There are various methods of payment in international trade. Credit in any international trade transition is provided by the exporter, importer, bank, or a combination of these. Exporters who have sufficient cash flows can finance the entire trade cycle, starting with the production of the product by the exporter down to eventual payment made by the importer. This form of credit is referred to as export credit. Exporters may also need bank funding to supplement their cash flow in some instances. On occasions the exporter may not desire to provide the financing, the importer will have to finance the transaction itself, either internally or externally, through its financial institution. Banks can play a significant role to both exporters and importers in trade financing. Generally, the basic forms of payment applicable in international transactions include; Open account, prepayment, credit letters, drafts, consignment, and open account. These forms of payments used in international transactions differ in the way risk is divided among the buyer and the seller (Weiss, 2007, p. 114).
Forms of International Payment Forms
Payment by Open Account
Payment by account in international trade works in a way that the exporter first sends the shipments followed by bills for the goods and related costs. Importers can then make payments through ways such as; international money orders, bank transfers, Pay Pal, or credit cards. This mode of payment is cheap and does not involve any risk to the importer. However, it is riskier for the exporter if the importer fails to pay for the goods. In case of default, the exporter can forget the legal remedies. The only protection for the exporter is that of the underlying contract of sale and importers reputation or credibility (Madura, 2006, p. 565).
Open account form of payment in international business is the most commonly used method of payment in the import and export trade. The main reason is that most international trade is carried out between companies with affiliations or large companies that have mutual understanding. Small importers are not likely to be given open account terms from foreign exporters. However, some may earn their confidence with steady purchases and reliable performance (Weiss, 2007, p. 114). Exporters on the other hand are supposed to be aware of fraudulent tricks played by some importers. They may commence paying the exporter to secure the terms and then request an open account for the order. If the exporter accepts an importers order to open account, they will become progressively larger, and they will pay right in time. The exporter will then ship a large order, and the money from the importer may not arrive. Open account method may also be problematic in the sense that even honest importers can take along time to pay. In this case, exporters money will remain tied up and will weaken his cash flow (Madura, 2006, p. 565).
Prepayments
Prepayment refers to advance payment remitted by the importer to the exporter before shipment of the goods. In other words, a prepayment is when the buyer first pays for purchase and after which the seller ships the goods purchased. This method is riskier for the buyer, because of the lack of insurance in getting the goods. The seller on the other hand has a very secure position, because he will at one point have both the goods and the money. In other words, it is the best method of payment for goods in international trade (Jones, 2000, p. 45). Payments by buyers are usually made in the form of international wire transfer to the exporters’ bank account of foreign bank draft. With the progression of technology, electronic commerce has enabled firms engaged in international trade to make electronic credits and debits through an intermediary bank. This form of international payment provides the exporter with the greatest degree of protection. It is normally requested of those importers or buyers who are first timers whose credit worthiness is not known or whose countries are facing economic strains. However, most buyers are usually unwilling to bear all the risks by prepaying an order (Bertrand, 2004, p. 41).
Drafts
Drafts are also vital for making payments in international transactions. According to Madura (2006, p. 566), drafts are unconditional promises drawn by one party, usually the exporter, instructing the buyer to pay the face amount of the draft upon presentation. Drafts represent exporter’s formal requests for payment from the buyer. The importer is legally bound to pay the exporter by signing or accepting the draft. Drafts provide exporters with less protection because banks normally are not obliged to honor payments on behalf of buyers (Madura, 2006, p. 566). Most trading transactions often referred to as documentary collections, handled on draft basis are processed through banking channels. Documentary collection is a service provided by the exporter’s bank so that they can receive the payments from the buyer (Nelson, 2000, p. 87). This service is usually transacted by the seller’s bank to the buyer’s bank. The buyer’s bank then presents shipping documents to the buyer. If everything check out the buyer exchanges those for the payment (Nelson, 2000, p. 88).
This is more secure for both parties, but especially for the buyer. In other words, banks on both ends act as intermediaries in the processing of shipping forms and the collection of payment in documentary collection transactions (Nelson, 2002, p. 88). Incase a shipment is made under a sight draft; the exporter is paid once shipment has been made and the draft is presented to the buyer for payment. The buyer’s bank account will not release the shipping documents to the buyer until the buyer has paid the draft. Exporters are offered some protection, since banks release shipping documents only as per the exporter’s instructions. Shipping documents are necessary for the buyer to collect the goods. The buyer does not need to pay for the goods until the draft has been presented (Nelson, 2000, p. 88).
