To succeed in today’s global marketplace and win sales against foreign competitors, exporters must offer their customers attractive sales terms supported by appropriate payment methods. Because getting paid in full and on time is the ultimate 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. This trend is attributable to the increased globalization of the world economies and the availability of trade payment and finance from the international banking community.
As shown in figure 1. 1, there are four primary methods of payment for international transactions. During or before contract negotiations, we should consider which method in the figure is mutually desirable for both me and my customer. Figure 1. 1. Payment Risk Diagram Key Points
• To succeed in today’s global marketplace and win sales against International trade presents a spectrum of risk, which causes uncertainty over the timing of payments between the exporter (seller) and importer (foreign buyer).
• For exporters, any sale is a 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. Objective of the study: The objectives of the study are: 1.
Discuss theoretical aspects of international trade payment and finance. 2. Discuss Bangladesh aspects of international trade payment and finance.
Theoretical Aspects: There are four standard and common payment methods that are in use to make or receive payment for international trade market. It basically means received of payment against export and making payment against import: 1. Cash in Advance. 2. Open Account / Supplier credit. 3. Documentary collection. 4. Documentary Credit / Letters of Credit L/C. Cash-in-Advance: From the very title it is obvious that cash will be in advance. With cash-in-advance payment terms, the exporter can avoid credit risk because payment is received before the ownership of the goods is transferred.
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, because it creates cash-flow problems. Foreign buyers are also concerned that the goods may not be sent if payment is made in advance. Thus, exporters who insist on this payment method as their sole manner of doing business may lose to competitors who offer more attractive payment terms. There are some features of Cash-in-advance * Interest of exporter is fully protected. Interest of importer is not protected. * Banks are involved in the process of transferring payments. * Documents are shipment are directly handle by the exporters. * It is guided by Purchase and Sale Agreement. * It is one of the cheapest and least popular methods in the world. Open Account: An open account transaction is a sale where the goods are shipped and delivered before payment is due, which is usually in 30 to 90 days. Obviously, this option is the most advantageous option to the importer in terms of cash flow and cost, but it is consequently the highest risk option for an exporter.
Because of intense competition in 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 lose a sale to their competitors. However, the exporter can offer competitive open account terms while substantially mitigating the risk of non-payment by using of one or more of the appropriate trade finance techniques, such as export credit insurance. There are some features of Open account * Interest of importer is fully protected * Interest of exporter is not protected. Banks are involved in the process of transferring payments. * Documents are shipment are directly handle by the exporters * It is the most popular method in the world. Documentary Collections: A documentary collection (D/C) is a transaction whereby the exporter entrusts the collection of a payment to the remitting bank (is the bank on the counter of which documents are submitted by exporter, collect payment from importer on its behalf), which sends documents to a collecting bank (is the bank that is involved in the process of documentary collection other than the remitting 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. D/Cs involve using a draft that requires the importer to pay the face amount either at sight (document against payment) or on a specified date (document against acceptance). The draft gives instructions that specify the documents required for the transfer of title to the goods. Although banks do act as facilitators for their clients, D/Cs offer no verification process and limited recourse in the event of non-payment. Drafts are generally less expensive than LCs.
There are two methods of documentary collection: * Documents against payment * Documents against acceptanc Documents Against Payment (D/P) In this case documents are released to the importer only when the payment has been done. This is sometimes also referred as Cash against Documents/Cash on Delivery. In effect D/P means payable at sight (on demand). The collecting bank hands over The shipping documents including the document of title (bill of lading) only when the importer has paid the bill. The drawee is usually expected to pay within 3 working days of presentation.
Documents Against Acceptance (D/A) In this case documents are released to the importer only against acceptance of a draft. Under Documents Against Acceptance, the Exporter allows credit to Importer, the period of credit is referred to as Usance, The importer is required to accept the bill to make a signed promise to pay the bill at a set date in the future. When he has signed the bill in acceptance, he can take the documents and clear his goods. Figure 1. 2. Process of documentary Collection The following list of documents often used in international trade:
• Air Waybill Bill of Lading
• Certificate of Origin
• Combined Transport Document
• Draft or Bill of Exchange
• Insurance Policy (or Certificate)
• Inspection Certificate Air waybill: The Air Waybill (AWB) is the most important document issued by a carrier either directly or through its authorised agent. It is a non-negotiable transport document. It covers transport of cargo from airport to airport. Bill of Lading: A bill of lading is generated by a shipper, details a shipment of merchandise, gives title to the goods, and requires the carrier to deliver the merchandise to the appropriate party.
Certificate of Origin: The Certificate of Origin is required by the custom authority of the importing country for the purpose of imposing import duty. It is usually issued by the Chamber of Commerce and contains information like seal of the chamber, details of the good to be transported and so on. Combined Transport Document: Combined transport is a form of intermodal transport, which is the movement of goods in one and the same loading unit or road vehicle, using successively two or more modes of transport without handling the goods themselves in changing modes.
