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LEARNING OBJECTIVES
Understanding importance of payments in export transactions
Selecting appropriate instrument of international payments
Understanding payment risk and selection of right method of
payment
Understanding of basics of advance payment method
Learning mechanism letter of credit method of payment
Understanding technical issues of banker collection method of
payment
Understanding of basics of open sale account methods for exporter
Learning basics of consignment method of payment
Learning payment risk for exporters and management techniques
Learning how select right method of payment to protect interest of
exporter
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Delays or non-receipt of payment is not only increase the cost of doing
business but leads to the failure in export business. In export transaction,
there is always a time lag, between shipment of goods and receipt of
export payment. This time lag, increases the risk of delays or non-
payment. Any slackness in monitoring payment or casual approach
towards securing timely payments will lead to drastic financial results for
the exporter.
To ensure full and timely payment exporter has to select the right
instrument and method of international payment, so to, secure full and
final export payment from foreign buyers.
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RISKS INVOVED IN INTERNATIONAL TRADE PAYMENTS
International payment are very risky and exporters should have proper
planning to protect them. Followings are the some of the main risks
involved in international trade payments:
- Commercial risk of non- payment by importer on due date.
- Political risk of importer country.
- Non delivery risk of not shipping right goods to importer.
- Cancellation of order by the importer.
- Delays in making payment by importer.
- Loss of goods during voyage.
- Bad debt risk causing total loss due to non- payment.
- Currency fluctuation risk due to change in exchange rate of invoice
foreign currency against INR.
Depending on the risk element in the payment transaction, we have
to select a particular or combination of methods of payment used in
international trade. In addition to the selection of right method of
payment, exporter must cover the credit payment risk in the payment
transaction by getting ECGC policy, before shipment of the goods.
Commercial and the political risks are covered by this policy by
paying the requisite premium by exporter to ECGC.
Each and every payment transaction must be monitored, to ensure timely
export payment. Cancellation of export order and delays in payment risks
can be covered by demanding L/C from the importer. When payment
becomes the bad debts the services of debt recovering agent in the
country of the importer may be used before going for expensive and time
consuming litigation. Transit risk is covered by taking marine insurance
policy. Lastly, the currency risk can be hedged with bank by taking the
right type of forex derivative. Cheap and best hedging derivative available
from your bank is the FORWARD CONTRACT.
It is also advisable that exporter should obtain confidential report on the
foreign buyer either through ECGC or Bank or DUN and BRADSTREET
before making shipment to the foreign buyer.
It must be noted that buyer will make from its sales, to local consumers.
Further, exporter should complete the delivery schedule, to help the
importer to supply the goods to its consumers as per its commitments. No
body borrows money to pay the creditors. Only sales realisation of
importer encourages the payments. Hence, now it has become
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essential for each and every exporter, to understand the business
model of the buyer and help him to grow. His growth will ensure long
term relationship and timely payments.
Avoid dispute in international trade payments. Resolution of disputes is
expensive and time consuming for the exporter. Exporter must treat
exports as long term business strategy with focus to help the importers, to
grow in their business.
- LETTER OF CREDIT
- BANK COLLECTION
- CONSIGNMENT SALE
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for the importer. In spite of making payment, there is no guarantee
that importer will get right quality and quantity of goods on time.
TRUST HAS TO BE ESTABLISHED IN THE MIND OF IMPORTER FOR
GETTING ADVANCE PAYMENT.
To get the advance payment, exporter has to create trust in the mind of
the importer, that it has the capacity and capability to supply quality goods
on time. There is no one formula for creating such trust. Each export
transaction is unique. Special approach has to be developed. Depending
on the merits of each case exporter has to create trust situation, so to get
the advance payment from importer.
Advance payments provides free or at low cost funds, to the exporter
to manufacture/arrange goods for export. In this case, exporter is
doing business with importer’s money. Foreign buyer provides the
working capital for the execution of export transaction. Best model
of doing export business.
QUANTUM OF ADVANCE PAYMENT TO BE RECEIVED FROM
FOREIGN BUYERS
NEW EXPORTER
As per existing RBI exchange control regulations, for new exporter, there
is no limit to receive the advance payment against order from importer,
through banking channels, with interest or without interest payment
liability. Full or partial amount say 20%, 40%, 50%, 60%, 80% etc. of
the export order can be received as advance payment.
Exporter has to ship the goods to importer, within 1 year from the date of
receipt of advance payment. This shipment commitment of the exporter is
monitored by the bank which receives advance payment for him. Further,
documents relating to this transaction has to be routed through advance
receiving bank for monitory that shipment has been completed within
stipulated period. In case an importer demands interest on the advanced
amount, it can be paid unto LIBOR+1% only.
ILLUSTRATION
Let us suppose that an exporter is dealing with State Bank of India New
Delhi. But advance payment has been received through PNB New Delhi.
