The payment method you use when trading internationally has a large bearing on the financing you require and level of risk to which you are exposed. Lee Baty is HSBC Head of Business Banking for Global Trade and Receivables Finance. Here he answers key questions about international payment options and how to manage financial risk when trading internationally.
Q: When trading internationally what are the key payment options?
Lee Baty (LB): “Securing payment is a vital consideration in any international trade transaction. Remember, an export is a gift until it is paid for. Many of the risks when trading overseas can be insured against or mitigated through the payment mechanism. However, as demonstrated by the risk ladder, if the exporter reduces his risk this has the effect of increasing the importer’s risk. Over time a number of ways to settle international trade debts have evolved: Open account payment, documentary collections, letters of credit and payment in advance.”
Q: What is ‘open account payment’?
LB: “It’s similar to offering credit to a UK customer. Typically, the credit term, for example, 30 days, begins once you invoice for goods supplied, in line with your agreed terms of trade. About 80 per cent of global trade happens on an open account basis. It’s the most straightforward and cheapest method of payment, but you must be comfortable with your trading partner. Many businesses trade internationally with relatively low-value transactions, shipping goods on an open account, sending an invoice and getting paid in 30 days. You bear the risk while waiting to be paid.”
Q: So why the need for other payment options?
LB: “ As orders increase and the business relationship grows, opportunities increase, but the level of risk to which your business is exposed also increases, of course. Other trading instruments – such as letters of credit and documentary collections– offer greater protection while the relationship and trust develops.”
Q: How do I decide which payment option is most appropriate?
LB: “For any individual transaction, the most appropriate method will depend on the level of risk involved, how strong your negotiating position is and how the cost of financing compares for you and your customer.”
Q: What is a ‘documentary collection’?
LB: “A documentary collection is a process, in which the seller instructs his bank to forward documents related to the export of goods to the buyer’s bank with a request to present these documents to the buyer for payment, indicating when and on what conditions these documents can be released to the buyer.
Documentary collections offer a more secure method of trading than OA for exporters and a simpler lower cost alternative for importers. DCs are also a convenient mechanism to agree a period of credit between buyer and seller. ”
Q: What are ‘documentary credits’ or ‘letters of credit’?
LB: “Other than payment in advance, they are the most secure method of payment. Your customer arranges a letter of credit with their bank – the ‘issuing bank’ – which pays a correspondent bank in the UK – the ‘advising bank’ – once you submit all the agreed documentation. Documentary credits are typically used for exports to customers to whom you haven’t sold previously, and for customers and countries that present particular credit risks. The main advantage of using a letter of credit is that it can give security to both the seller and the buyer”
Q When are advance payments or part-payments used?
LB: “Typically, for low-value sales to individuals or new customers. Although it’s the least favourable option, start-ups often use advance payment in the form of credit cards. For example, an importer may use a credit card to buy samples from (China-based websites) Alibaba or Taobao. Many websites use an online payment processor such as PayPal, Google Checkout or WorldPay. If there’s a problem, many third-parties may not offer the protection you can get from a credit card company. But, be aware that accepting credit card payment for international transactions may carry the same risks as in your domestic market.”
First steps to exporting
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