Payment Methods & Terms for International Trade

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There are risks involved in international trade and by understanding a few common methods of international payments and related terms, you can maximize returns and minimize losses on your world trade deals.

In this article, we’ll review five different payment methods for international trade, as well as their pros and cons.

Cash in Advance Pros & Cons
Secure ✅

1. Cash in Advance

Using the cash-in-advance payment method is the safest for exporters because they get paid before goods are shipped and ownership changes hands.

Usually, payments are made using wire transfers or credit cards.

This is a highly undesirable option for importers as there’s a risk of not receiving the goods, making it unfeasible for business cash flow.

Small purchases are often paid for in advance with cash.

Exporters that rely solely on this method of payment cannot remain competitive.

Cash in advance is one of the most commonly used payment methods for international trade. Essentially, it requires the buyer to pay for goods before they’re shipped. This gives importers better control over costs since they have access to the products before they actually have to make any payments.

Safer 🔒

2. Letter of Credit

A letter of credit, or documentary credit, is basically a promise by a bank to pay an exporter if all terms of the contract are executed properly. This is one of the most secure methods of payment.

It is used if the importer has not established credit with the exporter, but the exporter is comfortable with the importer’s bank. 

Here are the general steps in a letter of credit transaction:

1.The contract is negotiated and confirmed.

2.The importer applies for the documentary credit with their bank.

3.The documentary credit is set up by the issuing bank and the exporter and the exporter’s bank (the collecting bank) are notified by the importer’s bank.

4.The goods are shipped.

5.Documents verifying the shipment and all terms of the sale are provided by the exporter to the exporter’s bank and the exporter’s bank sends the documents to the importer’s issuing bank.

6.The issuing bank verifies the documents and issues payment to the exporter’s bank.

7.The importer collects the goods.

Letter of Credit Pros & Cons
Documentary Collection Pros & Cons

3. Documentary Collection

The exporter gives the ownership documents of an asset to their bank, which then presents them to the importer after payment is received.

The importer can then use the documents to take possession of the merchandise.

The risk for the exporter is that the importer will refuse to pay, and even though the importer won’t be able to collect the goods, the exporter has very little recourse to collect.

The steps involved in a document against payment transaction are as follows:

1.The buyer and seller enter into an agreement and the buyer requests a document against payment from its bank.

2.The buyer’s bank issues a document against payment, confirming the buyer’s commitment to pay the seller the specified sum of money upon receipt of certain documents.

3.The seller ships the goods to the buyer and sends the documents to the buyer’s bank and requests payment.

4.The buyer’s bank examines the documents, verifies that all conditions of the document against payment have been met, and then notifies the seller that payment will be made.

5.The buyer’s bank pays the seller the amount stated in the document against payment.

6.The goods are delivered to the buyer, who then pays the amount stated in the document against payment to its bank.

Risky ⚠️

4. Open Account Terms

An open account transaction is a sale where the goods are shipped and delivered before payment is due usually in 30, 60, or 90 days.

Also known as O/A, is an international payment term in which payment for goods is due at a future date according to an agreement between the buyer and seller.

This is one of the most advantageous options to the importer, but it is a higher-risk option for an exporter.

Foreign buyers often want exporters to offer open accounts because it is much more common in other countries, and the payment-after-receipt structure is better for the bottom line.

Open Account Terms Pros & Cons
Consignment & Trade Finance Pros & Cons
Risky ⚠️

5.Consignment and Trade Finance

Consignment is similar to an open account in some ways, but payment is sent to the exporter only after the goods have been sold by the importer and distributor to the end customer.

The exporter retains ownership of the goods until they are sold.

Exporting on consignment is very risky since the exporter is not guaranteed any payment.

Consignment, however, helps exporters become more competitive because the goods are available for sale faster.

Selling on consignment reduces the exporter’s costs of storing inventory.