Whether you export or import goods, payment terms are an important part of profitable trade. However, the payment terms used can play a more important role in attracting good transactions, especially for sellers. Ideally, buyers want to delay payment as much as possible before they receive or even sell the goods.
The sellers also want to receive the money as soon as possible before delivering or immediately after receipt of the goods. This makes finding the best payment methods a balanced act that both parties want to get right. In addition, the payment terms you choose may be a factor in determining the attractiveness of your offer, and things become more unpredictable.
Cash in advance
Also known as “advance payment” or “order cash”. This is the most direct method of payment, in which the importer (usually the buyer) pays for the goods in advance before shipment. Payment can be made by any means agreed between the exporter and the importer. Popular options include TT, international cheques, and debit card payments.
Such payment terms benefit exporters as it means that they receive payment while still owning the goods. The typical procedure of the parties using this method is to agree to pay a certain percentage of the price before the start of production. After production, all or most of the unpaid prices will be paid before shipment. They may then agree to pay any remaining amount after the importer receives the goods.
Cash in advance brings great risk to the importer. This is because it puts them in a position where the exporter still owns and owns the goods and has received payment for the goods. This also creates an adverse cash flow situation for importers because they have to pay all prices in advance in a cash-a situation that most buyers are trying to avoid.
This method of payment is only available in very few cases. This may include situations where the size of the order is very small, or where the exporter is in a very strong negotiating position (such as the scarcity of goods). This is also an option for exporters who do not believe in the credibility of the importer or who fully trust the seller.
Letter of credit (L/C)
L/C is one of the most famous payment terms in international trade. It is also one of the safest payment methods, which is very popular in the Middle East and China. It involves the payment process made by the bank on behalf of the importer. It is a document secured by a bank indicating that it will pay the exporter the cost of the goods once certain terms and conditions are met. These terms and conditions are usually contained in the letter of credit itself and are mainly related to the inspection of the documents accompanying the goods rather than the goods themselves.
Before importers can obtain a letter of credit, they must be able to prove their credentials to the bank. When the bank completes the payment on behalf of the importer, they will turn to the importer for reimbursement. This is usually based on the terms agreed between the importer and the bank.
The letter of credit is mainly applicable to cases where there is a new untested trade relationship between exporters and importers. If the exporter is not satisfied with the importer’s reputation or cannot confirm it, they are also a good choice. Either way, a letter of credit provides exporters with less risk because they have a reliable guarantee of payment.
However, this payment term has its disadvantages. On the one hand, it is usually considered very expensive because the banks involved usually charge a lot of fees. Fees will vary according to the importer’s credit rating and the complexity of the transaction. In addition, banks generally do not inspect the goods issued by exporters. This means that there may be no provision for determining the quality of the goods in the process.
Documentary collections (D/C)
Documentary collection is a very balanced method of payment, providing almost equal exposure to exporters and importers. This method is done only between banks that represent both parties. The process begins when the exporter ships the goods and sends the documents required to claim the goods to the importer. These documents usually include bills of lading.
Importers also make payments to their banks, instructing them to make payments after confirming the documents. Once the document is confirmed, the document will be released to the importer to enable him to request the document. In this way, the documentary collection is almost like escrow (allowing you to pay to a third party before the agreement is completed).
There are two main methods during this payment term. They are D/P (DAP) and D/A (DA).
Payment document (DAP): the agreement here is that the bank will pay the exporter after seeing the document. Payment is not expected to be delayed here, and once the file is displayed (and found to be normal), payment must be completed.
Acceptance document (DA): the agreement here is that once payment is made on a fixed date, the document will be delivered to the importer’s bank. This means that payment will not be received immediately, but on the date agreed upon by both parties.
Because this kind of payment terms is more balanced, it will not bring too much risk to either party. The seller relinquishes ownership and possession of the goods only after receipt of payment or promise of payment. The buyer pays only when he sees the documents of the goods, or even after receiving the goods in kind. Compared with the letter of credit, the overall cost of this method is also lower and can be established in a shorter time.
However, like L/C, the focus of the two banks is on the documents, not necessarily on the goods themselves. This means that it may be more difficult to find quality problems before payment. If the importer fails to pay for the goods, this method of payment also provides exporters with little recourse. In addition, the documentary collection provides a balanced mode of payment for exporters and importers.
Open account (O/A)
This kind of payment terms relates to a trade agreement in which the exporter agrees to deliver the goods to the importer until payment is received later. Payment is due after the agreed time limit, usually 30, 60, or 90 days after delivery. Therefore, the importer receives the goods on credit and pays later.
It is beneficial to importers because they enjoy the status of picking up the goods without payment. It can reduce their operating expenses because they can simply order the goods and try to sell them completely before they have to pay the exporter. This also reduces their need for working capital because they do not have to worry about freeing up money to complete the payment before picking up the goods.
Because of these advantages, importers are always keen to find exporters who offer credit payment terms. In a buyer’s market (a market with more goods and less demand), you may see that credit terms are the main method of payment. Exporters who also want to show trust in important customers or want to attract valuable customers may be more willing to offer these terms.
However, you should keep in mind that opening an account is also very dangerous for exporters. The risk of unexpected events such as non-payment, late payment, and bankruptcy in this transaction is very high. In addition, exporters have to produce and transport goods without receiving payment. This will make their working capital less than they want. Overall, such payment terms are likely to put exporters in a very delicate position.
For these reasons, it is common for exporters to try to protect their status by exploring trade finance options. These are essential mechanisms to help exporters protect themselves from losses, waiting for them to receive full payment from importers.
You should explore this option only if you have a low-risk trade relationship with the importer. Another possibility is where demand is very low or where you want to win important customers.
Consignment
The last major payment deadline you should know is consignment. Here, the exporter produces, transports, and delivers the goods to the buyer, but receives payment only after the goods are sold. You can often see exporters with distributors or third-party agents abroad using this method of payment. This may be relatively rare in a normal relationship between buyers and sellers.
This rarity of payment terms is based on a simple reason-it poses incredible risks to exporters. The exporter bears all costs of producing, transporting, and delivering the goods to the importer. In addition, although the goods are owned by the importer, they are usually the property of the exporter. This means that the exporter will bear the loss in the event of fire, theft, storm, or other damage.
The exporter also bears the risk of non-payment or late payment by the importer. This is another risk and the goods may not even be sold as the parties wish. Therefore, it is understandable that exporters are unwilling to offer or accept these terms from buyers.Payment terms are most applicable to situations where there is an existing relationship between exporters and importers. Importers need to be reputable and trustworthy, and the goods must have been shipped to countries with political and commercial security. In addition, this payment period cannot be met at all without appropriate insurance measures.
Consignment can also give exporters an advantage when they can protect themselves well. For exporters, this may be a good opportunity to enter new markets, reduce inventory costs (and thus prices), or simply bring goods to market faster (bringing competitive advantage).
How to Choose the Best Payment Terms?
- Consider your financial needs and advantages.
- Think about your negotiating position. If you are in a better position, you may be able to ask for more favorable terms.
- Is the other party from a country with significant commercial or political risks? You may need a more secure term.
- In some industries, specific terms are usually used. For example, in the food and textile industries, it is common to see documentary collections, while letters of credit are common in oil and gas.
- General market conditions may be important. If it is a seller’s market, as an exporter, you may be able to set the most favorable conditions for yourself.
Please consider these questions carefully before deciding your payment terms. If you want to know more about payment methods or sourcing from China, you can contact professional China Toy Manufacturer.
