METHODS OF PAYMENT
There are several basic methods of receiving payment for
products sold abroad. As with domestic sales, a major
factor that determines the method of payment is the amount
of trust in the buyer's ability and willingness to pay. For
sales within the United States, if the buyer has good
credit, sales are usually made on open account; if not,
cash in advance is required. For export sales, these same
methods may be used; however, other methods are also often
used in international trade. Ranked in order from most
secure for the exporter to least secure, the basic methods
of payment are
- cash in advance,
- letter of credit,
- documentary collection or draft,
- open account, and
- other payment mechanisms, such as consignment sales.
Since getting paid in full and on time is of utmost concern
to exporters, risk is a major consideration. Many factors
make exporting riskier than domestic sales. However, there
are also several methods of reducing risks. One of the most
important factors in reducing risks is to know what risks
exist. For that reason, exporters are advised to consult an
international banker to determine an acceptable method of
payment for each specific transaction.
CASH IN ADVANCE
Cash in advance before shipment may seem to be the most
desirable method of all, since the shipper is relieved of
collection problems and has immediate use of the money if a
wire transfer is used. Payment by check, even before
shipment, may result in a collection delay of four to six
weeks and therefore frustrate the original intention of
payment before shipment. On the other hand, advance payment
creates cash flow problems and increases risks for the
buyer. Thus, cash in advance lacks competitiveness; the
buyer may refuse to pay until the merchandise is received.
DOCUMENTARY LETTERS OF CREDIT AND DRAFTS
The buyer may be concerned that the goods may not be sent
if the payment is made in advance. To protect the interests
of both buyer and seller, documentary letters of credit or
drafts are often used. Under these two methods, documents
are required to be presented before payment is made. Both
letters of credit and drafts may be paid immediately, at
sight, or at a later date. Drafts that are to be paid when
presented for payment are called sight drafts. Drafts that
are to be paid at a later date, which is often after the
buyer receives the goods, are called time drafts or date
drafts.
Since payment under these two methods is made on the basis
of documents, all terms of sale should be clearly
specified. For example, "net 30 days" should be specified
as "net 30 days from acceptance" or "net 30 days from date
of bill of lading" to avoid confusion and delay of payment.
Likewise, the currency of payment should be specified as
"US$XXX" if payment is to be made in U.S. dollars.
International bankers can offer other suggestions to help.
Banks charge fees -- usually a small percentage of the
amount of payment -- for handling letters of credit and
less for handling drafts. If fees charged by both the
foreign and U.S. banks for their collection services are to
be charged to the account of the buyer, this point should
be explicitly stated in all quotations and on all drafts.
The exporter usually expects the buyer to pay the charges
for the letter of credit, but some buyers may not accept
terms that require this added cost. In such cases the
exporter must either absorb the letter of credit costs or
lose that potential sale.
Letters of credit
A letter of credit adds a bank's promise of paying the
exporter to that of the foreign buyer when 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 to the exporter 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 condition of the
goods sold. Before payment, the bank responsible for making
payment verifies that all documents are exactly as required
by the letter of credit. When they are not as required, a
discrepancy exists, which must be cured before payment can
be made. Thus, the full compliance of documents with those
specified in the letter of credit is mandatory.
Often a letter of credit issued by a foreign bank is
confirmed by a U.S. bank. This means that the U.S. bank,
which is the confirming bank, adds its promise to pay to
that of the foreign, or issuing, bank. Letters of credit
that are not confirmed are advised through a U.S. bank and
are called advised letters of credit. U.S. exporters may
wish to confirm letters of credit issued by foreign banks
not only because they are unfamiliar with the credit risk
of the foreign bank but also because there may be concern
about the political or economic risk associated with the
country in which the bank is located. An international
banker or the local U.S. Department of Commerce district
office can help exporters evaluate these risks to determine
what might be appropriate for each specific export
transaction.
A letter of credit may be either irrevocable (that is, it
cannot be changed unless both the buyer and the seller
agree to make the change) or revocable (that is, either
party may unilaterally make changes). A revocable letter of
credit is inadvisable. A letter of credit may be at sight,
which means immediate payment upon presentation of
documents, or it may be a time or date letter of credit
with payment to be made in the future. See the "Drafts"
section of this chapter.
