Payment
in International Trade
Both
the exporter and the importer face risks in an export transaction because there
is always the possibility that the other party may not fulfill the
contract.
For
exporters there is the risk that buyer defaults; the customers might not pay in
full for the goods. There are several reasons for this: the importers might go
bankrupt; a war might start or the importers' government might ban trade with
the exporting country; or they might ban imports of certain commodities. Another
possibility is that the importers might run into difficulties getting the
foreign exchange to pay for the goods. It is even possible that the importers
are not reliable and simply refuse to pay the agreed amount of money.
For
the importers there is the risk that the goods will be delayed and they might
only receive them a long time after paying for them. This may be caused by port
congestion or strikes. Delays in fulfillment of orders by exporters and
difficult customs clearance in the importing country can cause loss of business.
There is also a risk that the wrong goods might be sent.
It
is to guard against such possibilities that different methods of payment have
been developed. There are three basic methods of payment in foreign trade.
1.
Cash in Advance By insisting on
cash in advance the seller obviously has complete assurance of obtaining
payment. This method is often used in cases where the buyer is unknown, for
example, at the time of the first sale to a customer when the exporter is not
familiar with the buyer's credit standing. Cash in advance may also be
appropriate when the political and economic conditions in the buyer's country
make payment uncertain. This method places the burden for financing the
transaction entirely on the buyer; once the buyer has made the cash payment, he
has no assurance that the seller will fulfill his side of the
transaction.
2.
Open Account This method is used
where there is complete trust between the seller and the buyer. The seller
dispatches the
goods,
debits the purchaser's account and sends his invoice. At some agreed period of
time, say once a month or every three months or after an agreed time following
the dispatch of each consignment, the buyer sends a remittance to the seller to
settle the outstanding balance on the account. Where dispatch by sea, air or
rail is involved, the supplier sends the documents relating to freight and
insurance to the buyer so that he may take possession of the goods when they
arrive.
Whichever
of these two extremes is decided upon, payment in advance or trading on open
account, the same methods of payment are available to the importer: SWIFT or
telegraphic transfers (TT), mail transfers (MT), and cheques or drafts.
3.
Payment against Documents The shipping documents are exchanged with the bank
representing the importer. There are two procedures: Documentary Bills and
Documentary Letters of Credit. The latter is the commonest method of payment and
will be dealt with in detail in the following lesson.
A
lot of foreign trade is paid for using Bills of Exchange, so it is necessary to
understand what a Bill of Exchange is. A Bill of
Exchange, or frequently referred to as a draft, is defined as “an unconditional order in writing, addressed by one person to
another, signed by the person giving it, requiring the person to whom it is
addressed to pay on demand, or at a fixed or determinable future time, a sum
certain in money, to or to the order of, a specified person or to
bearer”. The person who draws the bill (i. e. the exporter or the person to whom a debt is due) is
called the drawer. The person to whom the bill is addressed is called the drawee, and the person to whom payment is to be made is
called the payee. Usually the drawer and the payee are the same person (i. e. the firm drawing the bill will instruct the drawee to pay the bill “to the order
of ourselves”), but this is not essentially so. An
example of a bill of exchange is given at the end of this
lesson.
Bills
of exchange are often drawn in sets of three, which are dispatched separately so
that if there is any delay in the receipt of the first copy of the bill, the
second or third copy can be presented. The bills are identical apart from a
reference on the face of the bill to the other copies. Usually this takes the
form of: “At ninety day's sight pay this first bill of exchange (second and
third unpaid). The drawee must be careful to accept
only one copy of the bill.
A
bill of exchange is either a sight bill or a usance,
tenor or term bill. The former is one that is payable on presentation to the
drawee, i.e. when it is sighted by him. The other type
is payable either at some fixed future date or a number of months or days after
the bill has been sighted, or a set period after the date of the bill. A bill is
also either a clean or a documentary bill.
Commercial
bills of exchange fall into two categories, bank bills and trade bills. A bank
bill is one which is drawn on or bears the acceptance of a bank, i.e. a
commercial bank or a merchant
bank. As such, it carries little risk and can be
discounted at the finest (lowest) rate of interest. Bills drawn by and accepted
by commercial firms are known as trade bills and those bearing the signatures of
firms of first-class repute are fine trade bill and can be discounted at rates
of interest only fractionally higher than those for bank bills.
A
bill of exchange is a useful means of settlement in that
it:
(a) provides
written evidence of a debt which can be used in a court of
law;
(b) enables the
exporter to obtain immediate payment, by presentation if it is a sight bill, or
by negotiation if it is a usance
bill;
(c) enables the
importer to delay payment until the maturity of the bill.
If
a bill of exchange is a documentary bill it will be accompanied by the documents
relating to the goods for which payment is sought. The exporter presents the
documents called for in the contract between the importer and himself to his bank and instructs the bank to deliver them to
the importer against either acceptance or payment of the bill. If the documents
are to be released against the importer's acceptance of the bill, the bill is
called a D/A bill (documents against acceptance) and if
upon payment then the bill is a D/P bill (documents against payment). If a bill
is a sight or demand bill, the documents will be handed over only against
payment of the bill. If the bill is a usance bill, the
documents are usually handed over against acceptance.
If
a bill is dishonored, notice of dishonor must be given to the drawer and to each
endorser against whom it is desirable to retain recourse. A foreign bill
dishonored by non-acceptance must be protested for non-acceptance, and if such a
bill is dishonored by non-payment, it must be duly protested for non-payment.
Failure to protest releases the drawer and endorsers from liability on the
bill.
The
payment of drafts on a basis can be subdivided into three categories: sight
draft, tenor or time draft, and clean draft collections.
Sight
Draft Collection Under a sight draft arrangement the
exporter forwards all shipping documents, invoices, insurance certificates, etc.
along with his draft drawn at sight on the importer through his bank to the
importer's bank overseas with instructions that the documents can only be
released to the importer upon his payment of the draft. There are some
advantages to the exporter and importer by this method of payment. The title to and control of merchandise normally remain with the
exporter or his agent until the draft has been paid and the buyer is not
obligated to pay for the goods until he receives the
documents.
Time
Draft Collection Using this method of payment the exporter
draws on the importer a draft payable on a specified due date or a certain
number of days after sight or date. The time draft and documents are forwarded
through his bank to the importer's bank overseas with instructions to deliver
documents against acceptance only. This arrangement is more beneficial to the
importer than to the exporter since the importer is not obligated to pay for the
merchandise until a certain number of days (30, 60, 90, or whatever the term
might be) after sight or date. The exporter is thus in a less advantageous
position because after having given up title to and control of the goods, he is
relying, solely upon the importer's willingness and ability to pay as expressed
by importer's acceptance of the draft.
Clean
Draft Collection Under this arrangement the exporter
presents only the draft
drawn on the importer to the bank for collection the shipping and other
documents are sent directly to the importer. This method thus lacks the
protection of the documentary collection. It is generally used in countries
where a draft is needed for legal purpose or because it is required by the
exchange control authorities.
