Methods of payment in foreign trade

Terms & Methods of payment in foreign trade. To begin speaking on this topic I’d like to start with the risks which are faced by both sides – exporters and importers – in an export transaction. This is because there is always the possibility that the other side may not fulfill the contract. The risks for the exporters are the following: 1. the risk of buyer default 2. the customers might not pay in full for the goods: (this risk may be

caused by several reasons) - the importers might go bankrupt - a war might start - importers’ government might decide to ban trade with the exporting country - importers’ government might decide to ban imports of certain commodities 3. the importers might run into difficulties getting the foreign exchange to pay for the goods 4. the importers are not reliable & simply refuse to pay the agreed amount of money And the risks for importers are: 1. the goods will be delayed & they will only receive them

a long time after paying for them, because of: - port congestion - port strikes 2. delays in fulfillment of orders by exporters & difficult Customs clearance in the importing country can cause loss of business 3. the wrong goods might be send But all these risks can be reduced with the help of the banks, which provide several services which give security to exporters and importers.  the risk of buyer default or non-delivery by exporters is removed by the method of payment against shipping documents.

 exporters’ banks provide information about the financial reliability of their customers  banks help arrange buyer credit or finance for the sellers (without this a lot of trade would not take place at all)  the risks of financial lost because of a change in exchange rate can be avoided with the help of a bank, by buying the foreign exchange on the forward exchange market So we must admit that the terms of payment are an integral part of contract in international

trade. There are different methods of payment in foreign trade: in cash and on credit ( & in advance – according to Kotlyarov). Now I’d like to speak about the methods of payment on credit, because most modern business is done on a credit basis which may be: 1) by drafts (by Bills of Exchange – B/E), which is the most popular terms of payment on credit. A Bill of Exchange is a signed documents, such as a cheque, that orders a person or an organization,

such as a bank, to pay a fixed sum of money on demand or on certain date to the person specified. It is a document that can be exchanged for goods, money, i.e. it is a negotiable instrument like cheques or banknotes and can be a subject of the deal. There are various types of bills of exchange:  accommodation B/E: a bill that is signed by someone who promises to pay it to help another person to raise money. A person signing the accommodation bill is called the accommodation party, i.e. a person

with a good financial reputation who signs a bill to make it easier to exchange; sometimes accommodation bills are called ‘kites’, ‘windbills’ or ‘windmills’.  Discounted B/E: bill bought at a reduced price before it is due for payment;  Documentary B/E: a bill attached to shipping documents such as bills of lading, invoices, etc.;  Documents-against-acceptance B/E [D/A, D/A bill]: a bill sent by an exporter with other shipping

documents to an agent who will not release the documents until the bill of exchange has been signed (accepted) by the person receiving the goods; this is used when the bill of exchange is a period bill and must be paid by a specified date;  Document-against-payments B/E [cash-against-documents]: a bill sent by an exporter with other shipping documents to an agent who will not release the documents until the bill has been signed (accepted) by

the person receiving the goods; this is used when the bill of exchange is a sight bill and must be paid immediately;  Endorsed B/E: a bill signed on the back, that makes it payable to someone else. There are also some more kinds of B/E such as foreign B/E (payable in another country), inland B/E ( payable in the country where it was drawn up), period/term B/E, short B/E , sight B/E , time B/E, trade B/E. In terms of time of payment there are different conditions

on which the bills of exchange can be drawn up: • On demand: a bill of exchange must be paid immediately as it is presented for payment; • At sight: an inscription made by a drawer on a bill of exchange to show that it must be paid as soon as it is presented for payment; • After sight: an inscription made by a drawer on a bill of exchange to show that the bill would be paid within a specified time after the payer (the drawee) is presented with it; •

After date: an inscription made by a drawer on a bill of exchange to show that payment will be made at a specified time after the date given on the bill; such bills are called after-date bills. There are two main persons, working with the bill of exchange: The drawer is a person who writes a cheque/ a bank order/ a bill of exchange, etc. and therefore instructs a drawee to make a payment within a stipulated period of time.

The drawee is a person on whom a cheque/ a bank order/ a bill of exchange have been drawn up, the payer. The drawee must accept the cheque/ bill/ bank order and pay it within the stipulated period of time. Special attention needs to be drawn to the endorsement of bills of exchange. Endorsement is a signature on the back of a bill of exchange or cheque by the payee (beneficiary), making it payable to another person. There are various types of endorsements used in business transactions:

• Accommodation endorsement: the name and signature written on the back of an accepted bill of exchange as a guarantee that payment will be made on the date given; • Blank endorsement: a signature on a bill of exchange or cheque, by the payee, making it payable to any other person, i.e. to a bearer; • Restrictive endorsement: a signature on a bill of exchange or cheque, by the payee, making it payable only to a named person or account; it is no longer a negotiable instrument;

• Special endorsement: a signature on a bill of exchange or cheque, by the payee, making it payable to another person, i.e. to order. 2) Another method of payment on credit is in advance (the Importer credits the Exporter, for example, the contract may stipulate a 10 or 15% advance payment, which is advantageous to the Sellers). This method is used when the Buyers are unknown to the Sellers or in the case of a single isolated transaction or as part of combination

of methods in a large-scale (transaction) contract. 3) The third method of payment on credit is on an open account. Open account terms are usually granted by the Sellers to the regular Buyers or customers in whom the Sellers have complete confidence, but sometimes they are granted when the Sellers want to attract new Buyers then they risk their money for that end.

