In the trade work, payment methods have been perplexing everyone all the time. The security of payment is crucial, especially large orders, any accidental problems can even bring down the whole company. Therefore, this makes everyone cannot be cautious more.
Due to the regional problems of foreign trade operations and the complexity of specific situations, cash on delivery become difficult. For domestic suppliers, the safest payment method, in theory, is to collect all the payments before shipment. It can help them avoid losses and potential risks to the greatest extent.
In turn, buyers also hope that the payment method can protect them. If sellers don’t deliver the goods after they pay in full, what should they do? What if they get shipments of defective goods? Are they going to engage in a transnational lawsuit? The complexity of international trade and the differences in laws between countries make the process of taking evidence and trial protracted. It is common for a lawsuit lasting for several years. If it’s not a big order, it’s a waste of money and time.
Then, is there a solution that can protect both buyers and sellers?
Unfortunately, there is no absolute fairness in this world, and there is no absolute security. Doing business is risky, and the degree of risk of various payment methods is not the same.
Therefore, this article is devoted to discussing the five most common payment methods in the trade. Meanwhile, it analyzes their advantages and disadvantages for readers’ reference. I hope that it would be beneficial to you in practical work.
Section 1: T/T
T/ T: Telegraphic Transfer, also known as Wire Transfer. It refers to the remittance bank to pay a sum of money to the payee on the application of the remitter.
This is the most common method of payment in trade. The majority of peers also recognize it as the easiest and most direct way. It is similar to our conventional domestic transactions: cash on delivery.
However, in foreign trade, suppliers generally do not arrange the production immediately after receiving just one contract. Even if they have sufficient money, they will still feel a lack of security. So, to avoid risk, they will ask for the deposit. Suppliers receive the deposit, then prepare the material and arrange the production. If the customer cancels the order, the deposit will not be returned. This is relatively reasonable and in line with international practice.
Most of the T/ Ts have deposits, but the ratio is different, about 5%~50%. This is determined according to the actual situation and products. Of course, the customer’s reputation, scale, and degree of cooperation will also affect the ratio of deposits. Big customers or well-known customers may pay small deposits to show the sincerity, or no deposit. If the other party is a regular customer, due to mutual trust, the deposit may drop from the initial 40% to 10%, or even cancel the deposit. If it is the first time to cooperate, to share the risk, it is also reasonable to ask about 30% deposit.
The T/T is easy to operate. Customers can easily transfer money with a bank account. In addition to the necessary bank charges, there is no extra charge. So suppliers can get as much money as possible.
However, T/T also has two great defects, the collection of the final payment and the payment arrangement of the large order.
Defect 1: The collection of the final payment
Whether there is a deposit or not, for both parties, the final payment is the most crucial part of the order. The deposit is rarely more than 50%. Therefore, the final amount determines the value of the order to a greater extent. At present, there are two main ways to collect the final payment. The first is that customers will pay if the products have no problem after their inspection of the goods. Then the supplier ships. It is commonly known as “loan delivery.” The second is to inspect and ship the goods after the completion of the goods. The customer pays after receiving a copy of B/L. The supplier then provides the original B/L for custom clearance and receiving goods at the port of destination.
Both options are feasible, but both are risky. To choose the first one, customers will take most of the risk. What if suppliers do not deliver the goods after receiving the money? To pay with a copy of B/L, suppliers will be forced to take most of the risk. What if customers don’t pay after receiving a copy of B/L and privately takes the goods away by the designated forwarder? Or, customers wait for the goods to arrive without picking up the goods to require a discount. What should suppliers do at this time? If they don’t get the goods back and accept the requirement of discount, it will bring losses to the company. But, if they get the goods back, the loss will be even greater.
Although most businessmen are honest, profiteers exist. Since there are bad suppliers, there are also bad customers. So, the final collection of T / T has its own great defects.
Defect 2: the payment arrangement of the large order
For large orders, the choice of T / T will be even more difficult, mainly involving the issue of deposits. If an order counts 1 million dollars, will the customer accept a 30% deposit? Of course, he will have concerns. He will worry about whether the supplier will take the money and disappear.
But, if the deposit is too small, only 1% or 2%, it will not work for the supplier. Maybe the supplier spent $400,000 purchasing raw materials and arranging the production. If the target market changes, the customer will give up those goods. He only lost ten or twenty thousand dollars, but the supplier takes all the risks. This is unfair.
