Methods of

International
Trade Payments

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 Contents

Introduction 3

Cash in Advance 3

Letters of Credit 4

Documentary Collections 4

Open Account 5

Overall Risk Assessment 7

Conclusion 8

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Introduction:
To succeed in today’s global marketplace, exporters must offer their customers attractive
sales terms supported by the appropriate payment method to win sales against foreign
competitors. As getting paid in full and on time is the primary goal for each export sale, an
appropriate payment method must be chosen carefully to minimize the payment risk while
also accommodating the needs of the buyer. As shown below, there are four primary
methods of payment for international transactions. During or before contract negotiations,
it is advisable to consider which method is mutually desirable for exporter and importer.
Basically, there are four methods settlement of international trade. They are –

1. Cash-in-Advance
2. Letters of Credit
3. Documentary Collections
4. Open Account

A brief discussion pertaining to above methods taking risk factors into consideration are as
follows:

1. Cash-in-Advance
With this payment method, the exporter can avoid credit risk, since payment is received
prior to the transfer of ownership of the goods. Wire transfers (and credit cards) are the
most commonly used cash-in-advance options available to exporters. However, requiring
payment in advance is the least attractive option for the buyer, as this method creates cash
flow problems. Foreign buyers are also concerned that the goods may not be sent if
payment is made in advance. Thus, exporters that insist on this method of payment as their
sole method of doing business may find themselves losing out to competitors who may be
willing to offer more attractive payment terms.

Applicability- Cash in advance is applicable for use in high-risk trade relationships or

export markets, and ideal for internet-based businesses (e-Commerce in particular).
However, in the following situation, such method is applied:

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 (a) The importer is a new customer and/or has a less-established operating history.
(b) The importer’s creditworthiness is doubtful, unsatisfactory, or unverifiable.
(c) The political and commercial risks of the importer’s home country are very high.
(d) The exporter’s product is unique, not available elsewhere, or in heavy demand.
(e) The exporter operates an Internet-based business where the use of convenient
payment methods is a must to remain competitive.

Risk/Disadvantages: The risks/disadvantages associated under this method are as follows:

(a) Exporter is exposed to virtually no risk as the burden of risk is placed nearly
completely on the importer.
(b) Exporters may lose customers to competitors over payment terms.
(c) Intermediaries have no additional earnings through financing operations.

2. Letters of Credit
Letters of credit (LCs) are among the most secure instruments available to international
traders. An LC is a commitment by a bank on behalf of the buyer that payment will be
made to the exporter provided that the terms and conditions have been met, as verified
through the presentation of all required documents. The buyer pays its bank to render this
service. An LC is useful when reliable credit information about a foreign buyer is difficult
to obtain, but exporter is satisfied with the creditworthiness of importer’s foreign bank. An
LC also protects the buyer since no payment obligation arises until the goods have been
shipped or delivered as promised.

Transactions under LC
(a) The importer arranges for the issuing bank to open an LC in favor of the
exporter.
(b) The issuing bank transmits the LC to the advising bank, which forwards it to
the exporter.
(c) The exporter forwards the goods and documents to a freight forwarder.
(d) The freight forwarder dispatches the goods and submits documents to the
advising bank.

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 (e) The advising bank checks documents for compliance with the LC and pays
the exporter.
(f) The importer’s account at the issuing bank is debited.
(g) The issuing bank releases documents to the importer to claim the goods
from the carrier.

Applicability – LC is used in new or less-established trade relationships when exporter is

satisfied with the creditworthiness of the buyer’s bank.

