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Methods of Payment

Cash in Advance | Commercial Letter of Credit | Standby Letter of Credit
Documentary Collection | Open Account | Mixed Methods | Additional Methods of Payment
Currency of Payment

International Payment Instruments Comparison Chart
Exporter's Checklist

When deciding which method of payment to use, or combination of methods, the seller must weigh the risks and costs involved. The buyer doesn't want to tie up capital on product that it doesn't yet possess, which means that the seller can lose the sale if its competitors are willing to offer more attractive terms. On the other hand, the seller needs assurances that the buyer won't default on payment once it has received the goods. Companies need to develop an international credit policy that does not impede sales, but protects against loss. By answering the following questions, the seller can evaluate which payment options it can afford to offer the customer.

• Can the sale be made without offering credit?
• Does the buyer have a good credit history?
• What are conditions (i.e., market or political stability) in the buyer's country?
• What is company policy on extending credit?
• Can the seller offer credit and still make a profit?
• Can the business survive if it does not get paid?

Once the seller has determined the risks its company can afford to take, it's time to evaluate the risks associated with the more common methods of payment. Consulting with a qualified international banker at this time can help the seller make an informed selection. Ranked in order of risk from the seller's perspective, from the most secure to the least secure, the more common methods of payment are:

• Cash in advance
• Standby letter of credit
• Commercial letter of credit
• Documentary collection
• Open account
• Mixed methods
• Additional payment methods

The chart at the end of this section highlights the more common methods of payment and their associated risks.

Cash in Advance

Cash in advance is typically considered the safest method of collecting payment for the seller. Cash in advance can take the form of a wire transfer or payment by check. An international wire transfer is the preferred method, because it allows for quick receipt of good funds. Sellers should provide clear routing instructions to the buyer when using an international wire transfer including the name and address of the receiving bank and branch, the bank's SWIFT, Telex, and ABA numbers, and the seller's name and address, bank account title, and account number.

Collecting payment using an international check is a less attractive option than wire transfer because it can result in lengthy delays of final receipt of good funds. If the foreign buyer pays by check, made payable in U.S. dollars and drawn on a U.S. bank, the collection process is the same as any U.S. check. If, however, the check is in a foreign currency or drawn on a foreign bank, the collection process becomes more complicated and can delay the availability of funds. There is also a risk that any check may be returned due to insufficient funds in the buyer's account. This can result in a charge-back and possible overdraft charges in the buyer's account.

An additional factor to consider is that advance payment creates cash flow problems and increases risks for the buyer. If the competition is willing to extend credit, the buyer may go elsewhere.

Commercial Letter of Credit

A letter of credit (L/C) is a commitment or promise from the buyer's bank to pay the seller once the seller has met all the terms and conditions of the letter of credit. L/C's are irrevocable, which means that once the L/C is established it cannot be changed without the consent of all parties.

The L/C more evenly distributes risk between the seller and buyer. The seller is assured of payment when the conditions of the L/C are met and the buyer is assured of receiving the goods ordered. It is a commonly used method of payment, especially when the seller/buyer relationship is a new one.

The L/C is, however, not without disadvantages. If any discrepancies exist in the documents required by the L/C the buyer has the option to approve the discrepancies and pay for the shipment or reject the shipment. A rejected shipment means that the seller must quickly locate a new buyer, re-negotiate with the buyer, usually at a lower price, or pay for the shipment to be returned. An L/C also adds to the cost of the product and can tie up the buyer's working capital or credit line prior to final payment.

A word of advice: when using an L/C, the seller should always have its international bank and its freight forwarder carefully scrutinize the L/C. They can help you determine if the L/C is legitimate, if all the terms can be met, and all the necessary bases are covered.

There are four parties formally involved in the collection of payment using an L/C:

• Buyer or applicant
• Applicant's bank or issuing bank
• Beneficiary's bank, which can act as an advising bank or confirming bank
• Seller or beneficiary

Common Discrepancies in a Letter of Credit Which Can Lead To Non-Payment
Sample Letter of Credit--SWIFT Format | Swift Field Descriptions

Applicant--The applicant (buyer) applies to its bank for the issuance of an L/C. The applicant must have a credit relationship with the issuing bank or pay cash.

Applicant's bank--The applicant's bank, or issuing bank, issues the L/C. The applicant's bank verifies that all documents comply with the terms and conditions of the L/C, and pays the seller.

Beneficiary's bank--The beneficiary's bank can act as an advising bank and/or confirming bank. An advising bank is the beneficiary's bank in the U.S. It verifies that the L/C is authentic and notifies the beneficiary of its receipt. The advising bank also receives the documents from the beneficiary and forwards them on to the issuing bank. However, the advising bank has no liability for payment of the L/C.

