There are several basic methods of
receiving payment for
products sold abroad. As with
domestic sales, a major
factor that determines the method of
payment is the amount
of trust in the buyer's ability and
willingness to pay. For
sales within the United States, if
the buyer has good
credit, sales are usually made on
open account; if not,
cash in advance is required. For
export sales, these same
methods may be used; however, other
methods are also often
used in international trade. Ranked in order from most
secure for the exporter to least
secure, the basic methods
of payment are
1.
cash in advance,
2.
letter of credit,
3.
documentary collection or draft,
4.
open account, and
5.
other payment mechanisms, such as consignment sales.
Since getting paid in full and on
time is of utmost concern
to exporters, risk is a major
consideration. Many factors
make exporting riskier than domestic
sales. However, there
are also several methods of reducing
risks. One of the most
important factors in reducing risks
is to know what risks
exist. For that reason, exporters are
advised to consult an
international banker to determine an
acceptable method of
payment for each specific
transaction.
CASH IN ADVANCE
Cash in advance before shipment may
seem to be the most
desirable method of all, since the
shipper is relieved of
collection problems and has immediate
use of the money if a
wire transfer is used. Payment by
check, even before
shipment, may result in a collection
delay of four to six
weeks and therefore frustrate the
original intention of
payment before shipment. On the other
hand, advance payment
creates cash flow problems and
increases risks for the
buyer. Thus, cash in advance lacks
competitiveness; the
buyer may refuse to pay until the
merchandise is received.
DOCUMENTARY LETTERS OF CREDIT AND
DRAFTS
The buyer may be concerned that the
goods may not be sent
if the payment is made in advance. To
protect the interests
of both buyer and seller, documentary
letters of credit or
drafts are often used. Under these
two methods, documents
are required to be presented before
payment is made. Both
letters of credit and drafts may be
paid immediately, at
sight, or at a later date. Drafts that
are to be paid when
presented for payment are called
sight drafts. Drafts that
are to be paid at a later date, which
is often after the
buyer receives the goods, are called
time drafts or date
drafts.
Since payment under these two methods
is made on the basis
of documents, all terms of sale
should be clearly
specified. For example, "net 30
days" should be specified
as "net 30 days from acceptance" or "net 30 days from
date
of bill of lading" to avoid
confusion and delay of payment.
Likewise, the currency of payment
should be specified as
"US$XXX" if payment is to
be made in U.S. dollars.
International bankers can offer other
suggestions to help.
Banks charge fees -- usually a small
percentage of the
amount of payment -- for handling
letters of credit and
less for handling drafts. If fees charged by
both the
foreign and U.S. banks for their
collection services are to
be charged to the account of the
buyer, this point should
be explicitly stated in all
quotations and on all drafts.
The exporter usually expects the
buyer to pay the charges
for the letter of credit, but some
buyers may not accept
terms that require this added cost.
In such cases the
exporter must either absorb the
letter of credit costs or
lose that potential sale.
Letters of credit
A letter of credit adds a bank's
promise of paying the
exporter to that of the foreign buyer
when the exporter has
complied with all the terms and
conditions of the letter of
credit. The foreign buyer applies for
issuance of a letter
of credit to the exporter and
therefore is called the
applicant; the exporter is called the
beneficiary.
Payment under a documentary letter of
credit is based on
documents, not on the terms of sale
or the condition of the
goods sold. Before payment, the bank
responsible for making
payment verifies that all documents
are exactly as required
by the letter of credit. When they
are not as required, a
discrepancy exists, which must be
cured before payment can
be made. Thus, the full compliance of
documents with those
specified in the letter of credit is
mandatory.
Often a letter of credit issued by a
foreign bank is
confirmed by a U.S. bank. This means that the U.S. bank,
which is the confirming bank, adds
its promise to pay to
that of the foreign, or issuing,
bank. Letters of credit
that are not confirmed are advised
through a U.S. bank and
are called advised letters of credit.
U.S. exporters may
wish to confirm letters of credit
issued by foreign banks
not only because they are unfamiliar
with the credit risk
of the foreign bank but also because
there may be concern
about the political or economic risk
associated with the
country in which the bank is located.
An international
banker or the local U.S. Department
of Commerce district
office can help exporters evaluate
these risks to determine
what might be appropriate for each
specific export
transaction.
