Exporters are very familiar with the details of selling, transporting and getting paid for sales made around the world. They’ll already know everything in this article (and more!) but if you are considering selling to a foreign prospect or beginning to sell internationally, this will provide a brief description of the four ways to get paid.
Cash in Advance
The least risky payment method for a seller is Cash in Advance. This means that the buyer pays for the product before ownership transfers. For the seller, there is no risk of non-payment but for the buyer, Cash in Advance isn’t attractive because it creates a potential cash flow issue and isn’t competitive with other sources of supply that offer more lenient payment terms. In my experience, only unique products can command Cash in Advance because there may not be other companies that can provide the same product. Payments are usually made by wire transfer or credit card.
Letter of Credit
If getting paid up front isn’t an option (which it won’t be too often), the next “least risky” option is to require a Letter of Credit (LC). LC’s are a very common payment method that require the foreign buyer to use his bank credit to secure the transaction. The creditworthiness of the buyer’s bank stands in place of the creditworthiness of the buyer himself, which reduces risk for the seller. Once the good are shipped, specific documents must be reviewed to be sure the transaction is completed according to the terms agreed to by both buyer and seller. If so, the buyer’s bank makes a payment for the goods and then debits the buyer’s account. A combination of the buyer, seller, buyer’s and seller’s banks and a freight forwarder are involved in the transaction and processing of the required documents. There are many kinds of LC’s. For more specifics, please talk with your freight forwarder or the international department of your bank. (If you don’t have a bank with an international department, please contact me and I’ll make introductions.)
The pros of using LC’s are that the seller is secure in extending a form of credit to the foreign customer and the customer doesn’t have to pre-pay for the products. On the other hand, requiring a LC means the buyer must tie up his bank credit and incur fees for the ability to purchase from the supplier. Also, the documentation can be complicated which can lead to delays while specifics are reviewed and accepted by all parties.
Documentation Collections
If you have established a good relationship with your customer and trust them more, a more customer-friendly option is Documentation Collections (D/C). When using D/C payment terms, the seller’s bank collects payment from the buyers’ foreign bank after the goods are shipped and payment documents are presented. The seller’s bank doesn’t verify that the details of the transaction are accurate so the risk is higher than with LC’s or Cash in Advance. The cost is lower however and D/C terms are more market friendly for buyers.
Open Account
Finally, the most sales-friendly but usually riskiest payment method is Open Account. Selling on Open Account is what almost all companies do inside the US. Goods are shipped before payment is required. Sales are invoiced with payment terms of Net 30, 60 or more days. As a result, Open Account is the most sales-friendly since it doesn’t require the buyer to incur fees or tie up credit with his bank. In fact, Open Account gives credit rather than takes it. That’s why it’s the largest form of credit in the world… more than bank loans or any other form of credit. Since there is no security in this type of transaction, it is the riskiest for the seller because there’s always a chance the buyer won’t pay.
Fortunately, there a way to remove the risk of Open Account payment to take advantage of the sales growth potential it offers. Use trade credit insurance!! Then, you have the most sales/customer friendly offer AND the most secure. For more on how trade credit insurance works, how much it costs and why businesses use it, see my article Back To Basics: What Is Trade Credit Insurance?
Which is right for you?
To know which payment method is best, consider your company’s objectives. Do you want sales to grow? Are you willing to be more market-friendly to increase sales? Or, are you focused on security even if it costs some sales. How is your cash flow? Can you afford to wait for payment under open account terms or do you need quicker payment to cash flow your operation. The answers to these and other questions will make the choice of payment terms more clear.
For more on how to increase sales without payment risk, go to tateparker.com and download white paper on 11 Ways Businesses Benefit from Credit Insurance.
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