Shipments may also be made under a time draft, where buyer’s account is instructed by the exporter to release the shipping documents against signing of the draft. The buyer promises the buyer to pay the exporter at the specified future date by signing the draft. The buyer in this transaction can obtain the goods before paying for them. Exporters provide financing and are dependent upon the buyers’ financial integrity to honor the draft at maturity (Nelson, 2000. p. 88).
Consignment
According to Kidner (2003, pp. 391-392), consignment form of international payment, goods are shipped by the exporter to the importer while still retaining the actual title to the goods. In this case, the importer has access to the goods but does not have to pay for the goods until they have been sold to the third party. The dealing is based on the exporters trust on the importer to remit payment of the goods sold at that time. This is riskier to the importer incase the importer fails to pay, no draft is involved and the goods have already been solved. The exporter will have limited recourse incase of this eventuality. Due to this high risk, consignments are used seldom except by affiliates or subsidiary companies trading with the parent company (Kidner, 2003, p. 391).
Direct payment is the opposite of advanced payment. The Seller ships his goods and then waits for the buyer to make the payment to an account making it riskier for the seller. More secure methods are documentary collection and documentary credit (Kidner, 2003, p. 391).
Documentary Credits
Madura (2006,pp. 566) defines a documentary credit as “An instrument issued by a bank on behalf of the importer promising to pay the exporter upon presentation of shipping documents in compliance with the terms agreed therein”. In this effect, the bank substitutes its credit for that of the importer. This form of international payment is a compromise between the exporter and the importer because it affords certain advantages to both parties (Madura, 2006, p. 566). The exporters are guaranteed of receiving payment from the issuing bank as long as it presents documents by the documentation credits. As an important characteristic of documentation credits, the issuing bank is obliged to honor drawings under documentation credits regardless of the buyer’s ability or willingness to pay (Jones, 2000, p. 45). On the other hand, the importer is required to make payment for the goods only when a shipment is made and the necessary documents are provided in an appropriate state. Nevertheless, the importer will still depend upon the exporter to ship the goods as described in the documents since credit documents do not guarantee that the goods bought will be those invoiced and shipped (Bertrand, 2004, p. 114).
The most equally secure method of international payment is the method of documentary credit. There the bank, on the request of the buyer, guarantees to pay the seller the agreed payment for goods shipped. The seller must hand in agreed documents in exchange for the payment. In this case the buyer and seller are secure in getting their part of the deal, because there will be evidence in the documents that were required to make the transaction and after this the seller will get his payment because it is guaranteed by the bank (Bertrand, 2004, p. 114).
Conclusion
For exporters to succeed in international markets and gain sales against international competitors, they need to give clients attractive terms of payment supported by viable payment forms. The main point of being in business is getting paid in entirety and on time. The ultimate goal of engaging in export business is to have an appropriate payment form which must be chosen very carefully to reduce risks of payment while also accommodating the needs of the importer. Both exporters and importers must consider mutually acceptable forms of payment in international trade before and after contract negotiations. Among the key payment forms from international business discussed in this paper include; open account, prepayment, credit letters, drafts, consignment, and open account (Jones, 2000, p 40). In sum, the key points required in the conduct of international trade include: the understanding of various risks which lead to unpredictability over payment timings between the exporter and importer; for exporters, any international business sale is not authentic unless a payment is made by the importer; importers cannot effect payment before receiving them from exporters, otherwise the payment without the goods might be considered a donation; exporters always have the urgency of receiving payment as soon as the goods are dispatched to the buyer; and the importers require to obtain goods as soon as possible but withhold payment as long as possible (Snyder, 2002, p. 642).
Reference
Bertrand, R. 2004. Bank Guarantees in International Trade. Ydney: Kluwer Law International.
Jones, L. & Alexander, R., 2000. New International Business. Cambridge: Cambridge University Press.
Kidner, R. 2003. Statutes and Conventions. London: RoutledgeCavendish.
Madura, J. 2006. International Financial Management. New York: Cengage Learning.
Nelson, C. 2000. Import/Export. New York: McGraw-Hill Professional.
Snyder, F. 2002. Regional and Global Trade. New York: Hart Publishing
Weiss, K. 2007. Building an Import/Export Business. New York: Willey & Sons.