There are risks involved in international trade. For example, some methods have no guarantee that the payment can be received and cancellations can happen at any time. Therefore, choosing the right method for your business is important.
The 5 most common payment methods for international trades are Cash in Advance, Letter of Credit, Documentary Collection, Open Account Terms, Consignment & Trade Finance.
This article includes the pros and cons of each payment method to help you assess your options and find the right international payment method for your business.
Cross-border trading can be daunting for some business owners, so much so that they choose to avoid international markets altogether. This article will go through some common payment methods or ways for your business to start capitalizing on the global market.
So how do you safely and securely transfer money overseas? Start by understanding the different payment methods used in international trade and how their respective terms can influence your bottom line.
To sell internationally, it's critical to offer appropriate payment methods that are safe and have favorable terms for both the buyer (importer) and the seller (exporter).
There are risks involved in international trade and by understanding a few common methods of international payments and related terms, you can maximize returns and minimize losses on your world trade deals.
In this article, we'll review five different payment methods for international trade, as well as their pros and cons.
💡Tip: Learn how to make international payments via banks
1. Cash in Advance
Using the cash-in-advance payment method is the safest for exporters because they get paid before goods are shipped and ownership changes hands.
Usually, payments are made using wire transfers or credit cards.
This is a highly undesirable option for importers as there's a risk of not receiving the goods, making it unfeasible for business cash flow.
Small purchases are often paid for in advance with cash.
Exporters that rely solely on this method of payment cannot remain competitive.
Cash in advance is one of the most commonly used payment methods for international trade. Essentially, it requires the buyer to pay for goods before they're shipped. This gives importers better control over costs since they have access to the products before they actually have to make any payments.
Cash in Advance Pros & Cons
Immediate effect on cash flow management
Risk of not receiving shipment, Little recourse if shipment doesn't arrive.
Becomes insurance-heavy otherwise.
|Seller||Gets paid before goods are recieved.||No way to compete in the market, all competitors have this opportunity.|
2. Letter of Credit
A letter of credit, or documentary credit, is basically a promise by a bank to pay an exporter if all terms of the contract are executed properly. This is one of the most secure methods of payment.
It is used if the importer has not established credit with the exporter, but the exporter is comfortable with the importer’s bank.
Here are the general steps in a letter of credit transaction:
- The contract is negotiated and confirmed.
- The importer applies for the documentary credit with their bank.
- The documentary credit is set up by the issuing bank and the exporter and the exporter’s bank (the collecting bank) are notified by the importer’s bank.
- The goods are shipped.
- Documents verifying the shipment and all terms of the sale are provided by the exporter to the exporter’s bank and the exporter’s bank sends the documents to the importer’s issuing bank.
- The issuing bank verifies the documents and issues payment to the exporter’s bank.
- The importer collects the goods.
Letter of Credit Pros & Cons
Customizable payment terms
Payment only after shipment is received
Most expensive payment method.
Currency risk impacts the payment heavily
Customizable payment terms
Sale is secured by the Buyer's bank. (low risk)
Strict documentation requirements
Currency risk fluctuations impact the profit margins
3. Documentary Collection
Documentary collection or draft is a popular payment method among international traders. The payment process starts when the exporter sends a bill of exchange, also known as a sight draft, to the importer. The sight draft includes conditions for payment, such as the amount and due date.
The importer may obtain possession of goods if the importer has the shipping documents.
The documents are only released to the buyer after payment has been made.
This can be done in two ways.
Documents Against Payment
The exporter gives the ownership documents of an asset to their bank, which then presents them to the importer after payment is received.
The importer can then use the documents to take possession of the merchandise.
The risk for the exporter is that the importer will refuse to pay, and even though the importer won’t be able to collect the goods, the exporter has very little recourse to collect.
The steps involved in a document against payment transaction are as follows:
- The buyer and seller enter into an agreement and the buyer requests a document against payment from its bank.
- The buyer's bank issues a document against payment, confirming the buyer's commitment to pay the seller the specified sum of money upon receipt of certain documents.