Any change made to a letter of credit after it has been
issued is called an amendment. The fees charged by the
banks involved in amending the letter of credit may be paid
by either the exporter or the foreign buyer, but who is to
pay which charges should be specified in the letter of
credit. Since changes can be time-consuming and expensive,
every effort should be made to get the letter of credit
right the first time.
An exporter is usually not paid until the advising or
confirming bank receives the funds from the issuing bank.
To expedite the receipt of funds, wire transfers may be
used. Bank practices vary, however, and the exporter may be
able to receive funds by discounting the letter of credit
at the bank, which involves paying a fee to the bank for
this service. Exporters should consult with their
international bankers about bank policy.
A Typical Letter of Credit Transaction
Here is what typically happens when payment is made by an
irrevocable letter of credit confirmed by a U.S. bank:
- After the exporter and customer agree on the terms of
a sale, the customer arranges for its bank to open a
letter of credit. (Delays may be encountered if, for
example, the buyer has insufficient funds.)
- The buyer's bank prepares an irrevocable letter of
credit, including all instructions to the seller
concerning the shipment.
- The buyer's bank sends the irrevocable letter of
credit to a U.S. bank, requesting confirmation. The
exporter may request that a particular U.S. bank be
the confirming bank, or the foreign bank selects one
of its U.S. correspondent banks.
- The U.S. bank prepares a letter of confirmation to
forward to the exporter along with the irrevocable
letter of credit.
- The exporter reviews carefully all conditions in the
letter of credit. The exporter's freight forwarder
should be 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 should be
alerted at once.
- The exporter arranges with the freight forwarder to
deliver the goods to the appropriate port or airport.
- When the goods are loaded, the forwarder completes the
necessary documents.
- The exporter (or the forwarder) presents to the U.S.
bank documents indicating full compliance.
- The bank reviews the documents. If they are in order,
the documents are airmailed to the buyer's bank for
review and transmitted to the buyer.
- The buyer (or agent) gets the documents that may be
needed to claim the goods.
- A draft, which may accompany the letter of credit, is
paid by the exporter's bank at the time specified or
may be discounted at an earlier date.
Example of a Confirmed Irrevocable Letter of Credit
The example of a confirmed irrevocable letter of credit in
figure 13-1 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 Supplies
Company (A) by the drawee bank, C&S/Sovran Corporation (B)
as a result of the letter of credit being issued by the
First Hong Kong Bank, Hong Kong (C), for the account of the
importer, BBH Hong Kong (D). The date of issue was March 8,
1991 (E), and the exporter must submit proper documents
(e.g., a commercial invoice in one original and three
copies) (F) by June 23, 1991 (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
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 point 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 any of the information is incorrect or
misspelled, the exporter should get in touch with the
customer immediately and ask for an amendment to the letter
of credit to correct the problem.
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.
Similarly, documents must be presented by the date
specified for the letter of credit to be paid. Exporters
should verify with their international bankers that
sufficient time will be available for timely presentation.
International letters of credit are usually governed by
uniform customs and practices or by ICC Publication No.
- International bankers may be consulted for more
information.
Exporters should always request that the letter of credit
specify that partial shipments and transshipment will be
allowed. Doing so prevents unforeseen problems at the last
minute.
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 sometimes carry the risk that
they will be dishonored.
Sight Drafts_
A sight draft is used when the seller wishes to retain
title to the shipment until it reaches its destination and
is paid for. Before the cargo can be released, the original
ocean bill of lading must be properly endorsed by the buyer
and surrendered to the carrier, since it is a document that
evidences title.
Air waybills of lading, on the other hand, do not need to
be presented in order for the buyer to claim the goods.
Hence, there is a greater risk when a sight draft is being
used with an air shipment.
In actual practice, the bill of lading or air waybill is
endorsed by the shipper and sent via the shipper's bank to
the buyer's bank or to another intermediary along with a
sight draft, invoices, and other supporting documents
specified by either the buyer or the buyer's country (e.g.,
packing lists, consular invoices, insurance certificates).
The bank notifies the buyer when it has received these
documents; as soon as the amount of the draft is paid, the
bank releases the bill of lading, enabling the buyer to
obtain the shipment.
