Methods of payment in

international trade

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Lecture outline
Overview of the methods of payment
Exercises

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Methods of payment
Payment in advance
Open account
Consignment
Bills for collection/ Documentary collection
Documentary credits
Hybrid types of credit
Factoring and forfaiting
Countertrade

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Payment in advance

The buyer pays in advance

The risk of failure of the supplier

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Open account

The opposite of payment in advance

An open account means that the supplier
sends the goods in advance
The supplier takes the risk of non-payment

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Consignment (1)
The exporter ships the goods to the importer but
the merchandise remains his property
The merchandise is deposited in a consignment
stock and can be accessed and sold by the
importer
The payment for the goods is due after the
merchandise has been sold to a third party

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Consignment (2)
The consignment method involves the risk of
non-payment for the exporter but still decreases
the legal risk since the goods remain his
property
There are no documents which would entitle the
exporter to claim the payment and he can not
reclaim the goods
Invoicing takes place after the goods have been
accessed by the importer
This method benefits the importer since he does
not have to pay until he resells the goods
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Consignment (3)
The consignment payment method involves also
the risk of the creditworthiness of the retailer if
he does not pay, the importers cash flow will be
exacerbated, which may affect the ability to
settle payments with the exporter
An important issue to settle in the consignement
contract is the amount of goods kept in the
consignment stock
The importer will try to keep the stock as large
as possible, the exporter will try to reduce the
delivered quantities
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Consignment stocks- examples

This method is used usually between affiliated
and parent companies
Consignment can be used also for small
amounts of merchandise for demonstration/
market survey purposes
Consignment can be also used for specific
types of products, which require immediate
delivery by the importer to the retailer e.g.
pharmaceuticals

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Consignment stocks- examples

Consignement stocks are frequent between
wholesale and retail companies
This method is also used between the providers
of parts used for production in other companies
Consignment stocks are popular among EUcompanies due to the intracommunity supply of
goods (no duty paid)
Bonded stocks are established between
companies from countries were duty has to be
paid for the goods

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Documentary collection (1)

A very popular, inexpensive payment method
The exporter dispatches his goods and collects the shipping
documents (e.g. bill of lading, certificate of origin etc.)
The exporter draws a bill of exchange or promissory note on
his buyer
The bill/ draft is a formal demand for payment

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The bill of exchange (1)

A written order that binds one party to pay
a fixed sum of money to another party at a
predetermined future date
Drawn by one person (drawer) in writing,
addressed to another person (drawee)
Signed by the drawer engaging to pay on
demand or at a fixed or future date a
certain sum to a named payee
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The bill of exchange (2)

Source: Wikipedia

The bill of exchange- main

elements
The date of acceptance
The bearer- the person in possession of a bill
The holder- the payee or endorsee of a bill
The terms of delivery (Incoterms)
The terms of endorsement
The value of the transaction

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The promissory note

A written, dated and signed two-party instrument
containing an unconditional promise by the payer to pay
a definite sum of money to a payee on demand or at a
specified future date

Sometimes it is used instead of the bill of exchange in

documentary collection

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Documentary collection (2)

The exporter delivers the documents to his bank with
the request to forward them to its correspondent bank in
the buyers country
The correspondent bank presents the documents to the
importer for payment
A risk related to this method is that the bank is not
contractually obliged to honor payments from the buyer
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Documents against Payment

Documents against Payment (D/P)- the bill is payable at
sight at the moment of presentation
This method is safer for the exporter since the bank can
release the documents only upon the instruction of the
seller
The importer can not collect the goods without the
documents

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Documents against Acceptance

Documents against Acceptance (D/A)- the bill payable at
a specified future date, the importer is granted credit, he
only has to sign the bill upon presentation
The payment is postponed the bill is a time draft
Although the bill/note is a binding obligation for the buyer
the exporter still bares the risk of non-payment since the
bank is not obliged guarantee payment

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Documentary credits (1)

The safest payment method for exporters
The bank grants credit and issues a letter of credit
Contrary to the bills for collection method the bank
guarantees payment

This method protects also importers because banks are

involved in the document checking process and potential

claims for deliveries

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Documentary credits (2)

The bank issues credit on behalf of the importer-the
importer gives instructions
The letter of credit is a promise of payment on specified
terms
To receive the specified payment the exporter has to
present the necessary documents to a designated bank

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Documentary credits (3)

The bank has to honor the claims for
payment if the documents delivered by the
exporter are in line with the specification
even if the buyer refuses to pay
The importer has to pay only after delivery
and presentation of proper documentation

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Documentary credits (4)

Each documentary credit is designed
conforming to the specific contract
International code of practice- Uniform

Customs and Practice for Documentary Credits

issued by the International Chamber of

Commerce

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Uniform Customs and Practice for Documentary

Credits
Credit issuance
The responsibilities of the banks

Respective documents involved

Negotiation

Reimbursement

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Hybrid types of credit

Adapted to the changing production, sales and
transportation modes
Payment methods with the involvement of middlemen
Examples: back to back credit, transferable credit

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Standby credits (1)

The creation of standby credits was a reaction to US and Japanese

law prohibiting the issuance of guarantees on demand

Contrary to the documentary credit the documentation is not

specified in the contract
Standby credits differ from documentary credits in terms of the

identity of the documents issuer- the documents are issued by the

exporter
The exporter can obtain the payment upon a simple demand

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Standby credits (2)

Standby credits can be used as a support in
loan transactions

E.g. the credit will be executed if the importer

fails to fulfill his contractual obligations

The UCP applies to standby credits as well

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Non-traditional methods of
payment
Forfaiting

Factoring
Countertrade

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Forfaiting (1)
Forfaiting involves the purchase of receivables-the
trading company sells its transactions to a forfaiter

Usually used for financing exports of expensive

equipment e.g. machinery
In this method a forfaiting institution takes over the
debts of the importer
The forfaiting institutions (usually a bank) buys from the

exporter the documents entitling to payment e.g. bills of

exchange
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Forfaiting (2)
This way the exporter receives payment
immediately
Forfaiting transactions are without
recourse to the exporter
This means that the exporter is not liable if
the importer refuses to pay
The forfaiting institutions charge larger
interest on the debt than the market
interest rate
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Factoring

Involves also the purchase of receivables

It does not have recourse to the the seller -similalarly as forfaiting

Usually it is applied to short term transactions

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Countertrade
The payment is settled partially in goods or services, it
involves mutual transactions
Suitable for importers from countries with limited foreign
exchange
Sometimes numerous parties from various countries are

involved

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Exercises
What method of payment would you choose
in the following situations? Explain the
related risks and benefits of the chosen
method.

Group 1
You run a small company which exports wool to
few producers you have been working with over
the last 15 years. You want to sell your product to
one of your trade partners. The value of the
contract is 5000 EUR. You can not afford
expensive guarantees.

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Group 2
You are an important exporter of machinery
who already has a large market share. You
are looking for new customers in order to
cope with your competitors. You want to sell
your product to a new partner. The value of
the contract is 10 000 000 EUR.

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Group 3
You run a small cosmetic producing
company who is looking for new outlets
abroad. You can not afford expensive bank
guarantees. You want to sell a small
quantity of your product as sample to a new
trade partner.

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Literature
E. Bishop, Finance of international trade,
Chapter 3. Publication available via
Science Direct Database
J. Madura, International Financial
Management, Chapter 19, South-Western.
Cengage Learning, 11th edition, 2012.

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