Terms of Payment in international logistics
One of The Greatest concerns an exporting company has is to make sure that it will be able to collect payment from it s foreign customers. O, yes Legitimate payment.. An international transaction is generally perceived to involve a much greater non -payment of risk than a domestic sales.
Terms of Payment : There are Essentially Four methods to handle the issue of payment in foreign transaction but they all involve a different set of Risk with that.
Ok So what is Risk.. There are generally two types of Risk in an international business.
Country Risk or Political risk – The Probability of not getting paid by a certain creditor because the creditor’s country does not have foreign reserve to pay the debt or because the creditor is not legally allowed to pay the debt. Country risk is made up of an aggregate different issues ,some might be political and some strictly economical. Like strike of port personnel ,customs officers are on strike .Secondly the overall health of the economy shall also be considered . if there is high inflation price controls may be intitated.
World trade provides a summary report of a region of the world and of the situation in each country . it will also provide recommended terms of payment and credit terms for each country.
Commercial Risk – This is the area which is more difficult to obtain accurate and reliable information if the potential customer is a distributor who does business with other exporting firms, it is often possible to obtain firsthand information about that.. The commercial risk is probability of not getting paid by a certain creditor because they does not have the funds or because creditor refuses to pay the debt.
Lets come back to today Topic – Terms of payment– As said above there are four methods which are widely used as accepted terms in international transaction.
1- CASH IN ADVANCE – In this transaction the exporter requests customer to provide payment in advance before shipment of the goods takes place . These payment are generally made with SWIFT fund transfer from the customer bank to the exporter bank. This is the ultimate risk free alternative for the exporter. in this tranascation all risk are completely transferred to the importer.
It is can be done with adding like 70% Advance and 30% on documents or either 80 % advance and 20% on documents. This method is recommended way of conducting where International business has a substantial risk of political instability and Economic risk.
2- OPEN ACCOUNT – In an open account transaction the exporter conducts international business in manner similar to way it conducts domestic . the exporter just send an invoice to the importer and trust that the customer will pay the amount in reasonable amount of time within credit period usually granted to them.
The only resource is case of non -payment is legal action in the importing country , which is really a time consuming and expensive process. This term of payment is reserved to established customers with whom exporters maintain an ongoing relation ship. Major developed nation exporter use this term of payment. Basically in EU and American market.
3- Letter of Credit – One of preferred terms of payment in developing countries A Letter of credit is a document in which the importer’s bank essentially promises to pay the exporter if the importer does not pay.The credit worthiness of the bank is substituted in case of the importer.this concept is more complex .I will come up with separate blog for this whole process. For Now we can understand that the letter of credit is a contractual agreement between the issuing bank and the beneficiary . A tranascation conducted on Letter of credit is almost as good as cash in advance but it involves a lot more steps.
4- Documentary collection – It is a process in which an exporter ask a bank to safeguard its interest in foreign country by not releasing the shipping documents (Specially bill of lading – which confirms title of goods). Until the importer satisfies certain requirements, most often paying the exporter or signing a financial document which promising the exporter to pay the exporter with in a given period of time.
So above is mentioned four method of Terms of payments. There are various other important aspects in this topic.. Like How to open a letter of credit . I will come up with separate blog for that. apart from that – Credit Insurance , International Factoring, Exposure , How to use Bill of exchange in Documentary collection these are some important for APICS exams..
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