Terms of Payment

Presented by
Dr. Bishal Dey Sarkar

Ph.D.
Mail_ID: [email protected]
Phone No.: +91 9226682589
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INTRODUCTION
• One of the greatest concerns an exporting company has is to make sure that it can collect
payment from its foreign customers.
• There are several ways in which an exporting company can ensure that it is paid and paid
on time.
• A company can tailor its international terms of payment to the characteristics:
• of its customers,
• the countries in which it does business, and
• its own tolerance for risk.
• It is therefore relatively simple to choose an international sales term that secures the
interests of the exporter.
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INTERNATIONAL PAYMENT CHARACTERISTICS

1. Credit information
• Challenges of Assessing Foreign Customers
• Less credit information available on foreign customers
• Credit reporting agencies, accounting firms, and factoring houses may have
information, but it is not always readily obtainable
• Information may not exist for new firms or firms in developing countries
• Recent Improvements
• Centralized credit information portals offer links to access foreign countries’
credit agencies
• Collecting credit information, though, is usually much more expensive and
complicated
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INTERNATIONAL PAYMENT CHARACTERISTICS

2. Lack of personal contact
• Impersonal Communication
• Difficult Character Assessment
• Increased Risk Perception
• Intercultural Misunderstandings

3. Difficult and expensive collections

• Few Firms Offer Services: Limited availability of companies specializing in
international debt collection.
• High Costs: Collection fees can range between 5-30% of the receivable amount.
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INTERNATIONAL PAYMENT CHARACTERISTICS

4. No easy legal recourse
• Limited Legal Framework: International trade lacks a comprehensive commercial code and
established legal precedents compared to domestic settings.
• No Centralized Court: There's no single court with global jurisdiction to enforce contracts.
• UNCITRAL Offers Partial Solution: The UN Convention Contracts for the International Sale
of Goods (CISG) establishes some legal principles, but not all countries fully adopt it (e.g., USA,
UK).
• Uneven Enforcement: Interpretation and enforcement of CISG vary by domestic courts, leading
to uncertainty.
• Limited Legal Precedents: Scarcity of past cases for international trade disputes makes legal
outcomes unpredictable.
• No International Court for Businesses: The International Court handles disputes between
governments, not corporations.
UNCITRAL: United Nations Commission on International Trade Law
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INTERNATIONAL PAYMENT CHARACTERISTICS

5. Higher Litigation Costs.
• The cost of international litigation, arbitration, or mediation is generally much greater than that
of domestic litigation.
• Litigation: The act, process, or practice of settling a dispute in a court of law
• Arbitration: Dispute resolution method, where the parties agree to resolve their disputes
before private arbitrators instead of a national court
• Mediation: It is process, a neutral, trained mediator works to help disputants come to a
consensus on their own
• Seeking a ruling against an importer in the importer’s country is time consuming, can involve
several trips abroad, and necessitates hiring foreign law specialists, a process that involves
greater expenses than domestic disputes.
6. Mistrust.
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RISKS IN INTERNATIONAL TRADE

Commercial Risk
• The probability of not being paid by a creditor, either because the creditor does not have
the funds, or because it refuses to recognize the debt.
OR
• The ability (and the willingness) of the importer to pay the invoice in time.
• It is more difficult to obtain accurate and reliable information about commercial.
• Commercial risk can also be evaluated from private sources, including credit
report companies, factoring houses, some accounting firms, insurance companies,
and banks.
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RISKS IN INTERNATIONAL TRADE

Country risk
• Country risk is an aggregate of political and economic issues.
• It encompasses all the issues related to a country to which an exporter is shipping that
may affect payment, regardless of the importer’s creditworthiness.
• Political side, the government’s stability should be considered
• The overall health of the economy should also be considered
• Finally, exporters must also consider their exposure, which is the potential financial
impact of non-payment or reduced payment on the exporter’s business.

Source: The World Bank.

