At the time of entering into the contract for export, the importer and exporter agree as to when and how the payment will be made by the importer to the exporter. Depending upon the relative bargaining power of the importer and exporter, and having in view the requirements of the exchange control in the countries concerned, payment for the international trade may take place in any one of the following methods:
1 Advance Remittance
The exporter may require that the importer should make full payment in advance for the goods
to be exposed. This is possible where the goods enjoy seller’s market. The exporter would dispatch the goods after he receives the full payment from the importer. Or, he may even manufacture the goods only after he receives the payment. This is the most beneficial term of payment that the exporter can export, but it is at the cost of importer.
The importer has to fully rely on the integrity of the exporter and his capacity to execute the order in time. The transaction is financed solely by the importer, which entails additional cost to him. He shoulders the entire risk of the transaction. The credit insurance that is available to an exporter is not available to an importer. Because of these factors exchange regulations in many countries place restrictions on advance remittance against imports.
2 Cash on Delivery
For small items sent by post or courier, the term may be cash on delivery (COD). A part amount may be recovered by the exporter in advance and for the balance the article may be sent on COD basis. The importer should make payment to the courier at the time of receiving the goods. This is not a popular method of settlement for export of regular goods.
3 Open Account
The situation recommending open account business is the reverse of that for advance remittance. Under this method goods are dispatched directly to the buyer who takes delivery of them without making payment. He is free to dispose of the goods as he pleases. It is arranged that he will make payment to the seller at a predetermined future date, say, two months after each shipment. Open account as a method of settlement is possible where the commodity commands buyer’s market.
While the open account business is most advantageous to the importer, the exporter bears the entire risk and meets fully the financial requirement of the trade. The exporter loses control over the goods and relies on the integrity of the importer to receive payment. The credit risk to some extent is minimized because many countries have developed credit insurance schemes to protect exporters. In India we have Export Credit Guarantee Corporation undertaking this function. But exchange control regulations in India place severe restrictions on open account business for exports.
4 Consignment Sale
The exporter may have his selling agents abroad to whom the goods are dispatched. They receive the goods without making any payment. The selling agents on behalf of the exporter sell the goods and as and when the sale proceeds are received they are remitted to the exporter. Throughout, the goods remain at the risk of the exporter. The difference between open account system and consignment sale is that in the former case it is an absolute sale to the importer while in the latter case the importer receives the goods on behalf of the exporter. The ownership of goods in the case of consignment sale remains with the exporter. Consignment sale is prevalent in export of traditional goods from India.
5 Documents against Payment
The methods mentioned above are biased in favor of either party, viz., the exporter or the importer. A need arose for such a system which would enable the exporter not to part with the goods or the control over the goods till he receives payment and the importer does not pay until he gets the possession or control over the goods. A method which could fulfill this condition was the exporter drawing bill of exchange on the importer for the good exported. The goods are dispatched to the importer’s country but the relative documents are sent through a bank for collection. The bank hands over the documents to the importer only on receiving from the latter the value of the goods as advised by the exporter. Hence, this method is known as documents against payment or DP in short.
The bill of exchange system of collecting the export proceeds is no doubt impartial when compared to open account system and advance remittance system. Still the exporter faces the risk of non-payment by the importer. Even if the exporter does not lose control of the goods, in case of repudiation by the importer, he has to bear additional costs.
6 Documents against Acceptance
This is similar to the previous method with the difference that the documents will be accompanied by a usance bill of exchange, which gives a specific period of time for the importer to make payment. The collecting bank to the importer will release the export documents when he accepts the bill of exchange. Hence, this method is known as documents against acceptance, or DA in short.
No payment is made by the importer when he accepts the bill and receives the documents. He can get possession of the goods by using the export documents. He will pay the amount due on the bill to the collection bank on its due date.
DA bills are drawn when the exporter wants to extend credit to the importer for a specified period. For instance, 90 days DA will enable the importer to receive the documents immediately, but pay after a period of 90 days. DA bills are more risky to the exporter than the DP bills because he loses control over the goods before he receives payment for them.
7 Letter of Credit
When the exporter draws a bill of exchange on the importer he faces the risk of repudiation of the contract by the importer. A superior method of settlement of debt was devised which could assure the exporter that if he exports the goods as per the contact entered into with the importer and produces evidence to that effect, he would receive payment without default.
Letter of Credit is an undertaking by the importer’s bank that if the exporter exports the goods and produces documents as stipulated in the letter, the bank would make payment to the exporter. Thus the obligation of the importer under the contract is supplemented by superior obligations of a bank to make payment. The exporter now looks to the bank, which opened the letter of credit for payment instead of relying on the importer.
Letter of Credit has been acknowledged to be the best form of payment for international trade.
Next: Financing Exports