The importer pays for the goods before they are shipped for export. The supplier is fully protected from nonpayment for the goods as it gets done in advance. The importer is at a greater risk since the exporter may receive the payment, and either fails to deliver the goods in good time or deliberately does not export the goods (Madura, 2003).
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Letters of credit
Credit letters entail payment for the goods when they are being shipped for export. They involve a commitment by a bank on behalf of the buyer that the goods will be paid for. The customer will receive the goods after payment is done. The exporter has a minimum risk or none at all, as payment is received before the change of commodity ownership is done, depending on the conditions in credit terms. The importer is assured of getting the goods shipped, although right specifications, as indicated in the credit letter, are not assured (Madura, 2003).
This method involves the payment for the goods after they have been sold to the third party. The foreign distributor receives the goods and sells them, but the title of ownership remains with the exporting company. Payments done this way are risky to the exporter as they are not guaranteed of being paid once the goods have been sold. As a result, exporters have to take insurance of the goods exported as a cover in case payment is not done. Exporters, therefore, are forced to trade with reputable and trusted foreign companies. The method improves the competitiveness of exporters in the delivery of goods to the international market. The exporter is relieved of direct costs involved in the storage and management of the inventory. This method, however, is beneficial to the importer as he bears no risk and improves his cash flows (Madura, 2003).
In this method, the goods are delivered to the customer on credit. Payment is done at a later date after selling the goods. It benefits the customer because it reduces cost, but increases cash flows. The exporter takes a significant risk as buyers take advantage of completion to wishing their credit to be extended. Exporters risk losing potential customers to competitors if they don’t comply. Moreover, exporters are not assured that payment will be made as this entirely relies on the importer (Madura, 2003).
Drafts are handled by banks, though they are not obligated to make payments on behalf of the importer. There are two types of drafts namely sight draft and time draft (Madura, 2003). Sight draft needs the customer to pay for the goods once the shipment of goods is made, and the draft demanding payment is presented to the buyer (Madura, 2003). In this method, the exporter is assured of payment as the customer will not receive the shipping documents before payment is done. The limitation is on the buyer as the goods packed for shipment may not be the ones in the draft. A time draft means that the customer is allowed to receive the shipping documents when he appends his signature. Payment is done later on an agreed date. The exporter risks making losses as payment for such goods is not guaranteed (Madura, 2003).
Board of governors of the federal reserve system (2015). Web.
Madura, J. (2003). International financial management (9th ed.). Mason: Thomson/South-Western.
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