A letter of credit may be either
irrevocable (that is, it
cannot be changed unless both the
buyer and the seller
agree to make the change) or
revocable (that is, either
party may unilaterally make changes).
A revocable letter of
credit is inadvisable. A letter of
credit may be at sight,
which means immediate payment upon
presentation of
documents, or it may be a time or
date letter of credit
with payment to be made in the
future. See the "Drafts"
section of this chapter.
Any change made to a letter of credit
after it has been
issued is called an amendment. The
fees charged by the
banks involved in amending the letter
of credit may be paid
by either the exporter or the foreign
buyer, but who is to
pay which charges should be specified
in the letter of
credit. Since changes can be
time-consuming and expensive,
every effort should be made to get
the letter of credit
right the first time.
An exporter is usually not paid until
the advising or
confirming bank receives the funds
from the issuing bank.
To expedite the receipt of funds,
wire transfers may be
used. Bank practices vary, however,
and the exporter may be
able to receive funds by discounting
the letter of credit
at the bank, which involves paying a
fee to the bank for
this service. Exporters should
consult with their
international bankers about bank
policy.
A Typical Letter of Credit
Transaction
Here is what typically happens when payment is made by an
irrevocable letter of credit
confirmed by a U.S. bank:
1.
After the exporter and customer agree on the terms of
a sale, the customer arranges
for its bank to open a
letter of credit. (Delays may be
encountered if, for
example, the buyer has
insufficient funds.)
2.
The buyer's bank prepares an irrevocable letter of
credit, including all instructions to the
seller
concerning the shipment.
3.
The buyer's bank sends the irrevocable letter of
credit to a U.S. bank, requesting confirmation. The
exporter may request that a
particular U.S. bank be
the confirming bank, or the
foreign bank selects one
of its U.S. correspondent banks.
4.
The U.S. bank prepares a letter of confirmation to
forward to the exporter along with
the irrevocable
letter of credit.
5.
The exporter reviews carefully all conditions in the
letter of credit. The exporter's
freight forwarder
should be contacted to make sure that
the shipping
date can be met. If the exporter
cannot comply with
one or more of the conditions,
the customer should be
alerted at once.
6.
The exporter arranges with the freight forwarder to
deliver the goods to the
appropriate port or airport.
7.
When the goods are loaded, the forwarder completes the
necessary documents.
8.
The exporter (or the forwarder) presents to the U.S.
bank documents indicating full
compliance.
9.
The bank reviews the documents. If they are in order,
the documents are airmailed to
the buyer's bank for
review and transmitted to the
buyer.
10.
The buyer (or agent) gets the documents that may be
needed to claim the goods.
11.
A draft, which may accompany the letter of credit, is
paid by the exporter's bank at
the time specified or
may be discounted at an earlier
date.
Example of a Confirmed Irrevocable
Letter of Credit
The example of a confirmed
irrevocable letter of credit in
figure 13-1 illustrates the various
parts of a typical
letter of credit. In this sample, the
letter of credit was
forwarded to the exporter, The Walton
Building Supplies
Company (A) by the drawee bank,
C&S/Sovran Corporation (B)
as a result of the letter of credit
being issued by the
First Hong Kong Bank, Hong Kong (C),
for the account of the
importer, BBH Hong Kong (D). The date
of issue was March 8,
1991 (E), and the exporter must
submit proper documents
(e.g., a commercial invoice in one
original and three
copies) (F) by June 23, 1991 (G) in
order for a sight draft
(H) to be honored.
Tips on Using a Letter of Credit
When preparing quotations for
prospective customers,
exporters should keep in mind that
banks pay only the
amount specified in the letter of
credit -- even if higher
charges for shipping, insurance, or
other factors are
documented.
Upon receiving a letter of credit,
the exporter should
carefully compare the letter's terms
with the terms of the
exporter's pro forma quotation. This point is extremely
important, since the terms must be
precisely met or the
letter of credit may be invalid and
the exporter may not be
paid.
If meeting the terms of the letter of credit is
impossible or any of the information
is incorrect or
misspelled, the exporter should get
in touch with the
customer immediately and ask for an
amendment to the letter
of credit to correct the problem.
The exporter must provide
documentation showing that the
goods were shipped by the date
specified in the letter of
credit or the exporter may not be
paid. Exporters should
check with their freight forwarders to make
sure that no
unusual conditions may arise that
would delay shipment.
