Different Methods of Payments in International Trade
International trade is an unavoidable part of each country’s economy. The development of Information and Communication Technologies (ICT) has resulted in converting the whole World into a Global Village, where the distance is not a barrier for trading.
Inorder to conquer global market and get sales against foreign competitors, the exporters are required to offer attractive and convenient sales terms supported by apt payment methods.
A suitable payment method should be selected circumspectly to reduce the payment risk while conforming the needs of the buyer since getting paid in full and puntually is the primary objective of each overseas sale.
Some of the widely recommended and accepted modes of payment for International trades are:
1. Advance Payment
Advance Payment is a payment done by an importer to the exporter before shipment.
This method is most beneficial from exporter perspective as he receives funds in advance. The payment may be received either as soon as the order is confirmed or any time before shipment. The exporter may be willing to impose the term as a pre-condition only when he knows that the goods are in overwhelming demand and the goods are of rare-nature. Advance payments may be also used to negotiate a reduced price or to cover initial supply costs.
However with a buyer’s point of view, advance payment carries little risk, as he advances payment before dispatch of goods. Advance payment of term in exports and imports is picked by a purchaser only when he knows the seller in details on genuineness as a seller.
For international sales, wire transfers and credit cards are the most commonly used cash-in-advance options accessible to exporters. With the advancement of the Internet, escrow services turning into another cash-in-advance option for small export transactions.
2. Letter of credit
Letter of credit is a type of payment term opted by importers and exporters. Letters of credit (LCs) are one of the most secure instruments accessible to international traders. An LC is a commitment by a bank on behalf of the buyer that payment will be made to the exporter, provided that the terms and conditions stated in the LC have been met, as confirmed through the presentation of all required documents.
In other words, we can explain that a Letter of Credit is an undertaking issued by a Bank, at the request of a importer, affirming the payment to the exporter on presentation of complying documents as stated in the LC.
It is an assurance from the bank that a buyer's payment to a seller will be received on time and for the correct amount and thus makes elimination of possible risks. If the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase. Due to the nature of international dealings, including factors such as distance, contrasting laws in each country, and difficulty in knowing reliability of each party personally, the use of letters of credit has become a vital aspect of international trade. A letter of credit is typically a negotiable instrument, the issuing bank pays the beneficiary or any bank nominated by the beneficiary. If a letter of credit is transferrable, the beneficiary may assign another entity, such as a corporate parent or a third party, the right to draw. Banks typically require a pledge of securities or cash as collateral for issuing a letter of credit. Banks also collect a fee for service, typically a percentage of the size of the letter of credit.
An LC is useful when reliable credit information about a foreign buyer is hard to get, but the exporter is satisfied with the creditworthiness of the buyer’s foreign bank. An LC also secures the buyer because no payment obligation arises until the goods have been shipped or delivered as promised or guaranteed.
3. Documents against Payments - D.A.P or D/P basis
Documents against Payment – DP/DAP is a term of payment in international trade. It relies on an instrument generally used in international trade called a bill of exchange or draft.
In this term, the documents under consignment are delivered to buyer/importer only after collecting payment of goods by buyer’s bank. The exporter ships the goods and submits Shipping documents to importers Bank with their instructions to discharge documents to the importer against payment, where the importer needs to pay the exporter when the documents being released from the Bank. The collecting bank hands over the shipping documents including the document of title only when the importer has paid the bill.
Simply, D/P is an arrangement in which a seller directs the presenting bank to release shipping and title documents to the buyer only if the importer completely pays the accompanying bill of exchange or draft.
4. Documents against Acceptance (D/A)
Documents against Acceptance are another term of payment in international payment.
The Documents against Acceptance (D/A), depend on an instrument broadly used in international trade called a bill of exchange or draft. Under this, transaction utilizes a time draft or Usance (It is the allowable timeframe, allowed by custom, between the date of the bill and its payment) i.e, the Exporter allows credit to Importer. The importer is required to accept the bill to make a signed promise to pay the bill at a set date later on. When he has signed the bill in acceptance, he can take the documents and clear his goods.
Simply, D/A is an arrangement in which an exporter instructs a bank to discharge shipping and title documents to an importer only if the importer accepts the accompanying bill of exchange or draft by signing it. 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.
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