Combined transport is intermodal transport where the major part of the journey is by rail, inland waterways or sea, and any initial and/or final legs carried out by road are as short as possible Draft or Bill of Exchange: A Bill of Exchange is a special type of written document under which an exporter ask importer a certain amount of money in future and the importer also agrees to pay the importer that amount of money on or before the future date. Insurance policy: Also known as Insurance Policy, it certifies that goods transported have been insured under an open policy and is not actionable with little details about the risk covered.
Inspection Certificate: Certificate of Inspection is a document prepared on the request of seller when he wants the consignment to be checked by a third party at the port of shipment before the goods are sealed for final transportation. There are some features of Documentary Collection * Interest of importer risk protected. * Interest of exporter is better protected than open account * It is guided by Purchase Sale Agreement and URC 522 * It could be risky for the exporter if documents are not received by the importer * All the banks involved in documentary collection are the agents of exporter.
Documentary Credit or Letters of Credit: Letters of credit (LCs) are one of 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 stated in the LC have been met, as verified through the presentation of all required documents. The buyer pays his or her bank to render this service. An LC is useful when reliable credit information about a foreign buyer is difficult to obtain, but the exporter is satisfied with the creditworthiness of the buyer’s foreign bank.
An LC also protects the buyer because no payment obligation arises until the goods have been shipped or delivered as promised. Participants in LC Process: * Buyer- Buyer is also called Applicant * Seller- Seller is also called beneficiary * Issuing Bank- Is the bank that issued Letter of Credit. * Advising Bank- Is the bank using the service of which issuing bank advices credit to the exporter. * Nominated Bank- Is the bank nominated by the issuing bank at the counter of which documents may be submitted by the exporter in addition to the counter of an issuing. Reimbursing Bank- Is the bank through which issuing bank maximum reinvestment to the nominated bank. Payment process through LC process: The main steps in a typical documentary credit transaction are- 1. When exporter has finished the export contract, your importer arranges with a bank to open a documentary credit in exporters favour. This foreign bank is called the issuing bank and will usually check your buyer’s creditworthiness. 2. The issuing bank sends the documentary credit to any local bank of exporter called advising bank.
The advising bank verifies the authencity of the documentary credit and forwards it to exporter. 3. The documentary credit sets out the documents you must present to receive payment. When exporter has shipped the goods and compiled all the necessary documents, exporter lodge the document with the local bank called nominated bank- to arrange the payment. In most cases, the advising bank and the nominated bank are the same bank and may be exporter’s regular business bank. 4. The nominated bank checks the documents to ensure the terms of the documentary credit have been met.
It then sends the documents to the issuing bank with a request for payment. Sometimes a third bank called reimbursing bank, act as an intermediary between the nominated and issuing banks. 5. If the issuing bank is satisfied that exporter have provided all the necessary documents in the exact form required by the documentary credit, it forwards the payment to the nominated bank, which in turn pays you. A documentary credit will state whether exporter payment ‘at sight’ (immediately after bank verification of the documents) or at an extended term (for example, 30 days after sight). . Figure1. 3. Process of Documentary Credit Trade Financing Instrument: Companies often need financing to market, promote and manufacture their products and services. The financing needs of companies involved in international trade transactions are usually categorized as follows: (a) Pre-shipment financing: This is financing for the period prior to the shipment of goods, to support pre-export activities, such as wages and overhead costs. It is especially needed when inputs for production must be imported. It also provides additional working capital for the exporter.
Pre-shipment financing is especially important to smaller enterprises because the international sales cycle is usually longer than the domestic sales cycle. Pre-shipment financing instruments can take the form of short-term loans, overdrafts or cash credits. (b) Post-shipment financing: This is financing for the period following the shipment of goods. The competitiveness of exporters often depends on their ability to provide buyers with attractive credit terms. Post-shipment financing thus ensures adequate liquidity until the purchaser receives the products and the Exporter receives payment.
Post-shipment financing is usually short-term. Pre- and post-shipment financing may come in the form of secured or unsecured Loans or lines of credit from banks or financial institutions. Common methods used to obtain such financing are explained below. Factoring, export receivables financing or advance against documentary bills: The exporter who sells goods to an overseas buyer on credit terms requests his bank to make an advance based on such documents as a bill of exchange, a bill of lading or a simple invoice.