Similarly, documents must be
presented by the date
specified for the letter of credit to
be paid. Exporters
should verify with their
international bankers that
sufficient time will be available for
timely presentation.
International letters of credit are
usually governed by
uniform customs and practices or by
ICC Publication No.
400. International bankers may be
consulted for more
information.
Exporters should always request that
the letter of credit
specify that partial shipments and
transshipment will be
allowed. Doing so prevents unforeseen
problems at the last
minute.
DRAFTS
A draft, sometimes also called a bill
of exchange, is
analogous to a foreign buyer's check.
Like checks used in
domestic commerce, drafts sometimes
carry the risk that
they will be dishonored.
Sight Drafts_
A sight draft is used when the seller
wishes to retain
title to the shipment until it
reaches its destination and
is paid for. Before the cargo can be
released, the original
ocean bill of lading must be properly
endorsed by the buyer
and surrendered to the carrier, since
it is a document that
evidences title.
Air waybills of lading, on the other
hand, do not need to
be presented in order for the buyer
to claim the goods.
Hence, there is a greater risk when a
sight draft is being
used with an air shipment.
In actual practice, the bill of
lading or air waybill is
endorsed by the shipper and sent via
the shipper's bank to
the buyer's bank or to another
intermediary along with a
sight draft, invoices, and other
supporting documents
specified by either the buyer or the
buyer's country (e.g.,
packing lists, consular invoices,
insurance certificates).
The bank notifies the buyer when it
has received these
documents; as soon as the amount of
the draft is paid, the
bank releases the bill of lading,
enabling the buyer to
obtain the shipment.
When a sight draft is being used to
control the transfer of
title of a shipment, some risk
remains because the buyer's
ability or willingness to pay may
change between the time
the goods are shipped and the time
the drafts are presented
for payment. Also, the policies of the
importing country
may change. If the buyer cannot or
will not pay for and
claim the goods, then returning or
disposing of them
becomes the problem of the exporter.
Exporters should also consider which foreign bank should
negotiate the sight draft for
payment. If the negotiating
bank is also the buyer's bank, the
bank may favor its
customer's position, thereby putting
the exporter at a
disadvantage. Exporters should
consult their international
bankers to determine an appropriate
strategy for
negotiating drafts.
Time Drafts and Date Drafts_
If the exporter wants to extend
credit to the buyer, a time
draft can be used to state that
payment is due within a
certain time after the buyer accepts
the draft and receives
the goods, for example, 30 days after
acceptance. By
signing and writing
"accepted" on the draft, the buyer is
formally obligated to pay within the
stated time. When this
is done the draft is called a trade
acceptance and can be
either kept by the exporter until
maturity or sold to a
bank at a discount for immediate
payment.
A date draft differs slightly from a
time draft in that it
specifies a date on which payment is
due, for example,
December 1, 19XX, rather than a time
period after the draft
is accepted. When a sight draft or
time draft is used, a
buyer can delay payment by delaying
acceptance of the
draft. A date draft can prevent this
delay in payment but
still must be accepted.
When a bank accepts a draft, it
becomes an obligation of
the bank and a negotiable investment
known as a banker's
acceptance is created. A banker's
acceptance can also be
sold to a bank at a discount for
immediate payment.
CREDIT CARDS
Many U.S. exporters of consumer and
other products
(generally of low dollar value) that
are sold directly to
the end user accept Visa and
MasterCard in payment for
export sales. In international credit
card transactions,
merchants are normally required to
deposit drafts in the
currency of their country; for
example, a U.S. exporter
would deposit a draft in U.S.
dollars. U.S. merchants may
find that domestic rules and
international rules governing
credit card transactions differ
somewhat and should contact
their credit card processor for more
specific information.
International credit card
transactions are typically placed
by telephone or fax, methods that
facilitate fraudulent
transactions. Merchants should
determine the validity of
transactions and obtain proper
authorizations.
OPEN ACCOUNT
In a foreign transaction, an open
account is a convenient
method of payment and may be
satisfactory if the buyer is
well established, has demonstrated a
long and favorable
payment record, or has been
thoroughly checked for
creditworthiness. Under open account,
the exporter simply
bills the customer, who is expected
to pay under agreed
terms at a future date. Some of the
largest firms abroad
make purchases only on open account.
