency, the exporter should consult an international banker before negotiating the sales contract. Banks can offer advice on the foreign exchange risks that exist with a particular currency. Some international banks can also help hedge against such a risk, by agreeing to purchase the foreign currency at a fixed price in dollars, regardless of the currencies value at the time the customer pays. Banks will normally charge a fee or discount the transaction for this service. If this mechanism is used, the bank's fee should be included in the price quotation.
In international trade, problems involving bad debts are more easily avoided than rectified after they occur. Credit checks and the other methods that have been discussed in this chapter can limit the risks. Nonetheless, just as in a company's domestic business, exporters occasionally encounter problems with buyers who default on their payment. When these problems occur in international trade, obtaining payment can be both difficult and expensive. Even when the exporter has insurance to cover commercial credit risks, a default by a buyer still requires the time, effort, and cost of the exporter to collect a payment. The exporter must exercise normal business prudence in exporting and exhaust all reasonable means of obtaining payment before an insurance claim is honored. Even then there is often a significant delay before the insurance payment is made.
The simplest (and least costly) solution to a payment problem is to contact and negotiate with the customer. With patience, understanding, and flexibility, an exporter can often resolve conflicts to the satisfaction of both sides.
This point is especially true when a simple misunderstanding or technical problem is to blame and there is no question of bad faith. Even though the exporter may be required to compromise on certain points - perhaps even on the price of the committed goods - the company may save a valuable customer and profit in the long run.
However, if negotiations fail and the sum involved is large enough to warrant the effort, a company should obtain the assistance and advice of its bank, legal counsel, and other qualified experts. Since arbitration is often faster and less costly, this step is preferable to legal action if both parties can agree to take their dispute to an arbitration agency. The International Chamber of Commerce handles the majority of international arbitration and is usually acceptable to foreign companies because it is not affiliated with any single country. For information contact the vice president for arbitration, U.S. Council of the International Chamber of Commerce, telephone 212-354-4480.
The export credit insurance, issued by a financial institution in your favour, protects you against non-payments by the buyer or by the Issuing Bank (in case of insuring an unconfirmed L/C) due to commercial (insolvency, fraud) or political risk. In case of non-payment, you will usually receive 80-90% of the debt.
The credit insurance not only guarantees you the payment, but also enables you to provide better terms to your buyers. Remember the dilemma between high and low risk payment terms? Well, credit insurance is the solution for this predicament.
The insured payment also allows you to obtain additional funds from a bank. Similar to the discounting of funds under confirmed L/C, your bank will usually provide you with trade finance and use your credit insurance as a security.
Quite often you can compromise with the buyer by using different terms of payment for one transaction.
that I suggested you insist the buyer pay in advance when the goods are
required to be customised? I also mentioned that "cash in advance" is
the least preferred term for the buyer. The solution is mixed payments.
You estimate the cost involved in customisation,
When you experience difficulties with cash flow and do not have available funds to prepay freight and other pre-shipment expenses, you also may consider mixed payments.
Using mixed payments, you can avoid losses, which occur when the buyer refuses the payment under the sight draft.
the mixed payments were negotiated, the proportion has to be clearly
indicated in the contract of sale. For example:
Sample Draft/Transmittal Letter
1. U.S. DOLLARS - Enter the entire amount to be collected; if not in U.S. dollars, specify currency.
2. DATE - Enter the date the Draft is issued.
3. OF THIS FIRST EXCHANGE (SECOND UNPAID) - Enter the terms of payment (also called the Tenor of the draft): at 45 Days, at Sight, At 30 days B/L, etc. "Second Unpaid" refers to the duplicate copy of the draft (OF THIS SECOND EXCHANGE, FIRST UNPAID); once payment has been made against either copy, the other becomes void.
4. PAY TO THE ORDER OF - Enter the name of the party to be paid (Seller, "Payee"); this may be the the Seller of the Seller's bank, and will be the party to whom the foreign Buyer's bank will remit payment.
