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Modes of Payment in International Trade: An Extensive Guide

sahil bajaj

Sahil Bajaj

Senior Specialist - Marketing @ Shiprocket

June 17, 2024

11 min read

International trade involves the exchange of goods and services between different countries. This is facilitated by a lot of factors like trade policies, market demand, export competitiveness, etc. Various modes of payment in international trade allow for easy money transactions between exporters and importers.

With technological advancements, there has been a diversification in international payment modes. In international trade, multiple legal procedures and inspections must be followed by both the exporting and importing countries. Therefore, it is essential to select an appropriate payment method that both parties agree on to make the deal secure and insured for both sides.

Modes of Payment in International Trade

Common Payment Options in International Trade

There is no particular payment method that is suitable for all situations. Thus, there are different modes of payment in international trade. It is important to understand them so that you can maximise returns and minimise losses in your world trade deals.

Here are the best five methods with their pros and cons-

1) Cash in Advance (CIA):

Cash in advance is also referred to as pre-payment or advance payment. In this method, the buyer pays the amount in advance before the goods are delivered and shipped off to the buyer. It is one of the best methods for the seller or exporter as it eliminates credit risk.

There are various ways to pay in advance, such as bank wire transfers and credit cards. Escrow services are also becoming another cash-in-advance option for small export transactions. 

Cash in advance is the most desired mode of payment by exporters, particularly in situations where the risks of non-payment are high. However, this method is highly undesirable for importers or buyers as there is a risk of not receiving the goods, making cash flow a problem for their businesses. Therefore, exporters who rely on just cash in advance cannot remain competitive.

This payment mode is best for sellers who are dealing with new customers or customers with low credit ratings and for high-value products.

ProsCons
BuyerIt helps build confidence and reputation with the customersThere is a high risk for buyers of not receiving the shipment or no refund for the damaged goods
 It makes order processing and fulfillment processes fastUnfavorable cash flow
SellerThis payment method is best for exporters as they would receive complete payments securely before shipmentIt might lead to a loss of business opportunities to the other players in the market who provide more payment options
 No risk of non-paymentIt may hamper potential buyers who prefer more flexible payment options 

2. Open Account Terms:

Open Account is also known as Accounts Payable. In this payment method, goods are shipped to the importer before payment is due. The duration is usually 30, 60, or 90 days. 

In this method, payment for the merchandise is due at a future date as per the agreement between the buyer and seller.

This is one of the best modes of payment in international trade for buyers as it allows them to manage the cash flow effectively. On the contrary, the sellers don’t prefer this platform as it involves high risk for them.

Many businesses opt for this method because it helps maximise sales and is the most beneficial and convenient option for customers. However, exporters need to evaluate and analyse whether the additional sales volume is worth the risk of payment and take steps to manage that risk. For example, the exporter can seek extra protection using export credit insurance.

ProsCons
BuyerProvides flexibility to manage cash flow by setting the credit periodThe buyer may not receive the goods from the seller as expected
 Receives goods before the payment is dueThe seller may not comply with the laws and regulations of the countries involved in the transaction; this can lead to a delay in the shipment
SellerThe best way to attract more customers in competitive marketsExporters who are hesitant to extend credit may lose a sale to their competitors
 Facilitates larger transactions by spreading out payment over timeOpen account methods involve high risk for exporters

3. Consignment:

Consignment is yet one of the best modes of payment in international trade. This is a variation of the open account method, as in this payment method, the seller does not receive the payment until the buyer resells the goods. 

The payment is sent to the exporter once the foreign distributor has sold the goods to the final customer, and the unsold goods are returned to the seller within the timeframe agreed upon in the purchase contract. In this method, the exporter holds the ownership of the goods till the time the distributor sells them.

This method is beneficial for the buyer as they only need to pay once the goods are sold to the end customer. Consignment is recommended for buyers and sellers who have a good relationship or are reputable distributors and providers.

As the risk is high, therefore the sellers should ensure they opt for insurance coverage that can cover both the goods from transit to final sale and lessen any damages caused in case of non-payment by the buyer.

ProsCons
BuyerOnly need to pay once the goods are soldMight have to manage a large inventory
 It helps expand market reach by using foreign or third-party distributorsRelies on good faith that the seller will ship the goods
SellerIt can help lessen the direct costs of storing and managing the inventoryInvolves a high risk 
 Improves competitiveness by providing better terms to end customers It helps exporters become more competitive based on better availability and swift delivery of goods

4. Documentary Collection:

Documentary collection is one of the most used methods among international traders. In this payment method, both exporters and importers involve their banks. The exporter’s bank is called the remitting bank; it deals with the importer’s bank, known as the collecting bank, to release the payment.

As soon as the exporter ships the products, they need to provide shipping documents and collection orders to their bank. After that, these documents are sent to the collecting bank, attaching the payment instructions, such as the conditions for payment, the amount, and the due date. 

Once the payment is made, the funds are transferred from the importer’s bank to the exporter’s bank. The documents are only released to the buyer after the payment has been made.

It can be done in two ways-

a) Documents Against Payments:

In this method, the seller provides the bank with the ownership documents of the asset, which are provided to the buyer/importer once the payment is received. Using these documents, the importer can take possession of the goods.