Currently, many large orders will operate on split payment. For example, after signing the contract, customers pay a 3% deposit to the factory to prepare the material. Customer will pay another 7% after the inspection of the purchased raw materials. Then, there will be several in-line inspections. For instance, after one inspection when the goods are completed 30%, customers will pay 10% of the payment. When 60% of the goods is completed, customers will check again and pay 10%. After the completion of the goods, they do a final inspection and pay another 30%. After the final shipment with the copy of B/L, they will pay the remaining 40% of the final payment.
In this way, the risk is still not small. The first one is the final payment, which goes back to the previous defect 1. Secondly, even if both sides share the risk of the payment at each stage, once problems occur, one is troublesome if the other party defaults. Although they can resort transnational lawsuits, the experienced salesmen know that it has little practical effect except for striving for vindication.
Therefore, for large orders, the T/T payment method is in straitened circumstances.
Section 2: L/C
L/ C (Letter of Credit) refers to a written guarantee document issued by a bank to the third party at the request of the applicant. It contains a certain amount of money and is valid in a specified period. As long as the supplier provides the documents as required and complies with the terms, the bank will pay after confirmation.
L/C is the most complicated payment method in international trade, but with a relatively high safety factor. Buyers and sellers do not trust each other in their first cooperation. Buyer may be unwilling to arrange the deposit because the order is too large. They may also worry that sellers will not produce as required after the advance payment, or even take the money and disappear. Seller are also concerned that buyers will cancel the order, or after the delivery, they make an excuse to deduct or directly pay nothing. At this time, a third party is needed to provide guarantees for both of them, and the bank is a good guarantor. As long as they strictly perform the contract, the bank will assume its responsibility to provide security for the funds. During this period, L/C became a guarantee for the payment of the order.
L/C is caused by the fact that businessmen have found defects in various other payment methods. It makes up for the shortcomings of T/T and is widely used in today’s international trade. L/C also have drawbacks and problems. But overall, L/C is an easy way to reach a consensus between buyers and sellers, so that they can find a sense of security.
So to speak, the emergence of L/C has brought a great revolution to the trade field.
In the practice of foreign trade, L/C roughly has the following classification:
First, according to the responsibility of the issuing bank, it is divided into revocable L/C and irrevocable L/C.
However, since the appearance of “UPC600”, the bank is not allowed to issue revocable L/C. This is a good guarantee for the seller.
Second, depending on the existence of third-party bank guarantees, there are confirmed L/C and unconfirmed L/C.
Third, on the basis of the time of payment, it is classified as sight L/C, usance L/C and usance L/C payable at sight.
Fourth, in the light of whether the beneficiary will transfer the letter of credit, it is split into transferable L/C and non-transferable L/C.
In the course of trade, there will be a lot of this situation. An American company places an order to a Hong Kong trading company to buy a batch of furniture by L/C. But Hong Kong company is only a trading company. It will eventually place the order to the Vietnamese factory by L/C. At this time, it can ask the customer to issue transferable L/C. Then, it can transfer L/C so that the operation will be much easier. Then, they can make two rounds of transactions into one.
Fifth, in line with whether the letter of credit requires the accompanying shipping documents, it is divided into documentary L/C and clear L/C.
At present, most L/C are documentary credit. The general customers need suppliers to provide B/L, the invoice, the packing list and the certificate of origin to the bank when negotiating. The bank will review and pay.
But there is another rare situation, that is, clear credit. Clear L/C does not require shipping vouchers. It only needs invoices, packing lists, or several other documents. But it is used little. Because for customers, the lack of document of title submitted to the bank, receiving goods will be lack of protection.
Besides the above five articles, there are a lot of different L/Cs in trade practice and international settlement textbooks. But they are rare in practice.
In general, there are just two kinds of L/Cs to use often. One is L/C at sight; the other is usance L/C, such as L/C 60 days or L/C 90 days.
However, although the risk of L/C is relatively small and is easily accepted by both parties, there are still several defects to think and understand in practice.
Defect 1: The procedures are complex
The procedure of L/C is quite complex. There are at least four roles involved: the applicant for L/C, issuing bank, notifying bank, and beneficiary of L/C. The role that gives the final payment to the beneficiary of L/C, that is, the exporter, is called the reimbursing bank. And the negotiating bank is usually the issuing bank too.
