International trade has played a very crucial role in globalization however , it has not come without its risk in terms of payments resulting in uncertainties between sellers and buyers. As an importer or exporter, after finally agreeing on the type of INCOTERMS to be used in a trade it’s important to now consider an attractive payments method which is necessary to win over customers especially in this competitive business environment.
During a sale negotiations, it’s important to consider which payment method is most appropriate to minimize risk and accommodate the needs of both parties in the sale agreement.
Below is a brief explanation of the five payments methods mostly used in international trading.
- Cash in advance
This is a prepayment option in which case the importer pays the exporter before shipment of the goods. On the exporter’s side, this may be a good option especially for high risk trade relations and also first time trade transactions. However this method could make an exporter loose potential customers to competitors who may offer more flexible terms of payments. On the other hand this method is the highest level of risk for an importer as you pay in advance even before the exporter ships the goods.
In this payment option, the importer actually pays the exporter after the delivery or receipt of the goods. This could be done through international cheques or wire transfer. This option is more favorable to the importer as the ownership of the goods is transferred to him/her before payments are made thereby avoiding credit risk. On the other hand this method presents the highest level of risk to the exporter as goods are released to the importer before payments are made. As an exporter this method may only be ideal in a well established and trusted trade relation.
- Letters Of Credit(LC)
This is one of the most secured methods of payments for both parties involved in an international trade agreement. An undertaking is given by the buyers bank to make payments on behalf of the buyer to the seller once the terms and conditions in the LC have been meet. The buyer establishes credit with his bank, the buyers bank then makes a commitment to the sellers bank of its readiness to make payments, the seller’s bank then advises the seller in accordance with the terms of the LC. Shipment is made and subsequently payment is also recieved through the banks. The advantage with this option is that risk is spread once the terms are meet and there is also risk mitigation available. But this method is labour intensive and equally has an expensive transaction cost.
- Documents against Payments( DP)/ Site Bill
With this payments option, the goods are shipped and the seller sends the bill of exchange to the buyer through the exporter’s bank, The bank then sends the documents to the corresponding bank in the buyers country where the buyer is expected to make payments in exchange for the documents . NB, the term “site” means that the buyer is expected to make payments before ownership documents are released to him/her. This method also in a way have a minimum risk level for both parties as the importer is assured that the exporter has shipped the goods .The exporter on the other hand is also assured that ownership would be transferred to the importer only when payment is made.
- Documents against Acceptance (DA)/ Term Bill
With this method, the importer pays the exporter after the exporter ships the goods. In practice, the exporter after shipment, sends the ownership documents through the bank. The importer needs the shipping documents to clear the goods on arrival. The bank holds the documents until the importer undertakes to pay for the goods at an agreed later date. The “term” in this case means the importer pays at a later date agreed. This method could be a little risky for the exporter as the buyer agrees to pay at a later date which always have a room for default.
Choosing the right payment method is very essential to the sustainability of any international trade and helps to prevent conflicts of interest. Remember that, an exporter always feel any sale is a gift until payment is received whiles an importer would also feel any payment made is a donation until goods are delivered.
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