Including Some Pointers to Import/Export Information
How to pay or be paid becomes a crucial choice as soon as you begin doing business across borders. When you do business internationally, there are ways of paying that you might never hear about when doing business in just one country.
Some methods require extending credit. Chasing payment when something goes wrong is more difficult than when you are entirely in one country, too. If you can avoid payment problems, that is much better than facing such problems across a combination of distance, different legal systems, and in some instances political or economic issues.
This article outlines the most common methods that may be new to you. Among these, the least commonly used methods are toward the end. I am not delving into cybercurrency (e.g. BitCoin) which could take an entire article by itself. I am also not discussing forms of payment most people are already familiar with such as international wire transfer.
When negotiating an international contract, choose a method where each party is comfortable with its level of risk.
Quick List of Methods
These are some of the most common ways international business payments are done:
- Payment In Advance
- Documentary Letter of Credit
- Documentary Draft (Bill of Exchange)
- Open Account
- Standby Letter of Credit
- Consignment Sales
- International Countertrade
- Escrow
- Payment In Advance
Payment occurs: Before Shipment
This is usually done via international wire transfer from one bank account to another or bank-to-bank wire transfer (regarded as safer). It takes a few hours to a few days. Alternatively, it can be done with a credit card or telegraphic transfer. Note that it is possible for an imposter to collect payment at telegraphic transfer offices, and documentation via that method is limited.
Check clearing time can be as long as two months, so checks are not commonly used.
Even within one country, paying in advance requires great trust that the seller will deliver honestly and on time. When someone does not honor their portion of an international deal, trying to make them come through is complicated by having multiple legal systems involved. If you pay in advance internationally, you need to be absolutely sure the seller will deliver.
Highly insecure for buyers, but very comfortable for sellers. Payment transfer services incur fees.
Documentary Letter of Credit
Confirmed or Unconfirmed – Sight, Date or Time
This comes in a variety of forms:
- confirmed – sight
- confirmed – date or time
- unconfirmed – sight
- unconfirmed – date or time
A letter of credit is a bank-to-bank guarantee to pay the seller (beneficiary) upon presentation of specific documents that comply with terms set by the buyer (applicant). The documents convey title to goods by showing that specific steps have been taken, or as of a maturity date, or a designated period of time after an event. Terms of payment must be specified clearly and completely to avoid confusion and delay.
International Chamber of Commerce (ICC) publishes “Uniform Customs and Practices” (document number UCP600) to govern letters of credit. Worldwide, over 90% of banks honor these rules. There are revocable and irrevocable letters of credit, although UCP600 only accommodates irrevocable (terms and conditions can only be changed with explicit consent from all parties). If unconfirmed, the payment guarantee is by the buyer’s bank, and the letter of credit must be irrevocable. If confirmed, the guarantee is by the seller’s bank.
Banks charge a percentage of the transaction amount as their fee, which is usually but not always paid by the buyer. If fees are charged by both banks in the transaction, price quotes and the letter of credit should specify which party pays each fee.
Sellers tend to like letters of credit as a secure way to get paid. Buyers tend to be less keen about this because of the expense (typically one to eight percent) and processing can take up to a month, delaying order delivery. As parties become more comfortable dealing with each other, payment is likely to change to less expensive payment methods such as drafts.
Confirmed – Sight
Payment occurs: Typically linked to time of shipment.
Example clause: “£12,000 British pounds sterling net 15 days from shipment.”
Seller has risk with the confirming bank and documentary risk. Buyer must trust seller to make certain goods are delivered after payment is transferred.
Confirmed – Date or Time
Payment occurs: At maturity.
Example: “$21,000 US net 15 days from acceptance.”
Seller has risk with the confirming bank and documentary risk. Buyer must trust seller to make certain goods are delivered after payment is transferred.
Unconfirmed – Sight
Payment occurs: Typically linked to time of shipment.
Example clause: “25,000 euros net 15 days from shipment.”
Buyer has assurance that shipment occurs, but must trust seller to ship the goods described in the document.
Unconfirmed – Date or Time
Payment occurs: At maturity.
