GLOBAL SELLING BLOG

A complete guide on payment methods in international trade

There are five major payment methods in international trade including cash in advance, letters of credit, documentary collection, open accounts & consignments. Read to know more.
Payment terms in Export
The growing use of internet and technology has eased the process of running businesses not just domestically but internationally as well. In terms of payment methods, several new options are now being used not just by customers but by sellers, manufacturers, etc as well. International trade involves legal processes and inspections as per the regulations of both exporting and importing countries. Thus, to make deals more secure and insured, it is important to evaluate and consider the right mode of payment that are mutually desirable for both parties.

Payment methods in international trade

Accepting payments across the globe depends on a lot of factors like cross-border fees, foreign exchange fees, currency conversion and local regulations. In addition to this, certain risks are associated that impact payment exchange between parties across two countries:
• Foreign exchange risks: Usually associated with currency fluctuations
• Political risk: Arises when countries change their government policies that may negatively impact business such as trade barriers

Types of payment terms in exports

Cash in advance

With cash in advance terms of payment in international trade, exporters can eliminate the credit risk because payment is received before the products are shipped to the customer. For international sales, wire transfers and credit cards are the most commonly used cash in advance export payment method.

Pros

• This export payment method is beneficial for exporters as they would receive full payments securely before shipment.

• No risk of non-payment from the foreign buyer is associated.

Cons

• Foreign buyers may be concerned about the risk of not receiving good quality products after the payment is made in advance.

• Exporters who consider cash in advance payment method in international trade may lose out on business opportunities to competitors who offer more attractive payment terms in exports.

Letter of Credit

This is one of the safest and most commonly opted modes of payment in international trade. In this, the customer’s bank gives a written commitment to the exporter, which is called as a Letter of Credit (LC). It states a commitment by the bank on behalf of the importer that the payment will be settled to the exporter as per the timeline mentioned and will be subject to agreed terms and conditions.

Pros

• Beneficial to the exporter as they are satisfied with creditworthiness of the customer’s foreign bank prior to the shipment of products.

Cons

• This is a time-consuming process and involves payment and fees.

Documentary collection

In this term of payment in international trade, both parties involve their respective banks to complete the payment. The remitting bank represents the exporter while the collecting bank works on the behalf of the customer or importer. Once the exporter ships products to the importer, they need to submit the shipping documents and collect orders to the remitting bank. Documents are sent from remitting bank to the collecting bank along with instructions of payment. This is then passed to the buyer on which the payment from the collecting bank is transferred to the remitting bank. Finally, the exporter receives the amount from the remitting bank.

Pros

• This export payment method is more economical than Letters of Credit.uyer is associated.

Cons

• Here, there is no verification of the importer. With no commitment of payment from importer’s bank, there is no protection against cancellations of products by the importer.

Open Account

An open account payment method in international trade is where the goods are shipped to the importer before the payment is due. Payment is agreed on the fixed credit period which can extend typically to 30, 60 or 90 days.

Pros

• As the importer has the power to set the credit period, this enables cash flow management. For exporters, this mode of payment in international trade can help attract customers in the competitive market.

Cons

• Open account methods involve high risk for exporters. To minimize the risk, this payment mode is usually beneficial for buyers and sellers who have an already established and trusting relationship.

Consignments

The consignment mode of payment in international trade is the variation of open account in which the payment is sent to the exporter after the products have been sold by the foreign or third-party distributor to the end customer. An international consignment transaction is based on a contractual arrangement in which the foreign distributor receives, manages and sells goods to the exporter who retains title to the goods until they are sold.

Pros

• This method is more competitive and reduces the direct cost of storing and managing inventory.

Cons

• There is a lack of access to the end management of merchandise and no guarantee of payment after the sales to the exporter.

How to choose the right payment method for exports?

Here are some factors to consider while choosing a payment model for international trade:
1. Cash flow availability and needs:
Consider the importer’s availability and cash flow. For instance, understand if they will be able to pay right away or need time.

2. Legalities and import/export regulations of the destination country:
Consider international trading conditions of the importer’s country such as import licenses, subsidies, tariffs and quotas etc.

3. Type of product:
Is the product in high demand in the importing country? If yes, then the buyer might be willing to be more flexible with payment terms.

4. Creditworthiness of exporter and importer:
If the importer or the exporter’s creditworthiness is poor, then the mutual agreement will suffer. It is important to know the credibility of both the parties for successful business.

5. Competitors’ offering:
Research well to understand what other competitive businesses are offering in terms of export payment methods.
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Frequently Asked Questions

Which is better TT or LC?
Letter of Credit (LC) is a commitment by the bank on behalf of the importer that the payment will be settled to the exporter as per the timeline mentioned and will be subject to agreed terms and conditions. Telegraphic Transfer (TT) is treated as an electronic fund transfers where money is directly transferred between banks.
Is TT or Swift the same?
No, TT and Swift are not the same. Telegraphic Transfer (TT) is treated as an electronic fund transfers where money is directly transferred between banks, while Society for Worldwide Interbank Financial Telecommunication (SWIFT) doesn’t facilitate fund transfers but sends payment orders.
What is the difference between a Letter of Credit (LC) or TT?
LC is the written document from the buyer to a foreign bank to pay the exporter a sum of money when certain conditions are met. On the other hand, TT is made when the foreign buyer is ready to pay for products received.
Which is the most common payment method in international trade?
Letter of Credit (LC) is the most common payment method in international trade.
Published on August 29, 2022.

Sources:
1. https://2016.export.gov/tradefinanceguide/eg_main_043221.asp
2. https://www.trade.gov/methods-payment
3. https://www.investopedia.com/ask/answers/06/internationalfinancerisks.asp
4. https://www.privacyshield.gov/article?id=Trade-Finance-Guide-Chapter-2
5. https://www.investopedia.com/terms/l/letterofcredit.asp
6. https://www.thebalancesmb.com/how-to-choose-an-import-payment-method-1953391
7. https://www.investopedia.com/terms/t/telegraphic-transfer.asp
8. https://www.investopedia.com/articles/personal-finance/050515/how-swift-system-works.asp
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*Map not to scale. The map has been used for design and representational purpose only, it does not depict the geographical boundaries of the country. These do not conform to the external boundaries of India recognized by the Survey of India.

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