In considering methods of payment and the financing of overseas trade, we shall be concerned with two main aspects; firstly security of payment, safe and correct delivery of goods and secondly, the implications certain methods of payment or financing in international trade have for those in shipping business.
The method of payment in any sales contract is really a matter of negotiation between buyer and seller and will be related to the mutual trust that exists including the financial standing of the buyer.
If it is a very competitive buyers’ market then the buyer may be able to get more advantageous payment terms than if it is a sellers’ market. It must be remembered that unless cash is handed over directly from buyer to seller without any kind of paperwork every method of payment involves some form of cost.
There are a whole range of methods of payment, some of, which are unsuitable for international trade, which provide varying degrees of security and advantage for both buyer and seller.
The most advantageous for the seller is Cash with Order, a form of payment in advance. This may also be referred to as Advance Payment against Pro- forma Invoice or other expressions. This method would be most secure for the exporter since he would receive full payment for the goods ordered before any shipment is made. It is not, however, beneficial to the buyer because he would, in effect, be extending credit to the seller and would have little redress against delay in shipment or incomplete carrying out of the contract. However, it is not unusual for the buyer to have to pay some form of deposit upon the signing of a sales contract.
Open Account: is the most favorable form of payment for a buyer. The goods are ordered, the exporter dispatches the goods and sends the documents direct to the buyer and the seller awaits payment by some previously agreed manner. Often the payment terms may be monthly or even longer. While this method of payment is quite normal between companies that are known to be financially sound, in national trade, it is a less usual method in international business but it is increasingly used between companies that have established trading patterns, particularly in areas like the European Community.
An alternative to the above where there is mutual trust between buyer and seller can be the Bill of Exchange which is quite a complex subject in itself. Briefly, however, one should imagine a document similar in appearance to a cheque but which may stipulate payment at a date in the future; ninety days, for example, is quite common. This has the potential benefit to the Buyer of extending credit so that for example a buyer may be able to sell a significant proportion of the cargo he has purchased before he needs to pay the sum due on the Bill. Thus his cash flow is put under less strain, and he may be able to afford the purchase of larger quantities than under some less flexible form of payment. This in turn is a benefit to the seller, who is able to do more business with his customer as a result. The flexible nature of Bills of Exchange from the Seller’s point of view lies in the difference between the Bill of Exchange and a cheque. Unlike a normal cheque, a Bill of Exchange is negotiable and if the seller does not want to wait the full ninety days to collect payment he can discount (sell) the bill to a bank for slightly less than its face value. An example of a 90 day Bill of Exchange. At the time that this method of payment is agreed between the buyer and seller a rate of interest will normally be agreed at which the buyer will pay on the outstanding sum. In order to spread the burden of the buyer it may be agreed, for instance, that 25% of the cost of the goods should be paid on receipt (or on transfer of the documents or whatever terms have been agreed for the sale) with the balance payable on three equal Bills of Exchange maturing at 30, 60 and 90 days respectively.
The Buyer will sign and hand over the Bills of Exchange to the Seller as part payment (in this case) for the goods. If the seller does not discount the Bills at an earlier date, he will then present them on the due date at the buyer’s bank (or wherever has been agreed beforehand) for payment. If he chooses to discount one or more of the Bills, the Bank or Discount House who buys the debt may sell it on to other institutions or use it as security until the maturity date, when it will be presented for settlement.