Exporter should give the documents after shipment to SBI New Delhi with
instruction, to deliver them to PNB New Delhi for onward sending to the
foreign buyer. It is the duty of PNB, the advance payment receipt bank, to
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have control on the advance payment transaction, so that exporter
completes, the shipment within stipulated period of one year. Further,
exporter can return the advance payment within one year. After that, any
refund of the amount or to do shipment after one year, requires the
approval of RBI.
ESTABLISHED EXPORTER
Eligible exporters also doing profitable export business for the last three
years may receive advance payment without any amount restriction with
or without interest payment liability. In this case exporter is allowed to
make shipments of goods up to 10 years from the date of receipt of
advance payment. If advance payment amount is more than USD100
million, only in such case, bank has to inform RBI. Exporter must have
capacity and capability, to complete the shipments of orders. Exporter has
to use the advance payment only for producing or arranging the goods for
exports. In case, importer wants the interest on the amount of advance
payment, the exporter is allowed to pay interest up to LIBOR+2% p.a.
DISADVANTAGES
- Insisting of advance payment may cause the exporter to lose customers
to its competitors who may offer better credit facility to the importers.
- Buyer of good standing may find the payment of cash, in advance
unacceptable to them because of insecurity of funds and financial burdens
to him.
Banks play very important role in arranging payment under letter of credit.
Payment to the exporter under L/C is not made by the importer but by it’s
bank. Bank makes payment to the exporter against presenting complying
documents either immediately or after some time (equivalent to the credit
period given by the exporter). L/C makes payment to exporter based on
the desired documents by it. L/C issuing bank recovers the ultimate
payment from the importer after the receipt of documents complying with
terms and conditions of L/C. Operationally letter of credit is very similar
to functions of bank credit card transaction.
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If the financial standing of issuing bank is unsatisfactory and
importer is residing in high political risk country, exporter must
demand L/C duly confirmed by exporter bank or any other Indian
bank of good rating/standing.
L/C is initiated by the sale contract between exporter and importer. L/C is
created by mutual agreement of exporter and importer as one of
conditions of the sale contract. Further, it has to be opened/issued by the
importer bank on the specific request of the importer. Terms and
conditions of L/C along with the documents required to comply them
are decided by the importer as per the sale contract.
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prescribed by importer, to ensure the receipt of quality goods on
time. L/C makes payment to exporter is based on submitting complying
documents to the bank. Exporter gets payment before importer takes the
possession of goods. Negotiating bank follows the doctrine of strict
compliance, to protect the interest of importer. So L/C looks after the
business interest of importer and exporter.
DISADVANTAGE
-Exporter will get payment based on complying documents, Exporter has
to prepare the documents to comply with terms and conditions of letter of
credit. Compliance of documents with L/C terms/conditions has to be
decided by banks not by exporter or importer.
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-Discrepancy or defects in the documents will not allow payment to the
exporter. Discrepancies can be rectified before date of expiry of L/C.
-L/C makes the export transaction with strict time schedules. Any delays
will lead to discrepancy or denies the payment to exporter.
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documents, handling of goods and contacting the party in case
dishonouring of the documents by the importer. Special instruction has to
be issued to the banks depending on sight payment or payment after the
credit period.
Payment term under collection may on sight basis where no credit period
is given to the buyer. Sight term means to importer is to see and pay. In
case exporter gives credit period to the importer then documents will be
delivered to the importer against acceptance to make payment, on future
due date. Importer will take possession of the goods and later on due date
may make payment. Very risky payment term for exporter. Exporter
should avoid giving later payment term to new importers.
IMPORTANCE OF BILL OF EXCHANGE
In bank collection bill of exchange which a legal document under
negotiable instrument act 1882 plays very essential role. Bill of exchange
is an order in writing by the drawer (the exporter) to drawee (an importer)
to pay some definite amount immediately or after some time. If payment
term is immediate then sight bill of exchange will be drawn by the exporter.
If exporter gives some credit period to the importer, in this case time or
usance period bill of exchange, equivalent to credit period will be drawn.
Bank collections are governed by the rules contained in International
Chamber of Commerce Paris Brochure no 522 and payment instructions
issued by exporter to the bank.
MECHANISM OF BANK COLLECTION
Under this method exporter submit the documents after shipment within
21 days from date of shipment to the bank. This bank is called reimbursing
bank. Exporter also furnishes detailed instructions about the collection
and agreed payment term. If no credit period is given to the importer the
payment term will be sight. In case credit period is given to the importer
then term or usuance period bill of exchange will be drawn.
The documents along with instructions and collection term will be sent to
the collecting bank which is the correspondent bank of the exporter bank.
Duty of the collecting bank is to present the documents for payment in
case of sight bill of exchange and for acceptance of bill of exchange in
case of credit sale. Collecting bank duty is to collect the payment and send
to the exporter bank. Exporter will get payment when importer will make
the payment. Banks are helping in handling the trade documents and
payment.