At the beneficiary's request, an advising bank can add its confirmation to the L/C. This means that the confirming bank adds its promise to pay the beneficiary for documents presented in compliance with the terms and conditions of the L/C. The confirming bank charges a fee for this service, based on its perception of the credit risk of the issuing bank. The beneficiary would request this service if it feels that there is a risk of not receiving payment from the issuing bank, due to country or bank risk issues.

Beneficiary--The seller is called the beneficiary. The beneficiary is responsible for the collection, presentation, and accuracy of the documents required by the L/C.

A confirmed irrevocable L/C follows these steps:

1. After the terms of sale have been agreed upon, the buyer/applicant arranges for its bank to open an L/C.
2. The applicant's bank prepares an irrevocable L/C that includes shipping instructions.
3. The issuing bank sends the L/C to a U.S. bank, requesting confirmation.
4. The confirming bank in the U.S. prepares a letter of confirmation and delivers it to the beneficiary along with the irrevocable L/C.
5. The exporter/beneficiary, and the beneficiary's bank and freight forwarder, carefully review the L/C. The beneficiary verifies with its freight forwarder that the shipping dates can be met. If any of the terms or conditions in the L/C cannot be met, the beneficiary contacts the buyer/applicant immediately.
6. The exporter makes arrangements with the freight forwarder for the goods to be delivered to the port or airport.
7. Once the terms of the L/C have been met, the freight forwarder completes the documents required by the L/C.
8. The beneficiary or freight forwarder presents the required documents to the confirming bank.
9. The confirming bank reviews the documents. If the documents are in order and fully comply with the L/C, the confirming bank forwards them to the issuing bank for review and transmittal to the buyer/applicant.
10. The buyer/applicant, or its customs broker, receives from the issuing bank the documents necessary to claim title to the goods.
11. The confirming bank pays the beneficiary as specified in the L/C.

For more information on L/Cs, consult Uniform Customs and Practices for Documentary Credits (ICC Publication No. 500) or a qualified international banker.

Standby Letter of Credit

Like the letter of credit, the standby letter of credit is a commitment or promise from the buyer's bank to pay the seller once the seller has met all the terms and conditions of the standby letter of credit. The difference is that the standby letter of credit is a guarantee of payment from the bank only if the buyer defaults on the payment. The buyer pays on open account or credit terms. Should the buyer default, the seller presents to the bank a sight draft and a written statement certifying that the buyer has failed to make payment on the shipment secured by the standby letter of credit, and collects payment from them. The use of a standby letter of credit adds a bank guarantee of payment at a lower cost than payment collection using a letter of credit.

Documentary Collection

To collect payment from a foreign buyer using documentary collection, the seller sends a draft or other demand for payment with the related shipping documents through bank channels to the buyer's bank. The bank releases the documents to the buyer upon receipt of payment or promise of payment. The banks involved in facilitating this collection process have no responsibility to pay the seller should the buyer default. Documentary collection carries the risk that the buyer will not or cannot pay for the goods upon receipt of the draft and documents. If this occurs it is the burden of the seller to locate a new buyer or pay for return shipment.

Documentary collections are best considered when shipping by ocean freight. This is because the ocean bill of lading (b/l) is a negotiable document and acts as title to the goods. The steamship company will not release the shipment from the port unless the buyer has the original b/l, and the buyer cannot get the original b/l unless they pay the bank. In the case of air shipments, the b/l is not a negotiable document, does not act as title to the goods, and the benefit of using a documentary collection is lost.

Drafts--A draft (or bill of exchange) is a written order by one party directing a second party to pay to the order of a third party. Drafts are a negotiable instrument, easily transferable from one party to another. There are two types of drafts: sight drafts and time drafts.

Sight Drafts--In the case of a sight draft, once the goods have been shipped, the seller signs the original bill of lading and delivers it to the bank along with the sight draft, invoices, and other supporting documents required by the buyer and destination country, to be forwarded to the buyer's bank. The buyer's bank then notifies the buyer that it has received the documents. When the buyer pays the sight draft, the bank releases the bill of lading, passing title of the goods to the buyer.

Time Drafts--A time draft requires payment within a certain time after the buyer accepts the draft and receives the goods. By signing and writing "accepted" on the draft, the buyer is expected to pay within the stated time period. A buyer can delay payment by delaying acceptance of the draft or refusing to pay at maturity. In most countries, an accepted time draft is stronger evidence of debt than an unpaid invoice.

Open Account

Under an open account, collection of payment is the same as in cash in advance, wire transfer, or check. The difference is in the timing of collection. The exporter bills the buyer, who is expected to pay under agreed terms at a future date. Open account is a low-risk method of payment for the buyer and many large companies will only buy on open account. Due to the high risk involved for the seller, the seller must be confident that the buyer is well established, has a long and favorable payment record, has good credit, and is legally able to convert currency into U.S. dollars. Collection on delinquent payments under open account is difficult and costly due to the lack of documents and banking channels.

Mixed Methods

The payment options discussed in this section are not mutually exclusive. It is possible, and frequently practiced, that a seller will use a combination of payment methods. For example: the seller may require 50 percent of the payment as cash in advance using a wire transfer and the remaining 50 percent documentary collections using a sight draft.

