In trade we know that the payment method plays a very important role, whether you are a customer importing goods or a seller selling products worldwide. In the B2B industry it may not be as straightforward or easy to deal with payments, as every customer or seller has different ways to conduct their business. There are several complex processes involved in closing a deal, despite the fact that there are many alternatives available to ensure how payments can be made. 

Important: You must know that whichever payment term you opt for it will be a critical factor in determining how attractive your offer is for customers. We will explain the different types of payments possible to conduct international trade within the B2B industry. Purpose of this guide is to effectively explain payments in international trade, its meaning, how it works, and how to choose the right option which is best for your company.

Table of contents: 

• Payment terms in international trade
• The 5 important payment methods
• Comparing payment methods
• Picking the right payment method
• Conclusion

Payment terms in international trade

International trade may not be as smooth as many may think, the process of buying and selling can be delayed or slowed because of its complexity. Therefore, we understand how satisfying and relieving the moment is when a successful order is being finalised and conducted. You will have to deal with the timeline, the right payment, the pricing, the quality, logistics, packaging and so on in order to ensure the smoothness of completing a deal. Let’s dive into how to make/receive payments.

Payment terms speak for itself, the conditions set by both parties in international trade to come to an agreement on how to complete the payment. Meaning, these outlines which method of payment is used by importers and exporters to successfully conduct their trade deal. This includes whether there will be an upfront payment before delivery or not, who is responsible for the ownership of those products before delivery, and how payment will be made. Indeed, payments are one of the key aspects of a business, as the payment is the driving force of the business and determines whether it is profitable or not, which is quite obvious. Now, offering this right sort of payment solutions by sellers is essential because you want to ensure the customer feels at ease. Buyers often want to delay payment as much as possible, preferably all the way up until they have received their order and even in some cases after they’ve sold the products purchased from the seller. However, sellers want to collect the payment as quickly as possible, best scenario receiving at least part of the payment before starting to work on the order. All of these scenarios make it ever so important to find the suitable payment method to build a sustainable trade relation without the worry of payment being delayed, not received etc.

The 5 preferred payment methods and terms

Explaining the most common payment terms in international trade. These are letter of credit (LC), cash in advance, documentary collections, consignment, and open account. 

Letter of credit

This payment method is one of the most well-known terms of payment in international trade. This payment method is very popular in Asia and the Middle east. The popularity is due to the fact that it offers secure payments. The bank will get involved in this process in which they will be conducting the payment process for the importer. L/C is a piece of paper which acts as the guarantor from the banks explicitly stating that payment to exporter will be done for the products after an inspection has been conducted in which all terms and conditions are met. Note, that typically in this L/C document the terms and conditions are written down, most of the time the L/C’s are more concerned about the documentation that comes along with the products instead of the products. It is not so simple to obtain a letter of credit, the banks need to be satisfied with the credit worthiness of the importer before they can get involved as a guarantor in the payment process. Well now, the bank has agreed to make the payment on behalf of the importer, once the payment is done the bank will turn to the importer for repayment. Often this is on the terms set before going forward with the whole L/C process. When a new buyer and new seller come together without any prior trade history between them, they will most likely use the L/C method. Furthermore, the exporter may hint to this option because they are not fully satisfied with the credit worthiness of the importer. Whatever the reason may be to conduct the L/C method, we definitely do know that with this method it’s less risky for the exporter as they are certain in receiving the payment. We have been talking about the pros of this method and many may think this is the best solution ever. However, there are some disadvantages to note down. For example, this method is quite costly because the banks are getting involved and they will charge you for their services. The fees are not fixed, it is decided based on how strong the credit history is as well as the complexity of the transaction. Another important factor to note down, banks normally do not inspect the goods for the importer so there may not be a provision to establish whether the quality of the products as per description. Although the importer could hire a third party to do the inspection to ensure the quality of the goods, that also comes with a price tag. 

Cash in advance

This payment method is very convenient for the sellers as they will first receive the money in advance and after that they start working on the order. They can use the money received to prepare the order. The payment is pretty straightforward, whatever importer and exporter have agreed for making the payment it can easily be done via, wire transfer, international cheque, online banks, or payment by debit cards. In most scenarios, the payment will be 50 percent upfront and 50 percent before dispatch. Although it is a very convenient method of payment for the exporter, it brings a lot of risks for the importer. The reason for this is that the exporter still has the ownership of the products and possesses all the goods and on top of that he has already received the payment. Furthermore, a very unfavourable cash flow situation for the importer because they pay the order payment up front which is something a lot of buyers tend to avoid. Nevertheless, using this payment method is often with small orders, or the exporter has established a very strong ground for himself to enforce this way of conducting the payments. This way of business is not used a lot nor is it something importers applaud. There are several reasons why the exporter may want this type of payment method to be used. Exporters have doubts about the credibility of the buyer, or where the buyer has full trust in the exporter. Therefore, if an exporter wants to increase the number of buyers approaching them, it is essential to be very flexible and open minded in regard to payment methods. Unless, like previously mentioned, the exporter and importer have an adequate level of understanding and trust, then it makes sense to push through this method, although it doesn’t ensure that it always be as fruitful as many expect due to a good relationship.

Documentary collections (D/C)

Documentary collection is a form of trade finance, the seller will receive payment for the products from the buyer when the banks of both parties have exchanged the necessary documentation. The bank representing the seller will collect the payment and in exchange provide documents which acts as a release title for the shipped goods, normally after the order has arrived at the designated location of the buyer. In this transaction the banks play an exclusive role to ensure the payment and goods are securely received at both ends. Starting from the point when the seller dispatched the order and sent out the documentation to the buyer in order to claim the products. The documents include a
‘Bill of lading’. Most probably the importer will instruct the bank to release payment after the documents have been received and verified. The legitimacy of the documents is vital to prevent fraudulent incidents, therefore essential to ensure and validate the document first and then the payment goes ahead. This is very similar to escrow where a third party plays the role to ensure payment and products are delivered in a timely and secure manner. 

