Payment Methods and their difference regarding to the risks

 

In International trade, the following payment methods are used in the contracts:

1. Open account:

Importer place order; exporter ships goods to importer (importer receives shipping documents and picks up goods immediately); importer pays importer's bank on due date; importer's bank pays exporter's bank; exporter's bank pays exporter. The open account is a trade arrangement in which goods are shipped to a foreign buyer without guarantee of payment.

2. Consignment of goods:

Importer places order; exporter ships goods to importer (importer receives shipping documents and picks up the goods immediately. As the seller, you retain the title to the goods during the consignment period). Case 1: if goods are sold during consignment period, importer pays importer's bank after goods are sold; importer's bank pays exporter's bank; exporter's bank pays exporter; Case 2: if goods are not sold during consignment period, importer return goods to exporter (responsibility for return transportation costs should be clearly specified in the consignment agreement). In a consignment arrangement, the consignor (seller) retains title to the goods during shipment and storage of the product in the warehouse or retail store. The consignee acts as an agent, selling the goods and remitting the net proceeds to the consignor.

3. Payment by Time Draft:

Exporter ships goods to importer; exporter presents time Draft and shipping documents to exporter's bank; exporter's bank pays exporter on discounted basis in advance of draft maturity date; exporter's bank sends shipping documents to importer's bank; importer's bank releases original shipping documents to importer; importer pays importer's bank on draft maturity date; Importer's bank pays exporter's bank. If using time draft, importer pays importer's bank on draft maturity date.

4. Payment by Sight Draft:

Upon receipt and approval of L/C, goods are prepared and shipped in accordance with terms of L/C (FOB Port of export, C&F, CIF Port of import); exporter presents Sight Draft and shipping documents to exporter's bank; exporter's bank pays exporter as confirming bank; exporter's bank sends shipping documents to importer's bank; importer's bank pays exporter's bank; importer pays importer's bank; importer's bank release original shipping documents to importer so the carrier will release the goods to the importer. Bank drafts (bills of exchange) are written orders that activate payment either at sight or at ¡°tentor,¡± a future time or date. Each is useful under certain circumstances.

5. Authority to Purchase

This document is similar to the Authority to Pay in that the authority stems from a buyer and not from a bank. It is primarily used by Far Eastern banks in financing major purchases and differs from the Authority to Pay in that under an Authority to Purchase the drafts are drawn directly on the buyer. They are purchased by the correspondent bank usually with full recourse against the drawer and have been largely superseded by letters of credit. It specifies that a bank where the exporter can draw a documentary draft on the importer's bank. The bank has recourse upon the exporter if the importer fails to pay the draft.

7. Payment by L/C:

(1) Confirmed L/C: a L/C established by a foreign issuing bank that bears the confirmation of the advising bank (usually the exporter's bank) that the L/C is authentic and valid.

(2) Irrevocable L/C: a L/C with a fixed expiration date that carries the irrevocable obligation of the issuing bank (importer's bank) to pay the exporter when all drafts and documents are presented in accordance with the terms and conditions of the L/C. once issued, the Irrevocable L/C cannot be altered, modified or cancelled without the authorization of all parties named in the L/C to include the buyer, seller, and all banks involved in the transaction. If it is not stated in the L/C that it is Irrevocable, the L/C is assumed to be revocable.

The table below shows that the difference between these payment methods in order of decreasing risk to exporter and increasing risk to importer:

Method

Goods Available to buyers

Usual time of payment

Exporter risk

Importer risk

Open account

Before payment

As agreed

Most: relies on import to pay account

Least

Consignment

Before payment

After sold

Maximum: exporter retains title

Minor inventory cost

Time draft

Before payment

On maturity of draft

High: relies on import to pay draft

Minimal check of quantity/quality

Sight draft

After payment

On presenting draft to importer

If unpaid, goods are returned/disposed

Little if inspection report required

Authority to purchase

After payment

On presenting draft

Be careful of recourse

Little if inspection

report required

Letter of credit

After payment

When documents are available after shipment

None

Non if inspection report required

Cash

After payment

Before shipment

least

Most