The relatively low value of the dollar has encouraged exporters to enter into an increasing number of new relationships. This means establishing appropriate payment terms. The following is a rundown of those commonly used in international trade, proceeding from those with least risk to most risk to the exporter. Payment With Order: Buyer pays and seller ships. The buyer is actually extending credit to the seller. Despite favorable dollar exchange rates, competition will not permit repeat sales this way to creditworthy buyers in stable countries. It does make sense under the following circumstances:
-- First orders where little is known about the buyer. (Caution: Export control regulations require that sellers have at least minimal information on their foreign customers, if only that they do not appear on any of the government “bad guy” lists);
-- Poor commercial risk: No one else extends credit to this buyer so why should you?
-- Poor country risk: Amazingly, some savvy business people in poor countries find ways to access hard currency for payments;
-- Small order with little prospect of future business: Simply not worth the cost of opening an adequate credit file;
-- Deep discount for advance payment: You are probably giving your profit away and possibly sending a message of desperation to would-be customers. (This term is sometimes called Cash In Advance (which of course should never be abbreviated).
Confirmed Irrevocable Standby Letter Of Credit: Seldom used for actual payment as it requires absolute faith on the buyer's part that the seller won't wrongfully draw. We'll cover standbys in a future column along with demand guarantees, as their rules (called URDG) are changing. Confirmed Irrevocable Commercial Letter Of Credit: A bank in the buyer's country guarantees payment against presentation of conforming documents that prove specified events have taken place. This guarantee is enhanced by the guarantee of a second bank, usually in the seller's country. Frequent readers are aware that the rules governing letters of credit (UCP 600) were changed, effective July 1, 2007. Problems are that letters of credit can be expensive and the documentary requirements must be strictly observed. Benefits include a guarantee by a bank in the seller's country and a date certain when payments will be made for each compliant presentation.
Unconfirmed Irrevocable Commercial Letter Of Credit: As above except without the guarantee of a second bank. This works fine for trusted banks in stable countries, but provides no protection against country risk or the possibility that the issuing bank may be unable or unwilling to honor its obligation. It also results in slower payment as banks that advise credits without adding their confirmations are not required to pay unless and until the proceeds are received. Sight Draft, Documents Against Payment (also called Cash Against Documents): The seller ships the goods and sends the controlling documents through his or her bank to a bank in the buyer's country (usually the buyer's bank). The banks are instructed to release the documents only against payment. Here, no banks are guaranteeing payment, only that the seller's instructions will be followed. This is the international equivalent of COD since the idea is that the buyer can't get the goods without first obtaining the documents which the local bank withholds until payment is made. Rules called URC522 apply, but there are several risks. There is no protection against country risk; the buyer could simply walk away from the transaction, and the documentation must be structured so that the carrier will not release the shipment without it.
Documentary Time Drafts: Work like sight drafts except that instead of paying the buyer signs (accepts) a financial instrument akin to a promissory note for payment at some future time. There are two flavors which address when the clock starts running. Date drafts are due and payable X number of days from the date on the face of the draft. As this is usually the date of main carriage transportation, the seller provides financing X number of days from shipment. Time-sight drafts are payable X number of days from the date the buyer accepts the draft. Most buyers will defer acceptance until the goods arrive, so the seller finances X number of days from arrival. The risks for either are the same as with sight drafts plus the fact that the buyer will have the goods before payment is due, increasing the possibility of non-payment. Country risk may also be greater should conditions worsen from the time the draft is accepted to its maturity.
Clean Drafts: The seller ships, sends the documents directly to the buyer, and a draft (perhaps accompanied by photocopies) is routed through the banks. The only protection resides in the fact that companies tend to behave well at their own banks from which they probably borrow. Risks are the same as with documentary drafts, plus the fact that the buyer has unrestricted access to the goods.
Open Account: The seller ships and sends the documents directly to the buyer without any bank involvement. This is similar to the way most domestic business is done and should provide manageable risk with creditworthy buyers in stable countries.
A note to the new-to-export: Nothing replaces adequate information on your overseas buyers. Even the protection of confirmed irrevocable letters of credit can be put at risk by documentary error, as happens all too frequently. It's then that good people come through for you and snakes strike. Fortunately, most people are good.
Frank Reynolds is president of International Projects, Inc., an export management company. His column appears exclusively in The Journal of Commerce Online.
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