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In case of documents against acceptance, it will call the importer in the
branch office for acceptance. After the acceptance of bill of exchange, it
will give the documents to importer. Collecting bank will immediately
inform the exporter bank about the acceptance and due date of payment.
Thereafter, collect the payment from importer on due date and remit the
amount to exporter bank.
In case of non-payment or non-acceptance of bill of exchange by the
importer, collecting bank will inform the exporter bank and seek
instructions for protection of the goods and disposal of the documents.
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DISHONOURING IN BANKS COLLECTION BY IMPORTER
Dishonouring of bank collection means, in case of sight collection importer
may not make payment to collecting bank. In this case, he will not get the
document called bill of lading. Importer cannot take possession of goods
without this document. Goods when reached to the port will attract very
heavy port charges. To protect against payment risk, exporter must
obtain ECGC policy before shipment.
In case of time draft, importer will take delivery of goods and may not make
payment on due date. Goods gone and payment also gone. It is very
dangerous situation for the exporter. This payment term is very risky for
exporter. Give this facility to credit worthy importers where past dealing is
very satisfactory. Do not do shipment goods without taking ECGC
policy.
In case of non-payment, it will be very expensive, to take legal action
against the importer in the foreign country. Some- times exporter
may take the services of Debt Collectors. They also take very heavy
commission. It is prudent to take all precautions while selecting the
importer and to take ECGC policy before shipment.
In case of dishonouring of sight draft, exporter has to find out the
alternative buyer in the same country or in another country by giving
heavy discounts. In some case, exporter may have to bring back the
goods. It may be very heavy cost to the exporter, which may be
unbearable to the new exporter.
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DISADVANTAGES OF BANKER’S COLLECTION TO EXPORTER
Very risky for the exporter. Importer may not honour the commitment and
may not clear the goods at the foreign port. Port authorities may levy
heavy charges and penalties which will be paid by the exporter.
Documents against acceptance is more risky than sight payment for
exporters. This term may be given to very reputed big buyer or to
regular buyers with excellent past experience.
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and time schedule of shipments. Normally, this type of method is used
when parties have satisfactory with past payment record/dealings.
Under this arrangements the goods are shipped directly in the name of
the buyer or its agent. Documents relating to the goods are also sent
directly to the foreign buyer. Importer will get the goods without making
any payment. Normally importer gets the time to make the payment to the
exporter after some time as per the agreement. Importer will become the
owner of the goods. It will sell the goods to its local customers. It want to
make payment after collecting the payments from the customers. It wants
to do business with the money of the exporter.
OPEN SALE METHOD IS HIGH RISKY METHOD OF PAYMENT FOR
EXPORTER
However, there are risks for exporter to use to open-account sales method
of payment. The absence of documents and banking channels might
make it difficult, to pursue the legal enforcement of claims. In case of
dishonoring, the exporter might also have to pursue collection in foreign
country, which can be difficult and costly. Another problem is that
receivables may be harder to finance, because drafts or other
evidence of indebtedness is unavailable.
There are several ways to reduce credit risk. Exporter must take ECGC
policy or obtain factoring facility from ECGC or Banks or factor. Obtain
credit report on buyer to check credit worthiness.
Exporters contemplating a sale on open-account terms should thoroughly
examine the political, economic, and commercial risks. They should also
consult with their bankers for obtaining finance for the transaction before
issuing a pro forma invoice to a buyer. Further, no shipment without
obtaining ECGC policy. Exporter should ask the importer to arrange
acceptance of usuance bill of exchange by reputed bank in importer
country. In this case bank has to make payment on due date. Further in
high value and regular base export transactions, exporter can demand
stand by letter of credit from reputed bank in importer country. This will
ensure payment from the bank in case of default by the importer.
CONSIGNMENT SALES METHOD OF PAYMENT
Mostly this method is used when exporter makes long term commitments
for the supply of goods to the distributors in importing country or to big
foreign buyers.
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The goods are shipped to a foreign distributor directly and documents are
also sent directly to it. Distributor will get the goods on execution of the
trust receipt and sell them on behalf of the exporter. The exporter retains
title to the goods until they are sold. In this case exporter must get
payment within the period of 15 months from date of shipment. Foreign
party will make payment by sending payment schedule to the bank
containing the payment and details of expenses with receipts.
The exporter has high risk and a least control over the goods with this
method. The ownership remains with the exporter. All charges relating to
clearance and protection of the goods are on the account of the exporter.
Foreign buyer will remit the payment after deduction of all these charges.
Goods are under the possession of the consignee but owner ship lies with
the exporter.
Further, shipment charges and insurance charges will be paid by
exporter and must be arranged with Indian companies. Normally this
arrangements are used while dealing with the distributor or the agents of
the exporter. In addition, it may be necessary to conduct a credit check on
the foreign distributor.
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