Example clause: “150,000 Japanese yen net 15 days from acceptance.”
Seller has risk with the issuing bank and documentary risk. Buyer has assurance that shipment occurs, but must trust seller to ship the goods described in the document.
Documentary Draft (Bill of Exchange)
Against Payment – Sight or Against Acceptance – Date or Time
This comes in a couple of forms:
- against payment – sight
- against acceptance – date or time
A draft is like a foreign buyer’s check. As with a domestic check, there is a risk that it might not clear. It differs from a domestic check in that title does not transfer to the buyer until the draft is paid (or at least legal steps are taken to ensure that it will be paid when it is due).
Documentary drafts fall under the category bills for collection. In some markets (particularly in Asia), these methods are favored as a cost-effective way to satisfy Exchange Control Regulations. ICC publishes “Uniform Rules for Collections” (document number URC522) to govern these. Worldwide, over 90% of banks honor these rules.
The documentation requesting payment is sent from seller’s bank to buyer’s bank, instead of directly from seller to buyer. The banks can sometimes help resolve any disputes that arise and threaten to disrupt the transaction. If the buyer fails to meet conditions specified in the documents, in some situations the seller can keep title to the shipment and may be able to recover the goods.
Drafts are often used when buyer and seller regard each other as trustworthy, there is no doubt about the buyer’s ability and willingness to pay, no constraining foreign exchange controls need to be dealt with, and the buyer is in a politically and economically stable nation.
Against Payment – Sight
Payment occurs: When draft is presented to buyer (often a verbal notification).
With a sight draft, the seller keeps title for the goods until they reach their destination and payment occurs. If shipment is by sea, the ocean bill of lading is endorsed by the seller. Then the seller’s bank sends it to the buyer’s bank, along with the sight draft and supporting documents such as invoices, consular invoices, certificates of insurance or packing lists. The buyer is notified when these documents arrive. When the draft is paid, the bank turns over the bill of lading so the buyer can claim the shipment. (Air bills of lading and railway or road transport have less rigorous requirements before the buyer can take the shipment. Therefore, a sight draft involves more risk if shipment is not by sea.)
The buyer can have a change of mind between the time when the goods are shipped and the time when the draft is presented for payment. If this happens, the bank is not obligated to pay. Similarly, the bank is not obligated to pay when governmental policies change and interfere with delivery. If such problems lead to the buyer not paying for or not receiving the shipment, the seller is stuck with the problem of what to do with the goods.
Against Acceptance – Date or Time
Payment occurs: At maturity.
A date draft stipulates a date on which payment is due.
A time draft stipulates that payment is due by a specific amount of time after the buyer accepts the time draft and receives the shipment, such as “20 days after acceptance.” (When the buyer writes “accepted” on the draft, that is trade acceptance.)
Open Account
Payment occurs: As agreed.
Goods are shipped. Seller sends a bill to buyer and buyer is expected to pay under agreed firms. This is much like having an open account for a customer within the States. Some large companies will only buy this way. There are markets, notably Europe, where buyers often expect Open Account. However, open account is appropriate only when the buyer has a long, good record as a payer and is definitely creditworthy.
Open account can be thought of as meaning “open to risk.” The ongoing nature of an open account raises the odds that political or economic situations may deteriorate. Legal enforcement to collect payment may be hindered because the extensive documents and banking involvements of other methods are missing–not to mention that pursuing collections abroad tends to be expensive and difficult. Factoring or export credit insurance may be advisable to reduce risk.
Highly insecure for sellers, but very comfortable for buyers.
Standby Letter of Credit
Payment occurs: If necessary.
This is a bank guarantee of payment that is triggered only if the buyer fails to pay in the normal manner, such as defaulting on payments due under Open Account. Note that this lacks the documentary controls in Letters of Credit.
International Countertrade
Payment occurs: Variable.
One party accepts goods, services, or something else other than money as partial or complete payment. Beyond that vague description, there are many variations.