There are two main methods within this payment term. Documents against payment (DAP) & documents against acceptance (DA).

• DAP – the agreement in this way is payment will be released instantly after receiving the authentic documents which are verified and valid for its purpose. No delay is expected in this.
• DA – documents will be sent from the bank representing the seller to the bank representing the buyer. This document is fixated on what date is set for releasing payment, that date is most probably agreed by buyer and seller both.

There is not too much risk for both buyer and seller when using this payment method since things are relatively balanced. Sellers will distance themselves from ownership and possession as soon as the payment is done or a solid ground of receiving payment has been established. Whereas the buyer will consequently release payment after receiving the documents or receiving the physical delivery. Furthermore, it's a far more costly way of conducting the transaction in comparison to L/C as well as that to set the foundation and putting this in place is less time consuming. But, similarly to the L/C this payment method has a core focus on the documents instead of the products. It’ll be harder to identify faulty products which don't go in line with the agreed specification.

Open account (O/A)

In this payment method the exporter agrees to deliver the products to the buyer without receiving any payment upfront nor any documentation but instead they have agreed to receive payment at a later date. Often there are three options in this to receive payment, 30, 60, or 90 days after delivery. This is a form of receiving products on credit where the payment will be completed after an agreed period of minimum a month. This is clearly very beneficial for importers, as they do not have to bear the burden of paying in advance, paperwork of various documents. Here the importer has the freedom to complete the order and even so sell the products, and the money generated can be partially used to pay for the order. Reducing operating expenses for the importer and as soon as the products are sold the payment is done, as well as the next order is placed. However, it is essential to pay on the agreed date regardless of whether products are sold or not. Exporters will lean on this method when they have certainty with their customers. A root level of trust has been established and the exporter must have the financial ability to act on this method. Furthermore, this is a very lucrative method for importers as it is less stressful and time consuming, but the majority of the risk is with the seller. For example, it is possible that payments are delayed, a company goes into bankruptcy, or other unforeseen circumstances can arise which will harm the exports by not receiving the funds. Exporters are less likely to opt for this method, although they may offer it to their loyal returning buyers. Whereas a new buyer will hardly be able to convince the exporter to go for this method. Exporters must be careful to whom they offer this payment method as they are in a very delicate position. Exporters can include insurance to protect themselves in case things go differently as expected. When there is a low-risk trading relationship then this option can be considered. Although it may be a very attractive option for buyers and it can surely be the decisive factor to initiate trade, still exporters must do their due diligence for their own protection of the business.

Consignment

Finally, the fifth major payment option is the consignment. Here the exporters agree to produce the goods, dispatch the goods, and deliver to the importer. The payment will be collected when the buyer/import has sold all the goods and has generated the amount to pay for the agreed price. Exporters who have distributors or third-party agents in various countries who work with them and for them by having exclusivity. This type of payment method is rarely used by normal sellers and buyers.  The reason why this is rare is because there is an incredible high risk for exporters. All the costs of producing, storing, shipping and delivering the goods lies on the shoulders of the exporter. Whereas the buyer has a simple job and that is selling the products, once sold they can make the payment. Consequences in case things go south for the exporter could be, non-payment, late payments by the importer and that could destabilise the cash flow or balance sheet of the exporter. It’ll make more sense if this payment method is used when there are close ties, good relationships, it is an entity of the seller, distributor and so on. Proper measures must be taken and looking at options for insurance is a no brainer. However, if an importer wants to persuade an exporter to use such a payment method, it is essential that they pose no threat and have a solid background in their finances. Even though it poses great risk for an exporter, and it may seem like all the benefits are for the buyer only, wrong! This could help an exporter enter new markets and explore various markets to drive trade. Obviously, exporters are able to produce products quicker and can manoeuvre efficiently in case a lot of demand for the products arises.

Here’s a image below that shows the risk level of each term for exporter and importer: 

How to pick between payment terms?

The delicate balancing act required when deciding on payment terms means it’s unlikely to be an easy task. As you make your decision on what terms to offer, the following tips will be helpful: 

• Consider your financial needs and strengths.
• Think about your negotiating position. If you are in a stronger position, you may be able to demand more favorable terms.
• Does the other party come from a country with significant commercial or political risk? You may want a more secure term here.
• In certain industries, specific terms are generally used. For instance, in the food and textile industry, it’s common to see documentary collections being used, while letters of credit are common in oil and gas.
• Prevailing market conditions can be important. If it’s a sellers’ market, you may be able to set the most favorable terms for yourself as an exporter.

Overall, it is important to keep in mind that you don’t have to pick just one of these terms for your entire transaction. A mix of terms can apply at different stages, such as before production, before shipment, and upon delivery. Consider how a mix of these terms can provide a more balanced transaction for you. 

Final thoughts

Deciding on payment terms is an important part of international trade. Although the process of setting these terms can be difficult, the positive trade-off is you are able to minimize the risks of the trade – which is always a good thing. 

Want to know more about how Lalaaji.com can help you trade globally and expand your business? Speak to an expert now.

 

References: 
1. https://www.tradefinanceglobal.com/trade-finance/payment-methods/ 
2. https://www.investopedia.com/terms/l/letterofcredit.asp 
3. https://www.thebalance.com/what-is-escrow-315826 
4. https://www.trade.gov/export-credit-insurance 
5. https://www.entrepreneur.com/encyclopedia/factoring 
6. https://www.gtreview.com/what-is-trade-finance/