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Chapter 14: Methods of Payment

IN THIS CHAPTER

  • Different ways to receive payment when you are selling products internationally
  • Selection of a payment method
  • Foreign exchange risk and payment problems
 

Download a PDF of a Basic Guide to Exporting.

SUMMARY

Experienced exporters extend credit cautiously. Because being paid in full and on time is of the utmost concern, the level of risk you are willing to assume in extending credit in global markets is a major consideration. There are several ways in which you can receive payment for products sold abroad; your choice will depend on how trustworthy you consider the buyer to be. With domestic sales, if the buyer has good credit, sales are typically made on open account; otherwise, cash in advance is required. For export sales, five methods of payment are common.

The basic methods of payment for exports, listed in order from most to least secure for the exporter, are:

  • Cash in advance: Receiving payment by cash in advance of the shipment might seem ideal. Your company is relieved of collection problems and has immediate use of the money. But for the buyer, advance payment tends to create cash flow problems and 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 about the possibility that goods paid for in advance will not be sent. For these reasons, exporters who insist on advance payment as their sole method of doing business overseas may find themselves losing out to competitors who offer more flexible payment terms.
  • Letters of credit and documentary collections: Letters of credit or documentary collections, commonly known as drafts, are often used to protect the interests of both buyer and seller, as follows:

o A letter of credit is a commitment by a bank on behalf of the importer (foreign buyer) that payment will be made to the exporter, provided the terms and conditions stated in the letter of credit have been met, as evidenced by the presentation of specified documents. You should keep in mind that banks pay only the amount specified in the letter of credit—even if higher charges for shipping, insurance, or other factors are incurred and documented. In addition, if the letter’s terms do not precisely meet those of the pro forma quotation, the letter of credit may be invalid and you may not be paid.

o A documentary collection is a transaction whereby the exporter entrusts the collection of the payment for a sale to its bank (remitting bank), which sends the documents its buyer needs to the importer’s bank (collecting bank), with instructions to release the documents to the buyer for payment. Although banks do act as facilitators for their clients, documentary collections offer no verification process, and there is limited recourse in the event of non-payment. Documentary collections are generally less expensive than letters of credit.

  • Escrow: Escrow in international trade is a service that allows both exporter and importer to protect a transaction by placing the funds in the hands of a trusted third party until a specified set of conditions has been met. A number of online escrow services have been created as online alternatives to traditional forms of payment. The third party accepts and holds payment from the buyer until the goods have been delivered.
  • Open account: With an open account, the exporter simply bills the customer, who is expected to pay under agreed terms at a future date. This has advantages of cash flow and cost but also obvious risks. A combination of competition in foreign markets, and the prevalence of the practice of extending credit to buyers in those markets, means exporters who are reluctant to do so may lose sales. However, an absence of documents and banking channels, for example, 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.
  • Consignment: Consignment in international trade is a variation of the open-account method of payment in which payment is sent to the exporter only after the goods have been sold by the foreign distributor to the end customer. Payment to the exporter is required only for those items sold. This is a common method in the export sales of heavy machinery and equipment, since the foreign distributor generally needs floor models and inventory for sale. Clearly, exporting on consignment is very risky since payment is not guaranteed and the exporter’s products are in the hands of an independent distributor or agent overseas. However, selling on consignment can help exporters become more competitive due to better availability and faster delivery of goods. It can also help them reduce the direct costs of storing and managing inventory.

Foreign Exchange Risk
A buyer and a seller who are in different countries rarely use the same currency. Payment is usually made in the buyer’s or seller’s currency or in a third, mutually acceptable currency. One of the biggest risks associated with foreign trade is the uncertainty of future exchange rates. One of the simplest ways to avoid the risks associated with exchange-rate fluctuations is to quote prices and require payment in U.S. dollars. Then, both the burden of exchanging currencies and the risk are placed on the buyer.

However, such an approach may result in losing export opportunities to competitors who are willing to accommodate their foreign buyers by selling in their local currencies. In addition to exchange rate fluctuations, another potential problem with doing this is that not all currencies are freely or quickly converted into U.S. dollars. If the buyer asks to make payment in a foreign currency, you should consult an international banker before negotiating the sales contract.

Payment Problems
Whenever possible, try to prevent payment-related issues before they happen. If they do occur, the simplest and least costly solution is to contact and negotiate with the customer. However, if negotiations fail and the sum involved is significant enough, your company should get the assistance and advice of your bank, legal counsel, and the U.S. Commercial Service, which can often resolve payment problems informally. When all else fails, arbitration is often faster and cheaper than legal action. The International Chamber of Commerce (ICC) handles most international arbitration. ICC arbitration is usually acceptable to foreign companies because it is not affiliated with any single country.

This chapter’s Success Story is Giant Loop, which makes equipment carriers for motorcycles. Started in 2008, Giant Loop, thanks to help from the U.S. Commercial Service, the Small Business Administration, and an Oregon State program, now sells in 20 countries, with sales growing 20 percent per year.


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