For example, Company A (importer) apply to HSBC to issue an L/C to an exporter trading company in Guangzhou, China. Let’s call it Company B. At this time, Company A is the applicant for L/C, Company B is the beneficiary of L/C. And HSBC is the issuing bank. But usually, L/C does not go directly to the beneficiary through HSBC, but through an intermediate bank, possibly the Bank of China in Guangzhou. In this transaction, the Bank of China becomes the notifying bank of L/C. After the end of the deal, Company B needs to contact the reimbursing bank if it wants to collect money. This reimbursing bank can be HSBC, that is, the issuing bank. It also can be other banks designated by L/C, such as Standard Chartered Bank, Citibank, and so on.
And there will be a lot of things involved, such as whether the documents are consistent, whether the customer can accept the discrepancies, whether the “soft terms” exist, whether there are obvious errors or traps, whether L/C needs to be modified, etc.
Because of the tedious procedures, the ability of exporters and documentation specialist needs to be high. And there is no room for a little carelessness in the examination of the certificate. Otherwise, it may cause considerable losses to the company. As a result, many companies prefer to use more flexible operations such as T/T or D/P.
Defect 2: The issue of soft clauses
The soft clauses of L/C will cause great losses to the company. Therefore, the document personnel cannot be careful enough in the process of examination. The production can be arranged if L/C has no errors. If there is any dispute, he must immediately ask the customer to discuss the amendment of L/C.
In particular, some customers require clear L/C and ask to send the original B/L or through telegraph. In this case, suppliers should be more careful. If they get the document of title and uses discrepancies as excuses, he can refuse to pay. Then suppliers will lose more money.
Defect 3: Discrepancy
L/C generally have discrepancies. Although discrepancies can be avoided theoretically, it is almost impossible to encounter any L/C with no discrepancies at all in reality.
Generally speaking, any difference between documents and L/C can be called discrepancies, such as a letter or punctuation. Banks can take these as excuses and deduct money.
But, if there is a serious problem or a problem that banks cannot easily judge, banks will terminate the payment and confirm it with customers. It will continue to pay only if customers are willing to accept the discrepancies. If customers are unwilling, banks will refuse to pay according to their request.
Of course, if customers don’t accept the discrepancies, exporters can discuss with banks whether those discrepancies can constitute a refusal to pay. But banks can only provide professional advice to exporters based on inter-document audits, and the final decision is in the hands of customers.
The discrepancy itself is a weakness of L/C. Overseas profiteers can add clauses such as “inspection report or approval report issued by the customer” to L/C, but intentionally delays after inspection. Then they can refuse to pay the goods after shipment on the ground that the documents are incomplete. In this way, exporters will be in trouble.
If it is a large order, it may involve shipment in batches or need to be transshipped, the terms of L/C will undoubtedly become more complex. In many cases, there will be various problems, resulting in many discrepancies. For exporters, the risks are not as dangerous as T/T’s final payment, but they still exist.
Section 3: D/P&D/A
D/P (Documents against payment) means that the seller submits the relevant documents to the bank after shipment; the buyer redeemed the bill through the local collection bank and then picked up the goods.
D/A (Documents against acceptance) means that the seller issues a bill of exchange after shipment, together with various documents to prompt the buyer through the bank; after the buyer accept them, he can pick up the goods with the documents.
In theory, D/P is safer than D/A. Once customers refuse to pay within the acceptance period, the exporter can do nothing. The goods have been taken away by customers and even sold out. At this time, exporters can only resort a multinational lawsuit, which is very troublesome.
But in practice, the risk of D/P is similar to that of DA. In many cases, customers will ask for forwarding D/P, such as D/P after 45days. Then the risk of exporters is doubled. At this time, importers can issue trust receipts to the bank; then they can take the relevant documents to pick up the goods. In this way, if importers are deliberately to defraud, exporters will cover the ultimate loss, and the bank is not responsible. Here, the long-term DP is equivalent to D/A in nature, and the risk is very high. Exporters must be careful when they negotiate such payment methods with their customers. They should measure the feasibility and problems in operation.
The operation of D/P and D/A is much simpler than L/C and the cost of a notifying bank is reduced. But the bank does not bear any risk and responsibility in the collection process. Therefore, salespeople must be very careful when discussing D/P payment with customers. They should check the credit and risk level of the bank. If necessary, they can entrust professional third-party agencies to make assessments before deciding whether they accept the two payment methods.
One convenient point to use D/P and D/A is that there is no “discrepancy” problem. As long as the relevant documents are provided with the right amount of money, there is no problem with the transactions.