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SWIFT: SOCIETY FOR WORLDWIDE INTERBANK FINANCIAL TELECOMMUNICATION

• This payment network allows individuals and businesses to make payments even if the
customer or vendor uses a different bank than the payee.
• SWIFT assigns each financial organization a unique code with either eight or 11
characters, known as a bank identifier code or BIC.
• To understand how the code is assigned, let’s look at the Italian bank UniCredit Banca,
headquartered in Milan. It has the eight-character SWIFT code UNCRITMM.
• First four characters: the institute code (UNCR for UniCredit Banca)
• Next two characters: the country code (IT for the country Italy)
• Next two characters: the location/city code (MM for Milan)
• Last three characters: optional, but organizations use them to assign codes
to individual branches.
• Example: BIC Code (Swift): AXISINBB
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TERMS OF PAYMENT
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TERMS OF PAYMENT: CASH IN ADVANCE

• An importer has to pay the exporter before the exporter ships the goods.
• Payment is usually made with an electronic fund transfer from the customer’s bank to
the exporter’s bank,
• Using the network of the Society for Worldwide Interbank Financial
Telecommunication (SWIFT).
• The importer must pay before the goods are shipped; therefore,
• No collection worries,
• No foreign-exchange fluctuation exposure,
• No cash-flow problems, and
• Nominal fees to pay to banks.
• In a cash-in-advance transaction, the risk is transferred to the importer.
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TERMS OF PAYMENT: CASH IN ADVANCE

• The importer sends cash to the exporter with the expectation that the exporter will
• Ship the goods that were requested,
• In the quantity that was ordered,
• In due time, and
• With the documents necessary to clear customs in the importing country.
• Cash in advance is a recommended in situations
• Fraud is rampant
• Substantial risk of political instability
• Foreign exchange freezes
• The cash-in-advance method is unsound for business conducted in developed countries,
and in countries in which there is a significant level of sophistication in international
business.
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TERMS OF PAYMENT: CASH IN ADVANCE

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TERMS OF PAYMENT: LETTER OF CREDIT

• Issuing bank: The bank that opens the letter of credit on behalf of the importer and pays
the exporter if the exporter provides the documents requested in the letter of credit.
• Beneficiary: The party that will be paid by the letter of credit, the exporter.
• Applicant: The firm whose payment is supported by the letter of credit, the importer.
• Advising bank: A bank that reviews the letter of credit on behalf of the beneficiary.
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TERMS OF PAYMENT: LETTER OF CREDIT

• A method of payment in which a bank promises to pay the exporter on behalf of the
importer, as long as the exporter has provided the documents requested in the letter of
credit.
• The promise of payment is not made upon the exporter meeting certain conditions (or the
importer not meeting certain conditions), but instead it is made on the documents of the
transaction.
• This is why a letter of credit is often called a documentary letter of credit.
• The letter of credit is a contractual agreement between the issuing bank and the
exporter that is undertaken on behalf of the importer.
• Extreme care must be taken in handling the documents related to a letter of credit;
otherwise, errors trigger a very time-consuming and expensive process of amendments
and corrections.
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TERMS OF PAYMENT: LETTER OF CREDIT: PROCESS

Issuance: The issue of a letter of credit, or the steps that take place before the exporter
ships the merchandise to the importer.
STEP 1: It starts with the process is the negotiation, which takes place between the exporter
and the importer, in which it is agreed that the term of payment will be by letter of credit.
The exporter then sends a pro forma invoice to the importer, which estimates the terms of
the transaction as closely as possible.
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TERMS OF PAYMENT: LETTER OF CREDIT: PROCESS

Issuance: The issue of a letter of credit, or the steps that take place before the exporter
ships the merchandise to the importer.

STEP 1:
• It starts with the process is the negotiation
• Both agrees that the term of payment will be
by letter of credit.
• The exporter then sends a pro forma invoice
to the importer, which estimates the terms of
the transaction as closely as possible.
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TERMS OF PAYMENT: LETTER OF CREDIT: PROCESS

STEP 2: The importer requests its issuing bank to open a letter of credit on the importer’s
behalf, naming the exporter as the beneficiary.
• The importer follows the exporter's instructions regarding the terms of the sale.
• Ensures that the application includes all necessary documents for customs clearance in
the importing country.
• The importer may also send a copy of the application to the exporter.

STEP 3: Issuing bank sends the LC (SWIFT

network/ fax/ mail) to the exporter’s bank.
• Advising bank checks several things: first, that
the letter of credit is drawn on a legitimate bank
and that its content meets the exporter’s
requirements.
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TERMS OF PAYMENT: LETTER OF CREDIT: ACTORS

• STEP 4: the advising bank notifies the beneficiary that the letter of credit is acceptable
from the bank’s perspective.
• By reviewing the letter of credit, the bank is not engaging its responsibility; it is only
acting as an adviser to the exporter and has no liability (will not have to pay) if the
issuing bank does not honor its commitment.

