It is important to ensure that you get paid in full and on time.
The payment terms you offer your overseas customer may depend on a number of factors:
- how well do you know your buyer?
- is this the first export order from this customer?
- what terms is the customer requesting?
- how much risk is involved?
- how large is the contract?
The main payment terms used in international trade are
- payment in advance
- letter of credit
- bank collection or documentary collections (D/C)
- open account
You should contact your bank for advice about which option is best for your particular situation.
With business to consumer sales, the buyer will usually pay at the point of sale. If buying online, there is a risk they won’t receive the goods. This is reduced by parcel tracking and consumer rights.
Business to business sales can be more complex. The buyer may expect credit terms which exposes you to the risk of delivering the goods and not getting paid.
Payment in advance
This is the safest method and is quite common, particularly for new customers. It is the most secure option for an exporter as payment is received before ownership of the goods is transferred. Also in highest risk, emerging markets, buyers may be aware that they will need to operate on these terms. However in some markets exporters who insist on this payment method may lose business to competitors offering more attractive payment terms.
Asking for payment in advance:
- is more secure for you
- passes the risk onto the buyer
- allows you to manage your cashflow
- may make you less competitive to the buyer
You should ask for payment in advance if customers:
- are new
- have poor credit ratings
- come from a high-risk country
- can’t be covered by credit insurance or payment guarantees
Letter of credit
A letter of credit (L/C) is a guarantee from a bank on behalf of the buyer. The bank makes a promise to pay if the buyer can’t.
The money is released when strict terms and conditions are met which usually involves providing:
- an invoice
- shipping documents
- quality assurance documents
- customs documents
The information and wording in the documents must be consistent. Not meeting the conditions can delay payment.
The main advantage of using a letter of credit is that it can give security to both the seller and the buyer. By asking for an appropriate letter of credit a seller is reassured that they will receive their money in full and on time. A letter of credit is one of the most secure methods of payment for exporters as long as they meet all the terms and conditions.
An exporter should ideally insist on a confirmed irrevocable letter of credit. An irrevocable letter of credit cannot be changed or cancelled unless everyone involved agrees. A confirmed letter of credit is one to which a second bank, usually in the exporter’s country, adds its own undertaking that payment will be made.
Bank collection or documentary collections (D/C)
This is more secure than open account. Your bank collects the value of the invoice on your behalf. Your bank issues instructions to your buyer’s bank for release of the documents against either payment (documents against payment) or acceptance of a bill of exchange (documents against acceptance).
In these terms the risk is reduced for the exporter and also for the buyer. Additionally, bank collection or documentary collection is more time and cost effective than a letter of credit. A documentary collection is used primarily for shipments by sea.
Where you have a high level of trust with your customer, open account terms could be appropriate. This is the simplest method of payment but you still need to ensure that it is clear when, where and how you will be paid. The goods or service on open account terms will be shipped and delivered before payment is due, which maybe negotiated to be in 30, 60 or 90 days from date of invoice, delivery or completion. A definite due date should be clear and agreed. This is the most risky payment option.
Before offering terms to a customer you should:
- credit reference check them through providers like Experian, Equifax or TransUnion
- ask them for a bank reference and trade references
- get to know the buyer and visit their offices and website
- source information from local Chambers of Commerce or trade associations
- consider being paid in advance for the first few invoices to build trust
- think about getting insurance against non-payment
Exporters considering open account terms can offset the risk of non-payment by using trade credit insurance.