Section 4: O/A
O/A( Open Account) means a payment method that the exporter delivers the certificate of property right and related documents directly to the importer after the shipment, and collects payment from the importer after a period.
In general, O/A is the riskiest of all payment methods. If exporters ship the goods first and deliver all the documents, they will lose all protection. Once customers break a contract, exporters will bear all losses.
Even long-term D/P or D/A, there at least is the importer as a link. However, O/A relies entirely on customers reputation, without any guarantee or third-party involvement to share the risk. At this time, exporters should be cautious if it is not a regular customer or reputable customer. To some extent, O/A can be equivalent to T/T after shipment. Collection security depends on the buyer’s credit. O/A 45 days is to pay after 45 days of shipment, which is the same with T/T 45 days.
For big buyers, the payment method of O/A is common. Many customers are willing to choose L/C at sight or a T/T with a 30% deposit at first. But it will gradually turn to O/A. This is not necessarily due to customers’ tight funding, but because the customer needs to avoid risks. In addition, it is for the convenience of operation. Customers can settle once a quarter, half a year or a year, which is much simpler than L/C, D/P, D/A, and more cost-effective.
Section 5: The safest payment method
Exporters are engaged in the trade industry and naturally need to deal with money. They need to pay downstream factories or purchase raw materials. They need to sell the finished product to customers and even have to pay part or all of the freight forwarding fee. Therefore, the security of the payment method needs much attention. If they are not careful enough, they may lose both the money and the goods. As a result, suppliers are willing to lower the profits to control the risk.
Is there an absolutely safe payment method? In theory, there are. It’s T/T in advance or T/T 100% in advance. It is naturally the safest to receive all the money before production. At least, exporters need not worry about losing both money and goods.
In this way, customers have to bear all the risks. So, as long as they have other choices, they will not agree.
In the following, the above-mentioned common payment methods are arranged according to the size of the risk, only for the reader’s reference:
T/T 100% in advance < T/T( with deposit, the rest balanced before shipment) < LC at sight < L/C x days < T/T 100% before shipment < T/T(with deposit, the rest balanced copy of B/L) <D/P < T/T balanced copy of B/L < D/A < T/ T x days < O/A.
The magnitude of the risk is clear at a glance. As for which one to choose, it depends on the negotiation between the two sides.
In general, small and medium-sized customers are more likely to accept T/T. But big customers prefer O/A and various payable at usance.
If suppliers do business directly with big customers, it may be difficult to negotiate the terms of payment. Big buyers have a lot of stable suppliers. So they have a lot of alternatives. Moreover, buyers are far stronger than sellers, so they are not equal in negotiation. It is difficult for buyers to be willing to meet suppliers’ T/ T unless suppliers agree with their requirements.
If suppliers are to do business with big buyers through intermediaries, it would be much easier. The existence of intermediaries helps big buyers to avoid risks. Or big buyers choose them for their distribution ability, advantages in various resources and channels, excellent design ability, etc. In this way, intermediaries have the opportunity to negotiate on payment methods and strive for greater interests for their own companies.
For example, the US’s Sears places an order to trading companies in Guangzhou with the payment of O/A 60days. Sears gives the same order to a US importer with the same payment method. However, when the importer gives the order to the trading company in Guangzhou, the payment method may become T/T with 20% deposit, rest balanced copy of B/L. Here, intermediaries may earn 30% of the profits. But they need to guarantee the quality and delivery of the goods. They need to accept a 60-day forward payment and bear the risk of payment because they have to advance the money to the exporter.
Many exporters may start to stir after making several orders with big buyers through intermediaries. They want to supply customers directly to shorten the intermediate cost. But in fact, this does not necessarily lead to more profits. If you have this idea, you’d better ask yourself if you can accept the risk of collecting money.
The payment method itself is a double-edged sword. It not only can protect you but also hurt you.
You should be flexible when negotiating. When striving for your interests, you should also take care of the other party. When advising the other party, you can also reasonably avoid potential risks for the company. This is what professional foreign trade people should do.
Conclusion of choosing payment methods
In doing business, both exporters and importers are afraid of being cheated. Therefore, choices and negotiations of payment methods often affect the progress of business development and consultation.
However, before the negotiations, businessmen must know various foreign trade payment methods and their advantages, disadvantages, and risks. In this way, it is easier to reach agreements with customers.
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