If you are new to the export business you have probably already run into the problem that every exporter faces: how do you get paid for the goods you sell without getting cheated? The export business can be tough. You need to get paid for the goods you sell.. What if you do not get paid? Choosing the payment term is a big mistake. It means you ship the goods. You never see any money in return. You do not get any rupees or dollars or dirhams.
Choosing the payment term is very important. It can protect your export business. You can still win deals against companies that sell goods like you.
In this guide we will talk about the four common payment terms that people use in international trade. These are Advance Payment, Letter of Credit Documents Against Payment and Documents Against Acceptance. We will tell you the things and the bad things about each payment term. We will also tell you about the risks that are involved with each payment term. This will help you decide which payment term is best for your export business and the industry you are, in.
The 4 Main Payment Terms in International Trade
When you sell a product in the market there are four payment methods that buyers and sellers use. These are
- Advance Payment
- Letter of Credit
- Documents Against Payment
- Documents Against Acceptance
Out of these four only two are really safe for the person selling the product: Advance Payment and Letter of Credit. The other two Documents Against Payment and Documents Against Acceptance are risky because they depend on the buyer being willing and able to pay. Lets look at each one in detail.
1. Advance Payment The Safest Option for People Selling Products
Advance payment is simple: the buyer pays you first. Then you start making or getting the products after you get the money. This is the way to get paid in export trade because you already have the money in your account before you spend any money on the order.
The good things about Advance Payment are
- you do not have to worry about the buyer not paying you because you already have the money
- it helps you have money to use because you can buy things you need at a better price when you pay cash
- the paperwork is easy because there are no documents to fill out
The bad things about Advance Payment are
- it is hard to get the buyer to agree to pay you all the money upfront
- you might lose sales to sellers who offer the buyer better terms
- it makes it harder for you to sell products in markets where buyers want to be able to pay in a more flexible way
One good thing to remember is that if a buyer does not want to pay all the money upfront do not give up on the sale. Try to negotiate. Try to get the buyer to pay 50% of the money upfront. If that does not work try to get them to pay 30% or even a smaller amount. The goal is to get the buyer to pay some of the money upfront so they have a reason to follow through on the sale and not back out, through.
2. Letter of Credit The Bank Backed Guarantee
A Letter of Credit is basically a promise from the bank. The buyers bank tells your bank that they will pay you when you do what you said you would do in the contract and send in the shipping papers. The bank promises that you will get paid.
Here is how it usually works:
- You send the goods and make sure the papers are just right like the Letter of Credit says.
- You give these papers to your bank.
- Your bank sends them to the buyers bank.
- If the buyers bank says everything is okay they pay you.
80 percent of big international trade deals use this method, especially a type called Letter of Credit at Sight. This means that the buyers bank pays you soon as they get the papers and check that everything is okay. You do not have to wait.
The good things about Letter of Credit are
- The bank promises you will get paid, not just the buyer.
- It is safe for both the buyer and the seller. The buyer knows they will get the goods and the seller knows they will get paid.
- It is one of the trusted ways to do business around the world which is why people use it for expensive shipments.
The bad things about Letter of Credit are
- The papers can be very complicated. The Letter of Credit says exactly what each paper must have and how it must look. If you make a mistake it can cause problems.
- If you make a mistake you will not get paid away. The banks will hold your papers and your money until you fix the mistake.. They may charge you extra fees.
- It can be expensive. The buyers bank and your bank both charge fees to handle the Letter of Credit so it costs more than ways of getting paid.
How to avoid problems with Letter of Credit
If you do the papers the first time you can avoid most of the problems. It is an idea to work with people who know about trade papers and can check everything before you send it in. If you do it right you should not have any problems.
The best way to do business with a buyer is to give them two choices: pay you first. Use a Letter of Credit, at Sight. This way you are. The buyer has options.
3. Documents Against Payment (DP)
When you use DP you send the goods. Then you send the shipping documents to your bank after the shipment is done. These documents include the invoice, the packing list, the certificate of origin and any other paperwork that is needed.
The process is like this:
- You give the documents to your bank.
- Your bank sends them to the buyers bank.
- The buyers bank tells the buyer that the documentsre there and asks for payment.
- When the buyer pays the bank gives them the documents.
- The payment goes back to your bank.
So DP is like a “pay and collect” system. The buyer cannot get the documents. Therefore cannot get the goods without paying first.
Advantages of Documents Against Payment
Documents Against Payment is cheaper than a Letter of Credit. It is also easier to find buyers because it is not as big of a commitment for them as paying in advance or using a Letter of Credit. Most of the risk is on the seller with Documents Against Payment.
Disadvantages of Documents Against Payment
The problem with Documents Against Payment is that there is no guarantee of payment. If the buyer does not pay when the goods arrive you have few options. The goods can also get stuck. Even though you have control of the documents and therefore the goods until the payment is made it is hard and expensive to get the goods once they have reached a foreign port.
A Real Case Study When a Buyer Backs Out
One exporter sent two to three containers of pink salt to a buyer in Australia using Documents Against Payment. Everything was set up. The shipment arrived at the port.. When it got there the buyer just backed out of the deal. The exporter had nowhere to put the goods. No other buyer wanted to buy them. The exporter had to try to find buyers but it was not easy.
The lesson is that when a buyer starts to hesitate that is when you should try to get some payment in advance even if it is a small amount. If the deal falls apart later, at least you will have some of your costs covered with Documents Against Payment.
4. Documents Against Acceptance (DA)
Documents Against Acceptance is similar to Documents Against Payment. With one big difference: it is a credit arrangement. Of paying right away when the documents arrive the buyer can take the documents clear the goods and pay later. Usually after 30, 60 or 90 days depending on what the buyer and seller agree on.
The buyer gets the documents and the goods before they pay so Documents Against Acceptance is usually a good idea for buyers that the seller has worked with for a long time and trusts.
Advantages of Documents Against Acceptance
- It is very easy to find buyers because they do not have to pay away. This is an attractive option, for buyers.
- Buyers can sell the goods. Then pay the seller, which is what many businesses like to do because it helps with cash flow.
Disadvantages of Documents Against Acceptance
- There is no guarantee that the buyer will pay. Once the buyer has the documents they own the goods. Can do what they want with them.
- If the buyer damages the goods sells them or just does not want to pay the seller can not do much about it. This is the way to sell goods and the seller should only use it with buyers they really trust.
Which Payment Term Should You Use
Here’s the order of priority for exporters:
- Try Advance Payment first. It is always best to start
- Offer Letter of Credit LC at Sight as your second option.
- If the buyer refuses both you can consider DP.. Only do this if you can afford to lose money if the deal does not work out.
- Avoid DA unless it is your option. Then only use it with buyers you know well and trust.
Why the “Safest” Term Is Not Always Best
Payment terms depend on the industry. For example in the leather gloves industry most transactions happen on DA terms. This means 30-day credit is the norm. If your industry works this way asking for Advance Payment or LC might cost you buyers.
The right approach is to:
- Know the payment terms in your industry.
- Ask for the terms you can get.
- Think about the risk of terms like losing buyers and the risk of looser terms like not getting paid.
Final Thoughts
There is no one “payment term for all exporters. Advance Payment and Letter of Credit are the options. They should always be your choice in negotiations. DP and DA have risks. Be careful with DP. Consider getting some upfront deposit. Only use DA with buyers you trust.
The best payment strategy comes from understanding your market and being alert to buyer behavior. Never be afraid to negotiate for some protection. Even a small advance, like 10-20% can make a difference.