Risk/Disadvantages: The risks/disadvantages associated under this method are as follows:

(a) Risk is evenly spread between seller and buyer provided all terms and
conditions are adhered to.
(b) Process is complex and labor intensive
(c) Relatively expensive in terms of transaction costs

3. Documentary Collections
A documentary collection (D/C) is a transaction whereby the exporter entrusts the
collection of a payment to the remitting bank (exporter’s bank), which sends documents to
a collecting bank (importer’s bank), along with instructions for payment. Funds are
received from the importer and remitted to the exporter through the banks involved in the
collection in exchange for those documents. Documentary collections involve the use of a
draft that requires the importer to pay the face amount either on sight (document against
payment— D/P) or on a specified date in the future (document against acceptance—D/A).
The draft lists instructions that specify the documents required for the transfer of title to the
goods. Although banks do act as facilitators for their clients under collections, documentary
collections offer no verification process and limited recourse in the event of nonpayment.
Drafts are generally less expensive than letters of credit.

D/C Transaction Flow

(a) The exporter ships the goods to the importer and receives in exchange the
documents.
(b) The exporter presents the documents with instructions for obtaining
payment to its bank.

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 (c) The exporter’s remitting bank sends the documents to the importer’s
collecting bank.
(d) The collecting bank releases the documents to the importer upon receipt of
payment.
(e) Or the collecting bank releases the documents on acceptance of draft from
the importer.
(f) The importer then presents the documents to the carrier in exchange for the
goods.

Applicability – It is used in established trade relationships and in stable export markets.

Risk/Disadvantages: The risks/disadvantages associated under this method are as follows:
(a) Exporter is exposed to more risk as D/C terms are more convenient and
cheaper than an LC to the importer.
(b) Banks’ role is limited and they do not guarantee payment
(c) Banks do not verify the accuracy of the documents

4. Open Account
An open account transaction means that the goods are shipped and delivered before
payment is due. Obviously, this is the most advantageous option to the importer in cash
flow and cost terms, but it is consequently the highest risk option for an exporter. Due to
the intense competition for export markets, foreign buyers often press exporters for open
account terms since the extension of credit by the seller to the buyer is more common
abroad. Therefore, exporters who are reluctant to extend credit may face the possibility of
the loss of the sale to their competitors. However, with the use of one or more of the
appropriate trade finance techniques, such as export credit insurance, the exporter can offer
open competitive account terms in the global market while substantially mitigating the risk
of nonpayment by the foreign buyer.

Applicability – Ii is applied (a) in secure trading relationships or markets or (b) in

competitive markets to win customers with the use of one or more appropriate trade finance
techniques.

Risk/Disadvantages: The risks/disadvantages associated under this method are as follows:

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 (a) Exporter faces significant risk as the buyer could default on payment
obligation after shipment of the goods.
(b) Additional costs associated with risk mitigation measures

Overall Risk Assessment:

Methods of international trade payment as discussed above outline risk factors. The degree
of risk under a method may be high for exporter but the same may be low for importer.
This can easily be presented through the following diagram:

From the above diagram, it is seen cash in advance is most secured for exporter but the
same is least secured for importer and so on. These methods need to be supported by the
land of the practicing country. In respect of Bangladesh, international trade is guided by
export & import policy in force and foreign exchange regulations. The practice of the
methods followed/allowed in Bangladesh is as follows:

Methods Export Import

Cash in Advance Ok Subject to observance of
specified conditions
Letter of Credit Ok Ok
Documentary Collection Ok Subject to allowable limit
specified in import policy
order
Open Account Allowed, subject to Applicable for specialized
realization of proceeds zones
within 4 months

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Conclusion:
To succeed in today’s global marketplace and win sales against international trade present
a spectrum of risk, which causes uncertainty over the timing of payments between the
exporter (seller) and importer (buyer). For exporters, any sale is gift until payment is
received. Therefore, exporters want to receive payment as soon as possible, preferably as
soon as an order is placed or before the goods are sent to the importer. For importers, any
payment is a donation until the goods are received. Therefore, importers want to receive the
goods as soon as possible but to delay payment as long as possible, preferably until after
the goods are resold to generate enough income to pay the exporter. Based on situations,
the methods are set between buyers and sellers for international trade.

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