Additional Methods of Payment

Credit Card--U.S. exporters who sell directly to the consumer may select credit cards as a viable method of payment. The rules governing credit card transactions differ from domestic use to international use. Exporters should check with their credit card company(s) for specific rules on international use of credit cards.

Consignment--Under consignment, the foreign distributor sells goods on behalf of the exporter. The exporter does not receive payment until the distributor sells the goods and transfers title of the goods. If the foreign distributor is unable to sell the goods, the exporter must pay for the return shipment. This method of payment is risky for the exporter.

Countertrade and Barter--Countertrade or barter may be necessary when selling to companies that cannot obtain convertible currency. In countertrade, the "buyer" agrees to undertake specified initiatives that compensate and benefit the "seller." Barter is the exchange of goods or services between two parties.

Currency of Payment

The simplest currency of payment for U.S. exporters is U.S. dollars. When quoting prices and requiring payment in U.S. dollars, exporters are placing the burden and risk of foreign currency conversion on the buyer. On the other hand, some U.S. exporters knowledgeable in foreign exchange find it profitable to accept payment in other currencies. If the shipment's value is large enough, say U.S. $25,000 to $50,000 or more, it may be possible to hedge against the foreign exchange risk. Experienced international bankers can offer advice on foreign exchange risks and offer suggestions on how to hedge against those risks.

International Payment Instruments Comparison Chart

Source: Firstar Bank

Exporter's Checklist

For Reviewing a Letter of Credit in Favor of the Seller

1. _____ Is the L/C irrevocable?
2. _____ Has the credit been confirmed, if requested?
3. _____ Is the type of credit (revolving, transferable, etc.) as agreed?
4. _____ Is the amount of the credit sufficient to cover all costs permitted by the terms of the contract? Are the  Incoterms correct? Have the terms "about" or "approximately" been included?
5. _____ Is the credit available with your bank, freely negotiable, or available with any bank, or is it restricted to the issuing bank or any other designated bank?
6. _____ Are the descriptions of the goods and unit prices, if any, in accordance with the sale contract? Have the terms "about" or "approximately" been included, if requested?
7. _____ Are transshipment and partial shipments allowed, if necessary?
8. _____ Are the points of dispatch/taking in charge/loading on board of the goods, as the case may be, and of discharge/final destination as agreed?
9. _____ Do the shipping and expiry dates and the period for presentation of documents after issuance of the transport document allow sufficient time for processing the order, effecting shipment, and presenting the documents to the bank?
10. _____ Are the provisions for insurance in accordance with Incoterms?
11. _____ Can the necessary documents be obtained in the form required and in the timeframe allowed by the credit?
12. _____ Have any unacceptable conditions been added to the credit without your approval; e.g., an inspection certificate to be provided by the buyer?

Source: Firstar Bank

Commercial Letter of Credit

Common Discrepancies Which Can Lead To Non-payment

General

1. Documents inconsistent with each other.
2. Description of goods on invoice differs from that in the credit.
3. Marks and numbers differ between the documents.
4. Absence of documents called for in the credit.
5. Incorrect names and addresses.

Draft (Bill of Exchange)

1. Amount does not match invoice.
2. Drawn on wrong party.
3. Not endorsed correctly.
4. Drawn payable on an indeterminable date.

Transport Documents

1. Shipment made between ports other than those stated in the credit.
2. Signature on bill of lading does 0not specify on whose behalf it was signed.
3. Required number of originals not presented.
4. Bill of lading does not evidence whether freight is prepaid or collect.
5. No evidence of goods actually "shipped on board."
6. Bill of lading incorrectly consigned.
7. "To order" bills of lading not endorsed.

Insurance

1. Insurance document presented of a type other than that required by the credit.
2. Shipment is underinsured.
3. Insurance not effective for the date in the transport documents.
4. Insurance policy incorrectly endorsed.

Deadlines

1. Late shipment.
2. Late presentation of documents.
3. Credit expired.

Source: Firstar Bank

Sample Letter of Credit--SWIFT Format

507 july 95 09:13 page: 2355 LP00

*** HARDCOPY msg id 0131-00010-00333 ***
RECEIVED FROM:     IMPORTER'S COMMERCIAL BANK
                                        TAIPEI, TAIWAN

sent to :
SELLER'S U.S. COMMERCIAL BANK
INTERNATIONAL DIVISION
SAN FRANCISCO, CA

date : 07 july 95     time : 09.13    issue of a documentary credit     **urgent**

-AUT/**** Authentication Result
*END

Source: Firstar Bank

Swift Field Descriptions

Most letters of credit are issued by electronic means. The following is a list of the fields in a SWIFT MT 700 message (Issuance of Documentary Letter of Credit). Only a few fields are mandatory; most are optional and depend on the nature of the transaction.

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