Actual payment is made monthly, quarterly or annually as agreed upon. This method is disadvantageous to the Exporter, but may be good to gain new markets. 4) And the last method of payment on credit is a Promissory Note, which is a document in which a person or an organization, such as a bank, promises (on behalf of the Buyers) to pay a fixed sum of money on demand or by a certain date, to the person specified (the

Sellers). To carry on this topic it is logically now to speak about the methods of payment in cash. There are different methods: 1. By cheque that is a special printed form that is filled in and signed by a person, the drawer of a cheque asking the bank, the drawee, to pay a sum of money to someone, the payee. Cheques are payable in the country of origin and it is practicable to use them in home trade in order to avoid wasting time. There are different kinds of cheques used: -

Blank cheque: a cheque that is signed but without the amount of money written in, this is added later by the person to whom the cheque is paid when the amount is known; - Certified cheque: a cheque marked by the bank it is drawn on as ‘Good for payment’, meaning that a cheque is true and genuine; - Crossed cheque: a cheque that has two lines drawn across it to show that it can only be paid into bank account and not exchanged for cash; -

Open cheque: a cheque that does not have two lines drawn across it and can therefore be exchanged for cash at the bank where it was issued; - Traveler’s cheque: a cheque for a fixed amount, sold by a bank, that can easily be cashed in foreign countries. - Stale cheque: a cheque that is not presented to a bank for payment within six months of being written; it will not be exchanged for money by the bank and will be returned, marked ‘out of date’; -

Stopped cheque: a cheque that the person who signed it has asked a bank not to pay; if such a cheque is paid, the bank must bear the loss; 2. By telegraphic or telex transfers or post (mail) remittance which is made from the Buyers’ bank account to the Sellers’ in accordance with the Buyers’ letter of instruction. Actually this method of cash payment may sometimes take several months, which is naturally very disadvantageous

to the Sellers. 3. By bank cables or electronic transfers which is relatively quick way of sending money to someone abroad. The sender’s bank cables the money (i.e. sends an instruction for it to be paid) to the bank of the receiver. The money should be paid in the receiver’s currency at the rate of exchange. The sum of money can either be credited to the receiver’s account or paid in cash against the identification. 4. By letter of credit (L/C) (or just by credit) – a letter from one bank to another, by which the

third party, usually a customer, is able to obtain money. There are different types of L/C: - circular – a L/C which is addressed to all branches, correspondents & agents to the issuing bank - direct – a L/C which is the issuing bank addresses to one particular branch (as opposed to a circular) - confirmed – a L/C to which the paying bank has added its guarantee that payment will be made against presentation of certain documents - unconfirmed – a

L/C which the issuing bank gives no promise that it will accept bills drawn upon it - documentary – a L/C to which a number of other documents such as Bill of Lading, an Insurance Certificate etc. have been joined by the exporter to obtain payment from the bank - irrevocable – a L/C that can only be cancelled or changed with the agreement of the person expecting payment - limited – a circular L/C which can only be used in certain number of places - traveler’s

– a document issued by a bank to a traveler whereby the traveler may receive money up to a stated amount from all the bank’s agents abroad, when the traveler’s L/C is used up it should be sent back to the issuing bank - revolving – a L/C under which its value is constantly made up to a given limit after payment for each shipment, which saves the charges on multiply L/C Thus, a confirmed irrevocable

L/C guarantees the payment for the goods being exported. Besides, all L/C can be valid within a stipulated period of time, after the expiry of which the payments can be made only with the consent of the parties concerned. A L/C is safe in business transaction as it provides for the payment to be effected only against shipping documents: Invoice, Bill of Lading, a copy of the Waybill, shipping certification, packing sheet,

Certificate of Quality, Certificate of Origin, Insurance/Policy Certificate. 5. For collection. It doesn’t give any advantages to the Exporter because it doesn’t give any guarantee that he will receive payment in time or at all. That’s why the Exporter usually requires that the Importer presents a guarantee of a first class bank that payment will be effected in due time.

Also, there is a long period of time between the delivery of goods & actual payment. But it is advantageous to the Importer because there is no need to withdraw from circulation bug sums of money before actually receiving goods. Payment for collection against documents (with subsequent acceptance or very often telegraphic collection with subsequent acceptance) is mostly used in trade with East European countries. The costs involved in effecting payment for collection are twice or three

timed lower than those by L/C. So, to speak more wide on this topic, it would be reasonable to mention the important role of the shipping documentation. Shipping documents are certain documents which are under the system known as documents for collection are sent by an exporter’s bank to the bank’s branch or agent in the importer’s country who delivers them to the importer when he pays or excepts a Bill of Exchange. The shipping documents consist of:

1. Invoice – is a document contains complete details of the order, the terms of shipment and payment, the value of the order & details of insurance. 2. Origin Bill of Lading (or a copy of rail or road waybill) – is a document of title goods which have been loaded on the ship. 3. Shipping specification – is the form which gives details of goods which being shipped 4. Packing Sheet – shows that the goods have been tested.

5. Certificate of Quality – shows that commodities have passed the task of grading. 6. Certificate of Origin – shows where the goods come from. 7. Insurance Policy/ Certificate. There are three basic methods of payment in foreign trade but traders usually use the one which is customary in their business. 1. Payment against documents. The shipping documents are exchanged with the bank representing the importers.

There are two procedures: Documentary Bills and Documentary Letters of Credit. The latter is the commonest method of payment. 2. Payment into an open account. This is used where there is complete trust between seller and buyer. Also there must be no political or currency problems. The exporters simply airmail the shipping documents to the importers who settle their account monthly

or quarterly. 3. Cash in advance. This is used only for small orders sent by parcel post. Whatever method is used, the Sellers have to check the credit status (financial strength) of the Buyers. The criteria, forming relevant method of payment is the stage of economic development of the countries, between which the payment is settling up.