The major risk for exporters in this method is that if the importer refuses to pay, they will not have much recourse to collect. However, the importer will also not be able to collect the goods.

Here are the steps involved in a document against payment transaction:

  • The buyer and seller enter into an agreement wherein the buyer demands a document against the payment from its bank.
  • The buyer’s bank will issue a document against payment, which mentions that the buyer will pay the seller a specific amount of money once the documents are received.
  • Now, the seller will ship the goods, provide the shipping documents to the bank, and request payment.
  • The buyer’s bank will verify the documents and see if everything is done as per the payment conditions. If all the terms are met, it will notify the seller that the payment will be made.
  • The buyer’s bank makes the payment to the seller. The goods are delivered to the buyer, and they now pay the amount mentioned in the document against the payment to their bank.

b) Documents Against Acceptance:

On behalf of the exporter, the remitting bank instructs the collecting bank to provide the transaction documents to the importer.

Here are the steps involved in a document against an acceptance transaction:

  • The buyer and seller enter into an agreement wherein the buyer demands a document against the acceptance from its bank.
  • The buyer’s bank will need to provide a document against the acceptance that will mention the buyer’s liability to pay the specific amount after receiving the documents.
  • Now, the seller will ship the goods, provide the shipping documents to the bank, and request payment.
  • The buyer verifies the documents and checks that all the terms of the document against acceptance are met; if yes, then they accept the documents.
  • The buyer’s bank pays the seller. After the goods are delivered to the buyer, the buyer pays the amount mentioned in the document against acceptance to its bank.
ProsCons
BuyerPayment needs to be made once the goods are deliveredThere is no verification of the importer
 Cheaper than Letters of CreditPayment is made before goods can be checked
SellerReduces administrative burdens for exportersThere is no protection against cancellations of products by the importer
 Enables faster order processing and shipmentRisk of having to pay for return transport if the buyer rejects or does not pay

5. Letters of Credit:

It is an excellent method of payment for both parties in international trade. Letters of credit (LCs) guarantee payment from one bank to another on behalf of the buyer and seller, provided that the terms and conditions stated in the LC have been met. They are the most secure instruments available to international traders.

The importer’s bank provides a written commitment, assuring the exporter about the payment upon fulfillment of agreed terms. This provides the exporter with assurance regarding the creditworthiness of the customer’s foreign bank before shipment. This method can be used if the importer does not have a good reputation or credibility with the exporter, but the exporter is comfortable with the importer’s bank. 

Once the confirmation of trade terms and conditions is done, the importer instructs his bank to pay the agreed-upon sum to the exporter’s bank. The buyer’s bank is also required to send a Letter of Credit as proof of sufficient and legitimate funds to the seller’s bank. The payment is only made once both parties meet all the mentioned terms and the shipment has been made.

ProsCons
BuyerStreamlines documentation and paperwork processRelatively expensive
 Customisable payment termsTime-consuming
SellerImproves financial securityStrict documentary requirements
 Terms can be customisedThis can cause delays because of the requirement for verification and authentication

Key Considerations for Selecting Payment Methods in International Trade

Here are some of the factors that you should keep in mind while selecting different modes of payment in international trade:

1) The value of the goods being shipped

If you are producing something bespoke for a client, you may ask them to pay for it in advance. Furthermore, you need to evaluate the demand for the product in the importing country. If the product is in high demand, you can set up the payment terms according to your convenience and flexibility.

Understanding market mechanisms and consumer preferences is essential for deciding on the appropriate payment method that resonates well with the product’s market position and profitability.

2) Cash Flow Requirements

You need to check the financial strengths and needs of both parties. This can have a huge impact on your cash flow. For example, if you offer a 90-day credit term to your top export market, it will highly impact your business’s cash flow. Therefore, evaluating the cash flow availability and requirements is essential.  

3) Import/Export Regulations

Understand the legalities of the country you are exporting to before shipping the goods. You should know about the import/export regulations, tariffs, quotas, fees, and other trade requirements that might hinder the payment procedure. Following their terms and conditions averts potential legal issues and ensures timely delivery of goods.

4) Competitor’s Offering

It is not possible to ask for cash in advance if all of your competitors are offering a 60-day open account. This can impact your cash flow and lead to client loss. It is important to analyse and research what your competitors are offering so that you can modify your payment methods, remain competitive in the market, and attract potential buyers.

5) Creditworthiness

You must check the credit scores of both importers and exporters. A good credit history improves trust in business relationships. On the contrary, a poor credit history can affect both parties’ desire to settle on the same terms and conditions. Performing credit checks eliminates the risks related to payment transactions.

Conclusion

The shipping industry is becoming competitive. Therefore, it is essential to choose the right payment method to stay ahead of the competition. 

The ideal payment method ensures seamless transactions and builds trust between importers and exporters. Therefore, always start by understanding the different payment methods used in international trade and how their terms can influence your business.

If you are confused and looking for a credible shipping partner you can rely on, look no further than ShiprocketX. The platform makes the payment process for global trade hassle-free and sends B2B shipments without any weight restrictions. 

With ShiprocketX, you can trade globally in more than 220 destinations. Moreover, this platform ensures that the payment methods you use are safe and provides favourable terms for both parties: the importer and the exporter.

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