• The advising bank then forwards the letter of

credit to the exporter, who determines that
the terms of the letter of credit are consistent
with what was agreed upon between the
exporter and the importer
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TERMS OF PAYMENT: LETTER OF CREDIT: PROCESS

Shipment

STEP 5
• Exporter ships the merchandise abroad. In the
process, exporter generates a lot of paperwork
(invoice, certificate of origin, export license,
packing list etc.)
• Exporter collects the paperwork's, from
different suppliers and sends them to its bank.
• No documents travel with the goods; they are
sent to the exporter’s bank, and eventually are
delivered to the importer through the banking
system.
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TERMS OF PAYMENT: LETTER OF CREDIT: PROCESS

STEP 6: The advising bank receives the documents from the exporter and sends the
documents to the issuing bank.

STEP 7:
• The issuing bank then checks the documents
again the requirements of the letter of credit.
• If the documents conform, the issuing bank
notifies the importer that the documents are
in order and it exchanges them against
payment by the importer.
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TERMS OF PAYMENT: LETTER OF CREDIT: PROCESS

Payment
STEP 8: Payment is first made by the
importer to its bank, in exchange for the
transaction documents.
STEP 9: The importers’ bank then wires the
payment to the exporter’s bank.
STEP 10: Finally the exporter’s account is
credited.
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TERMS OF PAYMENT: LETTER OF CREDIT

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TERMS OF PAYMENT: LETTER OF CREDIT

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TERMS OF PAYMENT: LETTER OF CREDIT

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TERMS OF PAYMENT: LETTER OF CREDIT

Applicability: A letter of credit used to be the payment term of choice in international

transactions, especially in those cases where:
• The exporter had no pre-existing business relationship with the importer,
• When the importer was in a high-risk country.

Documents required for a Letter of Credit

• Shipping Bill of Lading
• Airway Bill
• Commercial Invoice
• Insurance Certificate
• Certificate of Origin
• Packing List
• Certificate of Inspection
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TERMS OF PAYMENT: LETTER OF CREDIT- TYPES

• Revocable Letter of Credit

• Irrevocable Letter of Credit
• Confirmed Letter of Credit
• Unconfirmed Letter of Credit
• LC at Sight
• Usance LC or Deferred Payment LC
• Back-to-Back LC
• Transferable Letter of Credit
• Non-transferable Letter of Credit
• Standby Letter of Credit
• Freely Negotiable Letter of Credit
• Revolving Letter of Credit
• Red Clause LC
• Green Clause LC
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TERMS OF PAYMENT: LETTER OF CREDIT- TYPES

• Revocable Letter of Credit: It can be cancelled or amended by the issuing bank at any
time and without prior notice to or consent of the beneficiary.
• Irrevocable Letter of Credit: It cannot be cancelled or amended without the consent of
all parties concerned.
• Confirmed Letter of Credit: It is a LC to which another bank (bank other than the
issuing bank) has added its confirmation. The bank which adds its confirmation is called a
confirming bank and it becomes a party to the contract of LC.
• Unconfirmed Letter of Credit: Unconfirmed Letter of Credit is a Letter of Credit to
which no added guarantee from bank or any other financial institutions.
• LC at Sight: A LC that is payable immediately (within five to ten days) after the seller
meets the requirements of the letter of credit. This type of LC is the quickest form of
payment for exporters.
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TERMS OF PAYMENT: LETTER OF CREDIT- TYPES

• Deferred Payment LC: It is a LC that provides that the beneficiary will be paid, not at the time
the beneficiary makes a complying presentation, but at a later, specified, maturity date.
• Back-to-Back LC: A back-to-back letter of credit involves two letters of credit to secure
financing for a single transaction. These are usually used in a transactions involving an
intermediary between the buyer and seller.
• Transferable Letter of Credit: A Transferable Credit is one that can be transferred by the
original (first) beneficiary to one or more second beneficiaries. When the sellers of goods are not
the actual suppliers or manufacturers, but are dealers/middlemen.
• The LC can be transferred only once and only on terms stated in the credit, with the exception of
• The amount of the Credit, Any unit price stated therein,
• The expiry date,
• The latest shipment date or given period for shipment,
• The period for presentation of documents, any or all of which may be reduced or curtailed
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TERMS OF PAYMENT: LETTER OF CREDIT- TYPES