The lending bank generally advances from 50 to 100 per cent of the invoice value, depending on the perceived risk. * Inventory financing: An inventory of raw material or intermediate or finished products is used to secure a loan. Inventory financing is commonly used to finance trade in commodities, since commodity producers and traders typically hold substantial inventories. Inventory and warehouse receipt financing are discussed in more details in chapter IV in the context of structured commodity finance. Leasing: Some banks and financial institutions provide leasing as a medium- to long-term means of financing. Leasing is generally of interest to manufacturing companies that nee to import equipment or machinery to produce goods for export. The company procures the equipment and pays a monthly rental fee to a leasing company (or bank), which owns the equipment. Leasing thus allows an exporter to acquire capital goods for export production without having to make a large one-time cash outlay. Structured financing: Structured financing often refers to schemes whereby the lender extends a loan to the borrower by securitizing the current assets of the borrower over which the lender has control. These assets, including streams of expected cash inflows, serve as collateral for the loan. Structured financing techniques can be used for short-term financing as well as capital investment in countries where traditional financing is not available (or too onerous).
However, structured financing deals are specific to each transaction or operation being financed and thus require a level of financial expertise rarely available in emerging economies. Bangladesh Aspects: In Bangladesh generally the above trade payment methods and financing instruments are used. But Cash in advanced is used less than 1% to make domestic trade payment in Bangladesh. As like other countries cash in advance is the least popular method of trade payment in Bangladesh. Open account is the most popular method of trade payment around the world.
It is used more than 80% in international transaction. It is popular because in the market economy buyer is always powerful than seller and open account resembles the most common business tradition of supplier’s credit. But in Bangladesh the open account did not work because after 1971 Bangladeshi traders did some international trade through open account and Bangladesh could not pay to their exporter as a result country risk trading went down as in open account method suppliers provide goods on account.
According to the domestic regulation (Import policy order 2009-2012) on import of Bangladesh open account is not used in Bangladesh. To ensure importers’ security of others country and reputation of our country it has been imposed. Then the Bangladesh Bank make the regulation that Bangladeshi importer should be used L/C. in case of import other than few exceptions (raw material, book, journal etc. ) whatever you import in country that must be through Letter of Credit. Table 2. 1: Methods of Payment used in Making and Getting Payment Methods used| Import Payment(no of cases)| Export Payment(no of cases)|
Documentary credit| 85%| 65%| Documentary Collection| 10%| 30%| Cash in Advance| 2%| 2%| Open Account| 3%| 3%| Source: From the lecture of respective course teacher. (Data of 2012) From this table we can easily view the picture of trade payment method in our country. L/C has used 85% by Bangladeshi Importer in their total international payment and 65% by Bangladeshi exporter in their total international trade payment. L/C is a payment technique but it has financing component. Banks in Bangladesh also provide finance to importer to facilitate international business.
Documentary collection in case of export is higher than import and rest of the methods such as cash in advance and open account is remain same in export and import payment of Bangladesh. Concluding Remarks: Even at this real time communication world, letter of credit is considered to be the one of the safest way to remit and get proceeds. But still there are some factors to be re-considered like: a) Restructure of legal enforcement against defaulter importers and exporters in Bangladesh. ) Necessary changes in import policy to permit imports to be made without LC to reduce import cost and subsequently reduce prices on essential and consumable goods. In some countries of tight control on foreign trade operations, documentary credit is a very strong device in the government’s control and supervisory mechanism. In our country, this controlling over imports and exports are seen in a liberal ways but still some considerable changes in import and export policy and re-structuring and up-to-date foreign exchange guideline is required for our country’s smooth growth. ************************** References * U. S. Department of Commerce International Trade Administration * http://en. wikipedia. org/wiki/Combined_transport * http://www. google. com. bd/search? noj=1&q=what+is+bill+of+lading&oq=what+is+bill+of+lading&gs_l=serp. 3.. 0l10. 1425. 9130. 0. 9399. 40. 15. 1. 13. 13. 1. 293. 1568. 4j4j3. 11. 0…. 0… 1c. 1. 25. serp.. 19. 21. 982. ak_gnN5epFU * http://www. google. com. bd/search? noj=1&q=what+is+air+waybill+&oq=what+is+air+waybill+&gs_l=serp. 3.. 0i7i30l10. 642616. 662149. 0. 62825. 35. 26. 0. 2. 2. 2. 437. 3543. 11j2j5j3j1. 22. 0…. 0… 1c. 1. 25. serp.. 17. 18. 2129. NJY6MK5lL1M * http://www. google. com. bd/url? sa=t&rct=j&q=international%20financing%20method&source=web&cd=3&cad=rja&ved=0CDsQFjAC&url=http%3A%2F%2Fwww. unescap. org%2Ftid%2Fpublication%2Ftipub2374_chap2. pdf&ei=8jULUue-IIGtPOmYgIAG&usg=AFQjCNG-edG5L12wqcReEVt-T2Ccyy7EkQ&bvm=bv. 50723672,d. ZWU * tipub2374_chapter2. pdf * http://edupedia. educarnival. com/letter-of-credit-operation-in-bangladesh/ * Class Note.