Open account sales do pose risks,
however. The absence of
documents and banking channels may
make legal enforcement
of claims difficult to pursue. The
exporter may have to
pursue collection abroad, which can
be difficult and
costly. Also, receivables may be
harder to finance, since
drafts or other evidence of indebtedness
are unavailable.
Before issuing a pro forma invoice to
a buyer, exporters
contemplating a sale on open account
terms should
thoroughly examine the political,
economic, and commercial
risks and consult with their bankers
if financing will be
needed for the transaction.
OTHER PAYMENT MECHANISMS
Consignment sales
In international consignment sales,
the same basic
procedure is followed as in the
United States. The material
is shipped to a foreign distributor
to be sold on behalf of
the exporter. The exporter retains
title to the goods until
they are sold by the distributor.
Once the goods are sold,
payment is sent to the exporter. With
this method, the
exporter has the greatest risk and
least control over the
goods and may have to wait quite a
while to get paid.
When this type of sale is
contemplated, it may be wise to
consider some form of risk insurance.
In addition, it may
be necessary to conduct a credit
check on the foreign
distributor (see the section of this
chapter titled
"Decreasing Credit Risks Through
Credit Checks").
Furthermore, the contract should
establish who is
responsible for property risk
insurance covering
merchandise until it is sold and
payment received.
Foreign currency
A buyer and a seller in different
countries rarely use the
same currency. Payment is usually
made in either the
buyer's or the seller's currency or
in a mutually agreed-on
currency that is foreign to both parties.
One of the uncertainties of foreign
trade is the
uncertainty of the future exchange
rates between
currencies. The relative value
between the dollar and the
buyer's currency may change between
the time the deal is
made and the time payment is
received. If the exporter is
not properly protected, a devaluation
in the foreign
currency could cause the exporter to
lose dollars in the
transaction. For example, if the
buyer has agreed to pay
500,000 French francs for a shipment
and the franc is
valued at 20 cents, the seller would
expect to receive
$100,000. If the franc later
decreased in value to be worth
19 cents, payment under the new rate
would be only $95,000,
a loss of $5,000 for the seller. On
the other hand, if the
foreign currency increases in value
the exporter would get
a windfall in extra profits. However, most
exporters are
not interested in speculating on
foreign exchange
fluctuations and prefer to avoid
risks.
One of the simplest ways for a U.S.
exporter to avoid this
type of risk is to quote prices and
require payment in U.S.
dollars. Then the burden and risk are
placed on the buyer
to make the currency exchange. Exporters should also be
aware of problems of currency convertibility;
not all
currencies are freely or quickly
convertible into U.S.
dollars. Fortunately, the U.S. dollar is widely
accepted
as an international trading currency,
and American firms
can often secure payment in dollars.
If the buyer asks to make payment in
a foreign currency,
the exporter should consult an
international banker before
negotiating the sales contract. Banks
can offer advice on
the foreign exchange risks that
exist; further, some
international banks can help one
hedge against such a risk
if necessary, by agreeing to purchase
the foreign currency
at a fixed price in dollars
regardless of the value of the
currency when the customer pays. The
bank charges a fee or
discount on the transaction. If this
mechanism is used, the
fee should be included in the price
quotation.
Countertrade and barter
International countertrade is a trade
practice whereby a
supplier commits contractually, as a
condition of sale, to
undertake specified initiatives that
compensate and benefit
the other party. The resulting linked
trade fulfills
financial (e.g., lack of foreign
exchange), marketing, or
public policy objectives of the
trading parties. Not all
suppliers consider countertrade an
objectionable
imposition; many U.S. exporters consider countertrade a
necessary cost of doing business in
markets where U.S.
exports would otherwise not occur.
Simple barter is the direct exchange
of goods or services
between two parties; no money changes
hands. Pure barter
arrangements in international
commerce are rare, because
the parties' needs for the goods of
the other seldom
coincide and because valuation of the
goods may pose
problems. The most common form of
compensatory trade
practiced today involves
contractually linked, parallel
trade transactions each of which
involves a separate
financial settlement. For example, a
countertrade contract
may provide that the U.S. exporter
will be paid in a
convertible currency as long as the
U.S. exporter (or
another entity designated by the
exporter) agrees to export
a related quantity of goods from the
importing country.