• Non-transferable Letter of Credit: It is a LC that a beneficiary cannot assign, either
partially or entirely, to any other party.
• Standby Letter of Credit: It is a legal document that guarantees a bank's commitment
of payment to the exporter in the event that the importer–or the bank's client–defaults on
the agreement.
• Freely Negotiable Letter of Credit: The authorization from the issuing bank to pay the
exporter is not restricted to a specific bank, any bank can be a nominated bank as long
as the bank is willing to pay, to accept draft(s), to incur a deferred payment undertaking,
or to negotiate the L/C.
• Revolving Letter of Credit: Allows for repeated use without needing to issue a new
LC for each transaction. It is particularly useful for buyers and sellers engaged in
ongoing trade relationships with frequent shipments over a specified period.
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TERMS OF PAYMENT: LETTER OF CREDIT- TYPES

• Red Clause LC: A red clause letter of credit is a variation of the traditional LC that contains a
unique clause allowing the bank to make advance payments to the exporter before the exporter
presents any shipping documents.
• Green Clause LC: This is an extension of Red Clause Letter of Credit, in that it provides for
advance not only for purchase of raw materials, processing and/or packing but also for
warehousing and insurance charges at the port. pending availability of shipping space.
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TERMS OF PAYMENT: DOCUMENTARY COLLECTION

• Documentary collection is a process by which an exporter asks a bank located the

importer’s country to collect payment from the importer.
• The exporter asks the bank not to release the documents—specifically the bill of lading,
which is the certificate of title to the goods until the importer satisfies certain
requirements.
• Remitting Bank: In a documentary collection, the remitting bank collects the
documents from the exporter and sends them to the presenting bank. It has no other
involvement.
• Presenting Bank: In a documentary collection, the presenting bank interacts with the
importer and withholds the documents until payment is received or a draft signed.
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DOCUMENTARY COLLECTION: PROCESS

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DOCUMENTS FOR DOCUMENTARY COLLECTION

• Bill of Exchange: It is a legal document in the importing country that binds importer to pay a fixed
sum of money to the exporters on demand or at a predetermined date
• Sight Draft: A draft in which the importer promises to pay the exporter immediately, “at
sight.”
• Time Draft: A draft in which the importer promises to pay the exporter 30, 60 or 90 days
after the importer has signed the draft.
• Date Draft: A draft in which the importer promises to pay the exporter 30, 60 or 90 days
after the shipment date of the goods, regardless of the date on which importer has signed the
draft.
• Instruction Letter: In a documentary collection, a document prepared by the exporter that instructs
the presenting bank on the steps to take before releasing the documents to the importer.
• Trade Acceptance: Trade acceptance takes place when the importer signs the draft.
• Banker’s Acceptance: It takes place when the bank signs the draft on behalf of the importer.
• Aval: The promise by the presenting bank that the importer will honor the draft and that, should the
importer default, the bank will make the payment.
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CASH AGAINST DOCUMENTS / DOCUMENT AGAINST PAYMENT (D/P)

• It happens when the buyer needs to pay the amount due at sight.
• This payment is made before the documents are released by the buyer’s bank (collecting
bank). It is also known as sight draft or cash against documents.
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DOCUMENT AGAINST ACCEPTANCE

• It is an arrangement where the buyer is required to make the payment only after a
specific duration.
• Once the trade acceptance is received, the bank can release the documents to the buyer.
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DIFFERENCE BETWEEN LC AND DC

1. A letter of credit is a legally binding document that guarantees payment to the exporter.
A documentary collection allows a buyer to refuse a shipment if it does not match the
standards of excellence.
2. The importer's bank issues the letter of credit, while the exporter's bank issues a
documentary collection.
3. In the letter of credit facility, the bank pays the exporter if the importer cannot. The
bank bears no such liability in the documents' acquisition capacity.
4. The cost of issuing a letter of credit is higher, whereas documentary collection is less
expensive.
5. When commerce is at risk owing to location limitations, a letter of credit is favored, but
the documentary collection is preferable when the merchants have deep, reliable
relationships.
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TERMS OF PAYMENT: OPEN ACCOUNT

• Exporter sends an invoice to the importer along with the goods and expects the importer
to pay within a reasonable amount of time.
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TERMS OF PAYMENT: CONSIGNMENT

