To succeed in today’s global marketplace and win sales against foreign competitors, exporters must offer their customers attractive sales terms supported by appropriate payment methods. Because getting paid in full and on time is the ultimate goal for each export sale, an appropriate payment method must be chosen carefully to minimize the payment risk while also accommodating the needs of the buyer.

With cash-in-advance payment terms, the exporter can avoid credit risk because payment is received before the ownership of the goods is transferred. Wire transfers and credit cards are the most commonly used cash-in-advance options available to exporters. However, requiring payment in advance is the least attractive option for the buyer, because it creates cash-flow problems. Foreign buyers are also concerned that the goods may not be sent if payment is made in advance. Thus, exporters who insist on this payment method as their sole manner of doing business may lose to competitors who offer more attractive payment terms.

• For importers —considered to be high risk as you pay for your goods before your exporter ships them.
  
• For exporters —considered to be low risk as you get paid before you ship the goods.

Letters of credit (LCs) are one of the most secure instruments available to international traders. An LC is a commitment by a bank on behalf of the buyer that payment will be made to the exporter, provided that the terms and conditions stated in the LC have been met, as verified through the presentation of all required documents. The buyer pays his or her bank to render this service. An LC is useful when reliable credit information about a foreign buyer is difficult to obtain, but the exporter is satisfied with the creditworthiness of the buyer’s foreign bank. An LC also protects the buyer because no payment obligation arises until the goods have been shipped or delivered as promised.

• For importers – considered to be medium risk as there's some assurance that the exporter has shipped the goods before you have to pay.
  
• For exporters – considered to be low to medium level of risk as the issuing bank will pay for the goods you ship as long as you fulfil all the terms and conditions of the letter of credit.

Types of Letter of Credit

There are various types of Letter of Credit used in international transactions.

DA (Usance) or DP LC - A DA LC is a type of letter of credit wherein the payment is to be made on the maturity date in terms of the credit. The documents of title to goods are delivered to the buyer merely on acceptance of documents for payment. The buyer would then make the payment on the due date of the maturity of the LC. DP LCs are types of letter of credit wherein payment is made against documents on presentation.

Irrevocable & Revocable LC - Irrevocable letter of credit is a type of LC which can be cancelled or amended only with consent of the beneficiary, applicant and confirming bank. A revocable LC can be cancelled or amended at any time without prior intimation to the beneficiary. LCs are normally irrevocable.

LC With or Without Recourse - If the beneficiary holds itself liable to the holder of the bill if dishonored, then the LC is considered with recourse. Where the beneficiary doesn’t hold itself liable, the credit is said to be without-recourse.

Restricted LC - A restricted LC is one wherein a specific bank is designated to pay, accept or negotiate the LC.

Confirmed LC - A confirmed LC is a type of letter of credit in which the advising bank at the request of the issuing bank adds confirmation that payment will be made. The confirming bank’s liability is similar to the issuing bank. The confirming bank has to honor the payment if tendered by the beneficiary.

Transferable LC - If a LC can be transferred by the beneficiary in whole or in part to a second beneficiary (usually a supplier to the seller) then the LC is a transferable LC. The 2nd beneficiary however, cannot transfer the LC further.

Back to Back LC - In a back to back LC, a 2nd LC is opened by the original beneficiary in favor of the 2nd beneficiary against the security of the original LC. A back to back LC is usually opened for suppliers.

Standby LC - A standby LC is similar to performance bond or guarantee, but issued in the form of a LC. The beneficiary of a standby LC can submit a claim by means of documentary evidence, as stipulated in the LC document.

Revolving LC: In a revolving LC, the applicant would be allowed to use the LC facility again based on drawings made and payment made against the LCs.

Steps in Obtaining L/C

• Buyer and seller agree on the terms of a sale, seller requests buyer to arrange for his bank to open a L/C
  
• The buyer’s bank (issuing bank) prepares a L/C
  
• The buyer’s bank then sends the L/C to its corresponding bank (buyer’s bank), which is called the advising bank
  
• The advising bank forwards the L/C to the buyer for approval-- terms can be amended
  
• After final terms (agreed), goods shipped
  

A documentary collection (D/C) is a transaction whereby the exporter entrusts the collection of a payment to the remitting bank (exporter’s bank), which sends documents to a collecting bank (importer’s bank), along with instructions for payment. Funds are received from the importer and remitted to the exporter through the banks involved in the collection in exchange for those documents. D/Cs involve using a draft that requires the importer to pay the face amount either at sight (document against payment) or on a specified date (document against acceptance). The draft gives instructions that specify the documents required for the transfer of title to the goods. Although banks do act as facilitators for their clients, D/Cs offer no verification process and limited recourse in the event of non-payment. Drafts are generally less expensive than LCs.

Documentary sight collection

The importer pays the exporter after the exporter ships the goods.

The importer needs the shipping documents to clear goods on arrival. The bank holds the documents until the importer pays for the goods.

This is called a "sight" payment, sometimes known as "Documents against Payment" or "D/P".

Air freight companies usually release goods to the importer immediately, even though they may not have paid.

• For importers – considered a medium level of risk as there's some assurance that the exporter has shipped the goods before you have to pay.
  
• For exporters – considered as a medium level of risk as the goods you've shipped usually get released to the importer after they pay.

Documentary term collection

The importer pays the exporter after the exporter ships the goods.

The importer needs the shipping documents to clear goods on arrival. The bank holds the documents until the importer undertakes to pay for the goods at a later date.

This is called a "term" payment, sometimes known a "Documents against Acceptance" or "D/A".

• For importers – considered to be a medium to low level of risk as you will be able to receive and inspect the goods before you have to pay.
  
• For exporters – considered to be a medium to high level of risk as the goods you have shipped will be released to the importer when they undertake to pay at a later date. The importer may not honour this undertaking if there is a dispute or if they are experiencing payment difficulties.

An open account transaction is a sale where the goods are shipped and delivered before payment is due, which is usually in 30 to 90 days. Obviously, this option is the most advantageous option to the importer in terms of cash flow and cost, but it is consequently the highest risk option for an exporter. Because of intense competition in export markets, foreign buyers often press exporters for open account terms since the extension of credit by the seller to the buyer is more common abroad. Therefore, exporters who are reluctant to extend credit may lose a sale to their competitors. However, the exporter can offer competitive open account terms while substantially mitigating the risk of non-payment by using of one or more of the appropriate trade finance techniques, such as export credit insurance.

• For importers – considered to be a minimal level of risk as you pay after you have received the goods.
  
• For exporters – considered to be a maximum level of risk as you have released control of the goods before they have paid.