When a sight draft is being used to control the transfer of
title of a shipment, some risk remains because the buyer's
ability or willingness to pay may change between the time
the goods are shipped and the time the drafts are presented
for payment. Also, the policies of the importing country
may change. If the buyer cannot or will not pay for and
claim the goods, then returning or disposing of them
becomes the problem of the exporter.
Exporters should also consider which foreign bank should
negotiate the sight draft for payment. If the negotiating
bank is also the buyer's bank, the bank may favor its
customer's position, thereby putting the exporter at a
disadvantage. Exporters should consult their international
bankers to determine an appropriate strategy for
negotiating drafts.
Time Drafts and Date Drafts_
If the exporter wants to extend credit to the buyer, a time
draft can be used to state that payment is due within a
certain time after the buyer accepts the draft and receives
the goods, for example, 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 draft is called a trade acceptance and can be
either 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, for example,
December 1, 19XX, rather than a time period after the draft
is accepted. When 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 but
still must be accepted.
When a bank accepts a draft, it becomes an obligation of
the bank and a negotiable investment known as a banker's
acceptance is created. A banker's acceptance can also be
sold to a bank at a discount for immediate payment.
CREDIT CARDS
Many U.S. exporters of consumer and other products
(generally of low dollar value) that are sold directly to
the end user accept Visa and MasterCard in payment for
export sales. In international credit card transactions,
merchants are normally required to deposit drafts in the
currency of their country; for example, a U.S. exporter
would deposit a draft in U.S. dollars. U.S. merchants may
find that domestic rules and international rules governing
credit card transactions differ somewhat and should contact
their credit card processor for more specific information.
International credit card transactions are typically placed
by telephone or fax, methods that facilitate fraudulent
transactions. Merchants should determine the validity of
transactions and obtain proper authorizations.
OPEN ACCOUNT
In a foreign transaction, an open account is a convenient
method of payment and may be satisfactory if the buyer is
well established, has demonstrated a long and favorable
payment record, or has been thoroughly checked for
creditworthiness. Under 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.
Open account sales do pose risks, however. The absence of
documents and banking channels may make legal enforcement
of claims difficult to pursue. The exporter may have to
pursue collection abroad, which can be difficult and
costly. Also, receivables may be harder to finance, since
drafts or other evidence of indebtedness are unavailable.
Before issuing a pro forma invoice to a buyer, exporters
contemplating a sale on open account terms should
thoroughly examine the political, economic, and commercial
risks and consult with their bankers if financing will be
needed for the transaction.
OTHER PAYMENT MECHANISMS
Consignment sales
In international consignment sales, the same basic
procedure is followed as in the United States. The material
is shipped to a foreign distributor to be sold on behalf of
the exporter. The exporter retains title to the goods until
they are sold by the distributor. Once the goods are sold,
payment is sent to the exporter. With this method, the
exporter has the greatest risk and least control over the
goods and may have to wait quite a while to get paid.
When this type of sale is contemplated, it may be wise to
consider some form of risk insurance. In addition, it may
be necessary to conduct a credit check on the foreign
distributor (see the section of this chapter titled
"Decreasing Credit Risks Through Credit Checks").
Furthermore, the contract should establish who is
responsible for property risk insurance covering
merchandise until it is sold and payment received.
Foreign currency
A buyer and a seller 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 mutually agreed-on
currency that is foreign to both parties.
One of the uncertainties of foreign trade is the
uncertainty of the future exchange rates between
currencies. The relative value between the dollar and the
buyer's currency may change between the time the deal is
made and the time payment is received. If the exporter is
not properly protected, a devaluation in the foreign
currency could cause the exporter to lose dollars in the
transaction. 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
$100,000. If the franc later decreased in value to be worth
19 cents, payment under the new rate would be only $95,000,
a loss of $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. However, most exporters are
not interested in speculating on foreign exchange
fluctuations and prefer to avoid risks.
One of the simplest ways for a U.S. exporter to avoid this
type of risk is to quote prices and require payment in U.S.
dollars. Then the burden and risk are placed on the buyer
to make the currency exchange. Exporters should also be
aware of problems of currency convertibility; not all
currencies are freely or quickly convertible into U.S.
dollars. Fortunately, the U.S. dollar is widely accepted
as an international trading currency, and American firms
can often secure payment in dollars.