Most forms of countertrade can be thought of as forms of barter. However, direct barter is not common internationally. The two parties rarely have balanced needs for each other’s products, and agreeing upon the value of goods may be difficult. To get around that, the parties can trade through an intermediary. (There are brokers and export management companies that handle such transactions.)
Transaction cost and risk are often higher than with other types of international transactions. However, countertrade may be the only way to do business with a company that does not have access to foreign exchange or is in a nation whose currency is not readily exchangeable.
Consignment Sales
Payment occurs: After sale of goods.
On the surface, this looks like consignment sales within the States. The seller sends goods to a distributor in another country, and the distributor sells them on behalf of the seller. The seller keeps title to the goods until they are sold, after which the distributor pays the seller
Despite legally having title until goods are sold by the distributor, the exporting seller has considerable risk: practically no control over the merchandise, and delay before payment arrives. Appropriate insurance is highly advisable, including property coverage over the goods until they are sold and payment occurs.
Escrow
Payment occurs: As agreed, typically after acceptance.
Buyer deposits funds, property or other tangibles in an escrow account that is supervised by an escrow agent (a neutral third party trusted by both buyer and seller). When the terms of the escrow agreement are met (such as satisfactory delivery of goods to the buyer), the escrow agent releases the funds to the seller.
This mechanism is low risk for both buyer and seller if a reputable escrow agent is used. However, it adds cost (the escrow agent’s fee), takes time to set up, and can be difficult to set up internationally. It is normally only used for large transactions. Caution against fraudulent escrow agents is advised.
Remarks
Whenever payment depends upon presentation of documents attesting that specific conditions have been met, the shipping and documentation requirements in the sales contract and letter of credit or draft must agree precisely. If they do not, the bank may refuse to pay. Reportedly, more than half of document presentations for letters of credit have discrepancies. This is expensive–banks charge extra for each discrepancy, and resolution delays payment.
If this overview leaves you needing to know more, your commercial banker can help you sift through the options and set up the method that best fits your situation.
Books about International Payment
This is a Really BIG Subject
If you need a sophisticated understanding of international payments, no web page can tell you enough. This lens only touches the high points. To learn more, here are the most relevant books at Amazon. (Remember, you’ll need recently published books. Technology has made wondrous new methods available, which only newer titles can cover.) In the next module, I’ll suggest books about import/export, since that is probably what got you involved in international payments.
P.S. – You may want to start with simple books, but I can personally testify that sometimes an expensive book that’s hard to read is worth the trouble. Before I left the USA, I spent about $75 to buy U.S. Tax Aspects of Doing Business Abroad. At the time I resented the cost, and reading it was not a joy. It makes some of my university textbooks seem like exciting reading. But it has saved me thousands of dollars by helping me navigate the minefield of USA tax law in areas that even my accountant finds difficult.
The Future of Payment Systems (Routledge International Studies in Money and Banking)
Letters of Credit and Documentary Collections: An Export and Import Guide
Whoops!: Why everyone owes everyone and no one can pay by Lanchester, John (2010)
I gave this a five star review at Goodreads. A lot of people have done the same at Amazon. It does an amazing job of explaining the so-called Credit Crunch so ordinary people can understand what happened, with emphasis on the UK and USA markets. Reading this will help you spot warning signs of the next financial crisis and could keep you from stepping in it. The book starts simply and you gradually learn more and more. By the time you get to a lengthy complicated quote of Greenspan… by gosh, you understand it!
International Financial Management
This is a heavy duty book suitable for people who are moving to the upper management level or executive level of big multinational businesses, or studying MBA (maybe even PhD) material. If you have a small business that is just starting to do business internationally, you probably don’t have much use for this book yet.
Books about Import/Export Business
Import / Export Kit For Dummies
Import/Export: How to Take Your Business Across Borders
How to Open & Operate a Financially Successful Import Export Business (Book & CD-ROM)
Students at University of Warwick in England had the idea to create the Alibaba trade website. Recognizing that it’s much easier to get such a startup funded and running in the USA than in the UK, they got venture capital in the States. The result has changed the face of global business-to-business trade. Alibaba is the place most of the world looks first when seeking suppliers in another country.
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