Receiving guarantee of payment from a foreign entity is one of the most important factors of your export sale. This process is more difficult for overseas buyers versus domestic transactions, because the exporter does not generally have the same type of processing systems available. We have compiled a list of popular payment methods for exports. Review each carefully to determine which method would be the best for you and your buyer. Always be sure that you are comfortable with the transactions as they occur.
During the negotiation process, it is necessary to establish the method of payment before the transaction can continue. Payment must be guaranteed and satisfactory for both buyer and seller. For export payments, there are four basic payment types; cash in advance, letters of credit, collections, and open account. As an exporter, the ideal situation will be cash in advance, but this will not always be agreed upon, as it puts the importer at the highest risk.
Choosing the Correct Payment Method
To choose the best payment method for your business, you will need to determine seven risk factors involved with the transaction:
- Established or new customer relationship
- Type and size of order
- Importer’s political situation
- Importer’s economic situation
- Competitors’ terms
- Risk of price changes
- Need to control cash flow
A combination of these factors will determine the risk level associated with the export sale. Once a preferred payment method is decided upon, it will still need to be negotiated with the buyer. Keep in mind the seller and buyer have opposite needs, which will mean that payment method preferences will likely be different.
Cash in Advance
The exporter will always desire a cash in advance payment method. This type of payment mitigates all risk for the exporter, but then transfers the risk to the importer, making it a less popular option. It is a bad idea for the exporter to require only cash sales, simply because their competitors will allow for other options. Many buyers would be turned off if this was the only method the seller would accept.
Letters of Credit
One of the best methods of payment for both seller and buyer are Letters of Credit. Similar to domestic sales, this method is established with a bank promise. The letter is created by the importer’s financial institution, who backs the sale as long as the negotiated conditions are met. Payment from the buyer is not required until the goods have been confirmed as sent. This is a secure and popular method of export payment that meets the needs of both parties.
This method is a bank-to-bank process. The exporter’s financial institution will send a request to the importer’s bank to receive funds. The importer pays their bank, who then transfers the money to the exporter’s bank. Although less expensive that a Letter of Credit, this process does not offer a verification process. The banks, in this case, act as middlemen for the buyer and seller.
An open account is a process in which goods are shipped and accepted by the importer, but payment is not due for 30 to 90 days. Importers obviously favor this method, since they can receive and begin selling goods before beginning to pay for them. Exporters on the other hand, do not favor the method. They ship goods and do not receive payment for a good amount of time. Unfortunately for exporters, this method is popular simply because there is so much global competition. If a business does not agree to export goods under an open account, the buyer will find an exporter that will.
Making a Decision
There are many factors to consider when determining payment methods for exports. There are no cut and dried answers, but a process does exist to ascertain the pros and cons of each method. Consider prior business relationships, the importer’s country, competitor options, and long-term results for each. When in doubt, research options for different scenarios. Websites and financial institutions can help you with your choice. Do not forget to review costs associated with each method before committing to them.
Are you new to exporting? Our experts are here to help you grow or establish you export business. If you have questions or would like to consider trade financing, call us at Drake Finance!