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; further, some
international banks can help one hedge against such a risk
if necessary, by agreeing to purchase the foreign currency
at a fixed price in dollars regardless of the value of the
currency when the customer pays. The bank charges a fee or
discount on the transaction. If this mechanism is used, the
fee should be included in the price quotation.
Countertrade and barter
International countertrade is a trade practice whereby a
supplier commits contractually, as a condition of sale, to
undertake specified initiatives that compensate and benefit
the other party. The resulting linked trade fulfills
financial (e.g., lack of foreign exchange), marketing, or
public policy objectives of the trading parties. Not all
suppliers consider countertrade an objectionable
imposition; many U.S. exporters consider countertrade a
necessary cost of doing business in markets where U.S.
exports would otherwise not occur.
Simple barter is the direct exchange of goods or services
between two parties; no money changes hands. Pure barter
arrangements in international commerce are rare, because
the parties' needs for the goods of the other seldom
coincide and because valuation of the goods may pose
problems. The most common form of compensatory trade
practiced today involves contractually linked, parallel
trade transactions each of which involves 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 export
a related quantity of goods from the importing country.
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. Some
export management companies offer specialized countertrade
services. Exporters should bear in mind that countertrade
often involves higher transaction costs and greater risks
than simple export transactions.
The Department of Commerce can advise and assist U.S.
exporters faced with countertrade requirements. The Finance
and Countertrade Division of the Office of Finance,
Industry, and Trade Information monitors countertrade
trends, disseminates information (including lists of
potentially beneficial countertrade opportunities), and
provides general assistance to enterprises seeking barter
and countertrade opportunities. For information, contact
Finance and Countertrade Division, Office of Finance,
Industry, and Trade Information, International Trade
Administration, U.S. Department of Commerce, Washington,
D.C.; telephone 202-377-4471. UNCITRAL is expected to
publish a legal guide to countertrade contracts in 1992.
DECREASING CREDIT RISKS THROUGH CREDIT CHECKS
Generally, it is a good idea to check a buyer's credit even
if credit risk insurance or relatively safe payment methods
are employed. Banks are often able to provide credit
reports on foreign companies, either through their own
foreign branches or through a correspondent bank.
The Department of Commerce's WTDRs also provide useful
information for credit checks. For a fee, a WDTR may be
requested on any foreign company. Although the WTDR is
itself not a credit report, it does contain some financial
information and also identifies other U.S. companies that
do business with the reported firm. The exporter may then
contact those companies directly to find out about their
payment experience.
Private credit reporting services also are available.
Several U.S. services compile financial information on
foreign firms (particularly larger firms) and make it
available to subscribers. Reliable evaluations can also be
obtained from foreign credit reporting services, many of
which are listed in The Exporter's Guide to Foreign Sources
for Credit Information, published by Trade Data Reports,
Inc., 6 West 37th Street, New York, NY 10018.
COLLECTION 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 can
limit the risks involved. Nonetheless, just as in a
company's domestic business, exporters occasionally
encounter problems with buyers who default on payments.
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 time, effort, and cost.
The exporter must exhaust all reasonable means of obtaining
payment before an insurance claim is honored, and 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.
If, however, 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. If both parties can agree to take
their dispute to an arbitration agency, this step is
preferable to legal action, since arbitration is often
faster and less costly. The International Chamber of
Commerce handles the majority of international arbitrations
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 American Arbitration Association is also
a reputable arbitration agency that handles international
disputes; for information telephone 212-484-4000.
U.S. Government Trade Complaint Service
The Trade Complaint Service is available to aid U.S.
exporters who find themselves in a trade dispute as a
result of a specific overseas commercial transaction. These
disputes, which are processed through the Department of
Commerce's district offices, must meet certain criteria.
After a firm has made every effort to settle the complaint
without U.S. government assistance, cases are accepted
when it can be clearly shown that communications have
broken down and the value of the claim is more than $1,000.
Simple collection claims are not accepted.
Commerce makes every effort to restore communications
between the parties to the dispute in order to arrive at an
amicable settlement. When legal proceedings are initiated,
U.S. government assistance is normally withdrawn.
