Cash in Advance

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.


Open Account

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:
- As with a D/P, the importer can refuse to accept the goods for any reason, even if they are in good condition.
- The buyer can default on the payment of a trade acceptance. Unless it has been guaranteed by the clearing bank, the seller will need to institute collection procedures and/or legal action.


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 Drafts

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.

Sight Drafts

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.


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:

a. 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.
b. The opening bank will inform The Bank of China that the L/C has been opened.
c. The Bank of China will inform us that the L/C has been established.
d. We'll check all the terms and conditions listed in the L/C. If all terms and conditions are acceptable, we'll arrange the shipment within the time specified in the L/C.
e. After the goods are loaded onto the ship without any damage, the captain will issue the clean bill of lading to us.
f. We will submit the clean bill of lading and other relevant documents to The Bank of China to gather the payment. Only with clean bill of lading can you claim the ownership of the goods.
g. The Bank of China will send the clean bill of lading and relevant documents to your bank (the opening bank).
h. The opening bank will inform you that all documents are received.
i. You will go to the bank to make the payment to get the clean bill of lading and relevan documents.
j. With all of these documents, you can clear the import Customs and pick up the goods after the goods arrive on the destination sea port.

The typical L/C scenario takes 14-21 days to complete.


Other Payment Mechanisms

Consignment sales

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.

Countertrade

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.


Foreign Currency

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.


Payment Problems

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.


Export Credit Insurance

The payments in International Trade can be insured. The credit insurance enables you to expand your exports without fear of loss. I suggest that you try to insure payments under documentary collections, consignment and open account terms. You may even consider the
insurance of the unconfirmed L/C.

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.


Mixed Payments

Quite often you can compromise with the buyer by using different terms of payment for one transaction.

Remember 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,
which has to be prepaid and the balance may be payable under different terms, L/C, for instance.

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.

If the mixed payments were negotiated, the proportion has to be clearly indicated in the contract of sale. For example:
"Terms of Payment:
20% cash with the order
80% by irrevocable Letter of Credit confirmed by first class bank and payable at sight via the-advising-bank's-name and location in favour of your-company-name"


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.