• Consignment method of payment in International Trade is a variation of open account in
which payment is sent to the exporter after the goods have been sold by the foreign
distributor to the end customer.
• The key to succeed in exporting on consignment is to partner with a reputable and
trustworthy foreign distributor or a third-party logistics provider.
• Appropriate insurance should be in place to cover consigned goods in transit or in possession
of a foreign distributor as well as to mitigate the risk of non-payment.
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TERMS OF PAYMENT: CONSIGNMENT

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TERMS OF PAYMENT: PURCHASING CARDS

• A purchasing card (a P-card or procurement card) is a company credit card that your
company’s employees can use to purchase goods and services your business needs.
• Purchasing cards are typically used for low-value, high-volume transactions.
• Aside from that, it can also be used for:
• Emergency purchases
• Purchases needed to be made quickly
• Purchasing cards are a great, valuable tool for your business, regardless of size. Using this,
your business can save money, improve efficiency, and reduce fraud risks.
• Importers can pay exporters immediately after the goods have been shipped.
• The exchange rate on the transaction is the best a company can get.
• It is expected that this type of P-card transaction will increasingly take place in international
business
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TERMS OF PAYMENT: TRADE CARD

• A proprietary process that combines payment and documents and facilitates international
transactions.
• Created by the World Trade Centers Association in 1994.
• It combines the advantages of letters of credit and procurement cards.
• No payment is made until all the documents are in order and there are no
discrepancies.
• The buyer is obligated to pay if the documents are in order.
• The system is expedient (payment is received quickly).
• It has a secure system for transmitting documents, from the pro forma invoice to the bill of
lading, packing list, and other transportation documents.
• It has a system that checks the customer’s creditworthiness.
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TERMS OF PAYMENT: BANK GUARANTEES

• A bank guarantee is another instrument used in international trade, but in different situations.
• A bank guarantee is usually requested to secure the performance of the seller/exporter, rather
than to ensure payment from the buyer/importer.
• Bank guarantees happen in cases in which the exporter is a company contracting to build a
manufacturing plant, processing unit or sewer system etc.
• A bank guarantee applies to all long-term contracts in which the importer wants to ensure that
the work will be completed.
• The bank guarantee is offered by a group of banks rather than a single bank, because of the
amounts involved.
• Bank guarantee is an independent contract between the bank giving the guarantee (guarantor)
and the beneficiary.
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TERMS OF PAYMENT
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MCQ ON TERMS OF PAYMENT

1. The method of payment where the exporter relies on the undertaking of a bank to pay is
A. Bank guarantee
B. Letter of credit
C. Letter of comfort.
D. None of the above

Answer: Letter of credit

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MCQ ON TERMS OF PAYMENT

2. The beneficiary under a letter of credit is
A. The bank opening the credit.
B. The customer of the opening bank.
C. The confirming bank.
D. The exporter

Answer: The exporter

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MCQ ON TERMS OF PAYMENT

3. A letter of credit is opened on behalf of
A. Exporter customers.
B. Importer customers.
C. Any party wishing to make payment abroad
D. None of the above

Answer: Importer customers.

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MCQ ON TERMS OF PAYMENT

4. A letter of credit is addressed to

A. The beneficiary.
B. The negotiating bank
C. The reimbursing bank.
D. None

Answer: The beneficiary.

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MCQ ON TERMS OF PAYMENT

5. A letter of credit that provides for granting of pre-shipment finance as well as storage of
goods in the name of the bank is
A. A red clause letter of credit
B. A standby letter of credit.
C. A green clause letter of credit
D. A secured letter of credit

Answer: A green clause letter of credit

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MCQ ON TERMS OF PAYMENT

6. When a letter of credit does not indicate whether it is revocable or irrevocable, it is treated
as
A. Revocable
B. Irrevocable
C. Revocable or irrevocable at the option of the beneficiary.
D. Revocable or irrevocable at the option of the negotiating bank.

Answer: Irrevocable
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MCQ ON TERMS OF PAYMENT

7. The best form of method of payment for an importer would be

a) Open account
b) Letter of credit.
c) Documents against payment.
d) Advance remittance.

Answer: Open account

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MCQ ON TERMS OF PAYMENT

8. Amendment to a letter of credit should be advised through the

a) Negotiating bank
b) Advising bank.
c) Issuing bank
d) None of the above.

Answer: Advising bank.

Contact Details:
Email ID: [email protected]
Mobile No.: +91 9226682689

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