An experienced exporting firm extends
credit cautiously. It evaluates new customers with care and continuously
monitors older accounts. Such a firm may wisely decide to decline a customer's
request for open account credit if the risk is too great and propose instead
payment on delivery terms through a documentary sight draft or irrevocable
confirmed letter of credit or even payment in advance. On the other hand,
for a fully creditworthy customer, the experienced exporter may decide to
allow a month or two to pay, perhaps even on open account.
Other good credit practices include being aware of any unfavorable
changes in your customers' payment patterns, refraining from going beyond
normal commercial terms, and consulting with your international banker in
how to cope with unusual circumstances or in difficult markets. It is
always advisable to check a buyer's credit (even if safest payment methods
are employed). A Department of Commerce International Company Profile (ICP) provides useful information
for credit checks. For a fee, an ICP may be requested on foreign companies
in many countries. It contains financial information on the company and
a discussion regarding its size, capitalization, years in business, and
other information such as citing some U.S. companies that conduct business
with the firm. The exporter can then contact the U.S. companies to find
out about their payment experience with the foreign firm.
ICPs are not available in every country, and in these instances, EACs
can provide a list of private credit reporting services. There are several
U.S. companies that compile financial information on foreign firms (particularly
larger firms) and make it available to their subscribers. Also, banks
are sometimes able to provide credit reports on foreign companies, either
through their own foreign branches or through a correspondent bank.
As being paid in full and on time is of the utmost concern to exporters,
the level of risk in extending credit is a major consideration. There
are several ways in which you can receive payment when selling your products
abroad, depending on how trustworthy you consider the buyer to be. Typically
with domestic sales, if the buyer has good credit, sales are made on an open
account basis; if not, cash in advance is required. For export sales, these
ways are not the only common methods. Listed in order from most secure
for the exporter to the least secure, the basic methods of payment are:
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 dollar 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.
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.
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 documents 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 letter 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:
Example of a Confirmed Irrevocable Letter of Credit
The example of a confirmed irrevocable letter of credit in
Letter of Credit 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
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.
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 (see
Financing Export Transactions).
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.
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. 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.
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 of exchanging currencies and risk are placed on the buyer.
Exporters should also be aware if there are problems with currency
convertibility. Not all currencies are freely or quickly converted
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 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,
International Court of Arbitration of the International Chamber of Commerce, telephone 212-354-4480.
Figure 13 - Sample Confirmed Irrevocable
Letter of Credit
Prudent Credit Practices
Cash in Advance
Documentary Letters of Credit
and Documentary Drafts
Letters of Credit
Documentary Drafts
Open Account
Other Payment Mechanisms
Foreign Currency
Payment Problems
Figure 12 - Sample
Draft Transmittal Letter