International commercial payments may be broadly grouped into the following categories: (1) cash, (2) open accounts, (3) bills of exchange, and (4) letters of credit.
Cash is both a method of payment and a term of payment, but as a method of payment it is rarely used in international marketing. As a method of payment, the international marketing firm may use cheques like domestic trade. If accounts are maintained in banks in various countries, cheques may be drawn and paid in a variety of currencies. Or cash may be remitted by means of an international money order for small amounts.
Banks in India have deposit accounts abroad, and foreign banks have deposit accounts in Indian banks. Funds may be paid from any of these accounts for purposes of financing trade, yet an exporter in India receives rupees for the merchandise that is sold, regardless of whether the price was stated in Indian rupees or in some other currency. If, for example, the price was stated in US Dollars, then the Indian bank’s dollar account in USA is increased and the US bank’s Rupee account in the Indian bank is reduced. The conversion of the Dollars into Indian rupees is a foreign exchange transaction taken care of by banks. Of course, exporters can accept foreign currencies in payments but they usually do not care to do so.
Cash is also a term of payment. Cash may be called for with the order, or against certificates of manufacture as work on a complicated piece of equipment progresses. Today credit is increasingly demanded. Cash payment is not attractive to buyers since they bear the entire burden of financing the shipment. The buyer loses the use of funds for a considerable time before the goods are received, incurring a loss in the use of working capital as well as loss of interest. There may also be resentment of the view that the buyer is unworthy of credit. Furthermore, the buyer is dependent upon the honesty, solvency, and promptness of the exporter in the business deal. Today cash payment will probably be used when the importer is of doubtful credit standing, when the exporter is financially weak, on orders requiring special instructions,, or when the exporter is not cognizant of the competitive situation faced by manufacturers of other countries.
2. Open Account
The open account method of payment for export shipments is the opposite of the cash method. Under the open account, goods are shipped without documents calling for payment — the commercial invoice of the exporter indicating the liability. Since no documentary evidence of ownership or obligation exists, the open account presents difficulties because of differences in the laws and customs of countries which make it difficult to safeguard the interests of the exporter. In the open account method, the burden of financing rests upon the exporter. This requires a greater amount of working capital than other forms of payment and the exchange risks are assumed by the exporter. Despite the disadvantages of the open account, competitive pressures have forced many producers use this method after years of selling on more secure terms.
3. Drafts or Bills of Exchange
A draft or a bill of exchange, as it is known throughout the world, is an unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay, on demand or at a fixed or determinable future time, a definite sum in money to, or to the order of, a specified person or the bearer. An accepted draft or an accepted bill of exchange is called an acceptance. The person to whom it is addressed is called the drawee, and if he signifies his assent to the order in due form, he is called the acceptor. Such assent usually consists of the acceptor writing across the face of the bill, the date, “accepted payable at…….and affixing his signature. A draft is payable to the bearer when it is expressed to be so payable or when the only or last endorsement is an endorsement in blank. This endorsement in blank is one in which the name of the company only is shown, with the name of signatory and his title. The sum payable is a definite and specified sum, although it is required to be paid with interest or with collection charges, or according to an indicated ascertainable rate of exchange. No special form of words is essential for the validity of a draft, provided that the sense is clear and the bill conforms to the provisions laid down in the definitions given above.
Drafts are usually drawn in pairs, one of which is the “first of exchange” and the other the “second of exchange”. It is customary to send the first of exchange by the first mail and to send the second of exchange by a subsequent mail. If the first of exchange is lost, the second of exchange then becomes negotiable. However, if the first of exchange is negotiated, the second of exchange ceases to have any value.
It is drafts or bills of exchange, drawn by the shipper of goods or the provider of services in one country, on people in another country who are buying the goods or using the services, that constitute the chief supply of international currency.
A draft or a bill of exchange performs two or three functions. A draft payable at first sight is a demand for payment due and a receipt for payment made. A draft payable at some future period after sight becomes a demand for payment by the seller, a promise of payment by the buyer on the agreed date, and a receipt for payment after such payment has been made.
For More: Export Bills of Exchange
4. Letters of Credit
Letters of credit are the most important single factor in the export trade. They form the basis of a very large portion of world trade, and give security to both buyer and seller. Letters of credit are much more than a means of arranging payment between the two parties to a transaction; they also set out the ways in which the contract between the two parties is to be performed.
A letter of credit has been defined as a written instrument issued by the buyer’s bank, authorizing the seller to draw in accordance with certain terms, and stipulating in a legal form that all such bills shall be honored. Letters of credit are also known as commercial credits and banker’s credits. The terms of letters of credit vary greatly, because alterations are made to suit the requirements of each individual transaction. All such credits, however, have certain characteristics in common; all contain an authorization for some seller of goods to draw on a bank which promises to honor the drafts, although in the case of revocable credits, this promise is contingent upon the cancellation of the letter of credit or its not having been received. The bank thus places the security of its name behind the buyer. In the case of irrevocable credits, this security cannot be taken away, except with the consent of the beneficiary. Herein lies the main point of attractiveness of letters of credit from the exporter’s point of view — he is assured of obtaining payment for his goods, provided that he lives to the terms specified therein. On the other hand, the buyer, provided that he is able to satisfy his local bank as to his standing and the legitimacy of his requirements, can have his orders accepted by almost any firm in any country of the world.
It may be pointed out here that the bank issuing the letter of credit is the stake-holder in the transaction and is acting on behalf of the buyer who opens the credit. It is not a party to, and knows nothing about, the negotiations between the parties, and is not interested in the goods as such. In issuing a letter of credit, the bank is acting in accordance with the instructions which have been given to it by the buyer. The bank is not in a position to modify any of the details contained in the credit, whatever the reasons given by the exporter. This position must be clearly understood before describing the usual letter of credit requirements. Every little detail must be complied with by the exporter to enable him to obtain payment against the letter of credit and one small (and often apparently senseless) divergence will lead to considerable complications, entailing extra expense delay in payment, or non-payment and, probably also, offense to the buyer who opened the credit. The letter or credit must be minutely studied by the exporter; and if there are any details, however small, which call for adjustment, the exporter must ask the buyer to amend his instructions to the bank and the exporter must wait until the bank, which issued the credit to him, notifies him that the letter of credit has been amended as required. The amendments must follow the same channel as the original credit; it is no use for the exporter to ask the bank at his end to make the amendments. The form and actual wording of a letter of credit vary from bank to bank; but the basic contents are the same.
Credit: Export Management-CMU