U.S. exporters can take advantage of
countertrade
opportunities by trading through an
intermediary with
countertrade expertise, such as an
international broker, an
international bank, or an export
management company. Some
export management companies offer
specialized countertrade
services. Exporters should bear in
mind that countertrade
often involves higher transaction
costs and greater risks
than simple export transactions.
The Department of Commerce can advise
and assist U.S.
exporters faced with countertrade
requirements. The Finance
and Countertrade Division of the
Office of Finance,
Industry, and Trade Information
monitors countertrade
trends, disseminates information
(including lists of
potentially beneficial countertrade
opportunities), and
provides general assistance to
enterprises seeking barter
and countertrade opportunities. For information, contact
Finance and Countertrade Division,
Office of Finance,
Industry, and Trade Information,
International Trade
Administration, U.S. Department of
Commerce, Washington,
D.C.; telephone 202-377-4471.
UNCITRAL is expected to
publish a legal guide to countertrade
contracts in 1992.
DECREASING CREDIT RISKS THROUGH
CREDIT CHECKS
Generally, it is a good idea to check
a buyer's credit even
if credit risk insurance or
relatively safe payment methods
are employed. Banks are often able to
provide credit
reports on foreign companies, either
through their own
foreign branches or through a
correspondent bank.
The Department of Commerce's WTDRs
also provide useful
information for credit checks. For a
fee, a WDTR may be
requested on any foreign company.
Although the WTDR is
itself not a credit report, it does
contain some financial
information and also identifies other
U.S. companies that
do business with the reported firm.
The exporter may then
contact those companies directly to
find out about their
payment experience.
Private credit reporting services
also are available.
Several U.S. services compile financial information on
foreign firms (particularly larger firms) and
make it
available to subscribers. Reliable
evaluations can also be
obtained from foreign credit
reporting services, many of
which are listed in The Exporter's
Guide to Foreign Sources
for Credit Information, published by
Trade Data Reports,
Inc., 6 West 37th Street, New York,
NY 10018.
COLLECTION PROBLEMS
In international trade, problems
involving bad debts are
more easily avoided than rectified
after they occur. Credit
checks and the other methods that
have been discussed can
limit the risks involved. Nonetheless, just as in a
company's domestic business, exporters
occasionally
encounter problems with buyers who
default on payments.
When these problems occur in
international trade, obtaining
payment can be both difficult and
expensive. Even when the
exporter has insurance to cover
commercial credit risks, a
default by a buyer still requires
time, effort, and cost.
The exporter must exhaust all
reasonable means of obtaining
payment before an insurance claim is
honored, and there is
often a significant delay before the
insurance payment is
made.
The simplest (and least costly)
solution to a payment
problem is to contact and negotiate
with the customer. With
patience, understanding, and
flexibility, an exporter can
often resolve conflicts to the
satisfaction of both sides.
This point is especially true when a
simple
misunderstanding or technical problem
is to blame and there
is no question of bad faith. Even though the exporter may
be required to compromise on certain
points -- perhaps even
on the price of the committed goods
-- the company may save
a valuable customer and profit in the
long run.
If, however, negotiations fail and
the sum involved is
large enough to warrant the effort, a
company should obtain
the assistance and advice of its
bank, legal counsel, and
other qualified experts. If both parties
can agree to take
their dispute to an arbitration
agency, this step is
preferable to legal action, since
arbitration is often
faster and less costly. The
International Chamber of
Commerce handles the majority of
international arbitrations
and is usually acceptable to foreign
companies because it
is not affiliated with any single
country. For information
contact the vice president for
arbitration, U.S. Council of
the International Chamber of
Commerce, telephone
212-354-4480. The American
Arbitration Association is also
a reputable arbitration agency that
handles international
disputes; for information telephone
212-484-4000.
U.S. Government Trade Complaint
Service
The Trade Complaint Service is
available to aid U.S.
exporters who find themselves in a
trade dispute as a
result of a specific overseas commercial
transaction. These
disputes, which are processed through
the Department of
Commerce's district offices, must
meet certain criteria.
After a firm has made every effort to
settle the complaint
without U.S. government assistance, cases are accepted
when it can be clearly shown that
communications have
broken down and the value of the
claim is more than $1,000.
Simple collection claims are not
accepted.
Commerce makes every effort to
restore communications
between the parties to the dispute in
order to arrive at an
amicable settlement. When legal proceedings are initiated,
U.S. government assistance is
normally withdrawn.