- The seller ships the goods to the buyer and sends the documents to the buyer's bank and requests payment.
- The buyer's bank examines the documents, verifies that all conditions of the document against payment have been met, and then notifies the seller that payment will be made.
- The buyer's bank pays the seller the amount stated in the document against payment.
- The goods are delivered to the buyer, who then pays the amount stated in the document against payment to its bank.
Documents Against Acceptance
The exporter’s bank on behalf of the exporter instructs the importer’s bank to release the transaction documents to the importer.
The steps involved in a document against acceptance transaction are as follows:
- The buyer and seller enter into an agreement and the buyer requests a document against acceptance from its bank.
- The buyer's bank issues a document against acceptance, confirming the buyer's commitment to pay the seller the specified sum of money upon acceptance of certain documents.
- The seller ships the goods to the buyer and sends the documents to the buyer and requests payment.
- The buyer examines the documents, verifies that all conditions of the document against acceptance have been met, and then accepts the documents.
- The buyer's bank pays the seller the amount stated in the document against acceptance.
- The goods are delivered to the buyer, who then pays the amount stated in the document against acceptance to its bank.
Documentary Collection Pros & Cons
Cheaper than letter of credit
Payment is made once the goods are delivered
Relies on the seller to deliver the goods as specified. Payment is made before shipment is checked
Seller retains ownership of goods until payment is made
If the buyer cannot pay, seller is then required to pay the return shipment
4. Open Account Terms
An open account transaction is a sale where the goods are shipped and delivered before payment is due usually in 30, 60, or 90 days.
Also known as O/A, is an international payment term in which payment for goods is due at a future date according to an agreement between the buyer and seller.
This is one of the most advantageous options to the importer, but it is a higher-risk option for an exporter.
Foreign buyers often want exporters to offer open accounts because it is much more common in other countries, and the payment-after-receipt structure is better for the bottom line.
Additionally, it's important for importers and exporters alike to do their research and analysis before entering into a contract in order to avoid disputes over financial terms or other issues related to successful transactions.
Open Account Terms Pros & Cons
|Buyer||Payment not due until good received.||no effect|
|Seller||Increases sales||No guarantee that the payment can be received and cancellations can happen at any time.|
5. Consignment and Trade Finance
Consignment is similar to an open account in some ways, but payment is sent to the exporter only after the goods have been sold by the importer and distributor to the end customer.
The exporter retains ownership of the goods until they are sold.
Exporting on consignment is very risky since the exporter is not guaranteed any payment.
Consignment, however, helps exporters become more competitive because the goods are available for sale faster.
Selling on consignment reduces the exporter’s costs of storing inventory.
💡Tip: Learn more about types of Trade Finance on Statrys' blogs.
Consignment & Trade Finance Pros & Cons
Payment is received only after the goods are sold
Relies on good faith by the seller
Depending which country the good are stored, this could be a cost-saving measure
The Bottom Line
The bottom line is that when considering a payment method for international trade, it is good to keep in mind the different methods available to you and the costs associated with them.
Businesses have a myriad of options to choose from and with careful consideration, you can make sure that both parties in a transaction are satisfied with their agreement. Familiarising yourself with common payment methods and terms can help greatly in achieving that goal.
Despite these payment methods and accompanying terms, there are certain difficulties when it comes to trading which is dealing with foreign currencies and the exchange rate.
Are you looking for an easy and convenient way to make payments without having to go through the hassle of exchanging your money?
If your business is incorporated in Hong Kong, Singapore, or the BVI, you may want to consider Statrys for your business account.
Statrys offers business accounts catered to the needs of companies doing business internationally:
- A multi-currency business account in Hong Kong
- A EURO IBAN account
- Virtual and physical MASTERCARD payment cards with built-in controls and limits to manage business expenses
- FX services at competitive exchange rates (spot and forward contracts).
- All transaction fees are cheaper than with traditional banks.
What are the common payment methods for international trade?
What is documentary credit / letter of credit?
What is documentary collection?