Trade Articles

There are many ways in which an importer can pay to the exporter. But the four basic mode of payments, which takes various shapes of payments, are Payment in Advance, Open Account Payment, Documentary Collections and Documentary Credits / Letter of Credit. Each method is explained below:

Payment in Advance
In 'payment in advance' method, the entire risk is put on the importer. Under this term of purchase, the importer makes full payment to the supplier before the shipment of goods are done. The importer trusts the supplier that the shipment of the product will be on time and the goods will be as advertised. This method of payment generally takes place under the following circumstances:

• If the importer has not been long established.
• If the credit status of the importer is doubtful, unsatisfactory and/or the political and economic risks of the country are very high.
• If the product is in high demand and the seller does not have to accommodate the importer's financing request in order to sell the product.

This method of payment do not involve any commercial bank and is therefore inexpensive. But, the buyer faces a high degree of payment risk as he can do nothing if the seller sends poor quality goods or incorrect or incomplete documentation.

Open Account Payment
This method allows the importer to make payments to the exporter at some specific date in the future without issuing any negotiable instrument, only evidencing his legal commitment to pay at the committed time. Usually, this method takes place when either the importer has a strong credit history or is well-known to the seller.

This mechanism do not offers the seller any protection in case of non-payment. However, the exporter can structure this sale to minimise the risk of non-payment. He can reduce the repayment period and can retain title to the goods until the payment is made.

Though all the risks but still, open account payment is more prevailing in the international trade. Those exporters who offer such terms are increasingly obtaining credit insurance to mitigate the potential open account credit risks.

Documentary Collections
This term of payment offers an important bank payment mechanism. It serves the need of both, the exporter as well as the importer. In this mode of payment, the sale transaction is settled by the bank through an exchange of documents. Hence, it enables the payment and transfer of title simultaneously.

Documentary Credits / Letter of Credit
It is a credit instrument like letter of credit or back-to-back letter of credit. In this mode of payment, the buyer's bank undertakes to pay the seller when the terms and conditions have been met. The bank issues documentary credits to a customer according to his creditworthiness. Documentary credits are subject to the international rules, Uniform Customs and Practice (UCP 500) - issued on 01 January 1994.

Summarisation of Payment Methods

Escrow
Escrow is a legal payment arrangement where the money is delivered to the third party known as escrow agent. The escrow agent delivers the payment to the proper recipient. This mode of payment is typically used when the buyer and seller are unknown to each other.

In international trade, the buyer puts the payment in escrow by paying the escrow agent, on which both the parties agree. The seller sends the shipment and after acceptance by the buyer, the escrow agent releases the payment to the seller.