Payment method or payment term is most important factor for any trade, it becomes more crucial in case of export & import shipments where seller & buyer are far away from each other. Exporters/importers should choose the payment terms wisely so that they can avoid the risk.
1) Advance payment: In case of “Advance payment” buyer must make payment to seller before dispatch of the goods. Seller will issue a proforma invoice and buyer will pay as per the proforma invoice. This is the most safe payment term for Seller as the seller is getting the money before the shipment but the same payment term is least safe or risky for buyer as byer is making payment in advance without receiving the goods.
2) Open account: In this case buyer makes payment to seller after goods are arrived at buyers premises. Open account payment method allows buyer to make payment within 30 days/60 days/ 90 days as per contract. This method is the lease safe (risky) for seller and most safe for buyer.
3) Documentary collection: In this case seller/exporter will submit negotiable documents (Post shipment documents) to their bank called remitting bank requesting payment and the remitting bank will send those documents to buyer/importer’s bank. Importer’s bank will hold the documents until Importer pay the amount or makes promise to pay on a fixed date, both methods are described below.
a. CAD (Cash Against documents): In this case seller/exporter will submit the negotiable documents with bill of exchange at the bank after vessel departs and instruct the bank to release documents to buyer/importer once received the amount mentioned on bill of exchange. Bank will release the documents after importer pays the amount. It is same as DP/DAP(Documents against Payment) or Sight draft.
b. DA (Documents against Acceptance): In this case first importer accepts and promises to pay the amount mentioned in bill of exchange on a particular date then only bank releases the negotiable documents.
4) Documentary credit or Letter of Credit (LC):
In this case seller/exporter will submit the documents at their bank after vessel departs and seller's bank sends the same to buyer's bank, if all documents are in order as per transmitted LC then seller's bank remit the funds to seller's bank within the agreed time period.
The Letter of credit is a document which is the guarantee that seller will get paid the value of it's commodity.
Buyer's or importer's bank (issuing bank) will pay to the seller's or exporter's bank (accepting bank, negotiating bank). So, in this case the transaction is secured as seller get the assurance that they will receive the money at any cost.
There are different types of LC, let us discuss one by one:
a. Revocable LC: The LC can be cancelled or changed at any time by the buyer or the issuing bank without notification.
b. Irrevocable LC: The LC which cannot be cancelled or changed unless all parties (issuing bank, confirming bank, buyer/importer, and seller/exporter) agreed to do so.
c. Confirmed LC: Status of the LC is called as confirmed once confirming bank (exporter's bank) has added its obligation to the issuing bank.
d. Unconfirmed LC: If the LC is guaranteed by issuing bank but it is not confirmed by advising bank it is called as Unconfirmed LC.
e. Transferrable LC: The LC is known as transferrable LC if it allows first beneficiary to transfer credit (some or full credit) to secondary beneficiary (another party).
f. Un-transferrable LC: The LC is known as transferrable LC if it does not allow first beneficiary to transfer credit to secondary beneficiary.
g. Straight LC: The LC is known as straight LC if it is payable at opening bank within the credit limit. In this case beneficiary gets paid by issuing bank.
h. Negotiable LC: Beneficiary or the bank nominated by beneficiary gets paid by the issuing bank.
i. Restricted LC: In the case of a restricted LC only one nominated bank can be used for negotiation in relation to a letter of credit.
j. Unrestricted LC: The bank is not specified, which means that the letter of credit can be negotiated through any bank of the beneficiary’s choice.
k. Term (Usance) LC: Payment can be deferred in the case of a usance LC which gives time for the buyer to inspect or even sell the goods.
l. Sight LC: If the LC is at sight, once documents are verified & presented the payment will be done.
Buyer needs to reach out their bank to open a letter of credit, they need to submit export contract and apply for LC, once application is done bank will give LC draft for checking, that draft needs to be sent to the seller, once seller confirms the LC draft buyer's bank will transmit the LC.
The documents come under LC are to be prepared vary carefully, each word should match the LC otherwise bank may claim discrepancy charge as per the rule. Once operating LC is received export shipment can be planned.
Note: If the buyer is new to seller or it is the 1st shipment then I suggest payment should be done through LC.
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