5. UNITED STATES DOLLARS - Enter the amount from Field 1 in words; if payment is not to be made in U.S. Dollars, block out "United States Dollar" and enter correct currency.
6. CHARGE TO ACCOUNT OF - Enter the name and address of the paying party (Buyer, "Drawee"). For Letter of Credit payments, enter the name and address of the Buyer's opening bank as well as the L/C number and issue date.
7. NUMBER - Enter an identification, or Draft, number, as assigned by the Seller to reference the transaction.
8. AUTHORIZED SIGNATURE - The signature of the authorized individual for the Seller or the seller's agents ("Drawer").
9. FORWARD DRAFT TO - Enter the name and address to whom the Draft is being sent. Unless this is a letter of credit being negotiated in the U.S., this should be the name and address of a foreign bank.
10. FORWARDING DATE - Enter the date the Draft is being sent to the bank in Field 9.
11. DRAFT NUMBER - Enter the Seller's Draft number, as noted in Field 7 above.
12. PURPOSE OF DRAFT - Check the applicable box if the draft is part of letter of credit negotiation, a collection, or an acceptance.
13. LIST OF DOCUMENTS - Enter the number and type of each original and duplicate document to be included with this Transmittal Letter. Any document attached will eventually be released to the Buyer.
14. DELIVER ALL DOCUMENTS - Check either "Deliver all documents in one mailing" or "Deliver documents in two mailings." Generally, documents are delivered in one mailing.
15. DELIVER DOCUMENTS AGAINST - Ensure that the type of Draft attached (Block 3) is compatible with the "deliver against" instructions. Sight Drafts should accompany "Deliver against Payment" instructions, while Time Drafts should accompany "Deliver against Acceptance" instructions.
16. BANK CHARGES - The correspondent bank will not pay unless all charges are collected. Based on your agreement with the Buyer, indicate which party is responsible for both the remitting and presenting bank's charges. By checking "all charges for Account of Drawee," the Buyer is responsible for these charges; if the Buyer does not pay (or is not to pay) these charges, and id "Do Not Waive Charges" has not been checked, the Seller will be billed for expenses incurred.
17. PROTEST - Check "Protest" (specify "for nonpayment" or for "non-acceptance," depending on the type of draft attached - see instruction, Field 15) if you wish the correspondent bank to process written, notarized documentation in event that the Buyer refuses to pay or accept the Draft. Additional Bank expenses associated with a protest are usually charged to the Seller.
18. PRESENT ON ARRIVAL - Check if you wish the Draft to be presented on the arrival of the goods to the Buyer.
19. ADVISE - Check the appropriate blocks, and block-out the non-applicable terms, if you wish to be advised of payment/acceptance or non-payment or non-payment/non-acceptance.
20. IN CASE OF NEED - Enter the representative of the Seller in the country to which the Draft and documents are going, if one exists; check the block which describes the representative's authority.
21. OTHER INSTRUCTIONS - Enter any instructions to either the remitting or correspondent banks, such as remittance instructions, clarification of protest procedures, multiple-draft instructions, etc.
22. REFER ALL QUESTIONS - Enter the name of the contact, and his/her address & telephone number, in the Seller's country; specify if this contact is employed by the Shipper (Seller) or the Seller's agent (Freight Forwarder).
23. AUTHORIZATION - Enter the person authorized to sign the Transmittal Letter (see Field 8 above), the date prepared, and the authorized person's signature.
Sample Irrevocable Letter of Credit
The example of a confirmed irrevocable letter of credit in illustrates the various parts of a typical letter of credit. In this sample, the letter of credit was forwarded to the exporter, The Walton Building Supply Company (A), by the confirming bank, Megabank Corporation (B), as a result of c letter of credit being issued by the Third Hong Kong Bank, Hong Kong (C), for the account of the importer, HHB Hong Kong (D). The date of issue was March 8, 1997 (E), and the exporter must submit the proper documents (e.g., a commercial invoice in one original and three copies) (F) by June 23, 1997 (G) in order for a sight draft (H) to be honored.