For many businesses, venturing into international trade can be a daunting task. Beyond navigating unfamiliar markets and regulations, concerns of non-payment or delayed payment by foreign buyers often top the list. This is where trade finance options become an invaluable resource, acting as a compass for companies to navigate the complex world of financing cross-border transactions.
International trade involves inherent risks for both the exporter and the importer. The exporter worries about securing payment for their goods or services, while the importer is concerned about receiving the merchandise before releasing their funds. For exporters, any sale is a gift until payment is received. For importers, any payment is a donation until the goods are received. This is why many businesses are hesitant to export or expand into new markets. Trade finance bridges this gap by providing a secure and structured framework for conducting international transactions.
Because getting paid in full and on time is the ultimate goal for each export sale, an appropriate payment method must be chosen to minimize the payment risk while also accommodating the needs of the buyer. The ideal payment method strikes a balance between minimizing risk for the exporter and facilitating smoother transactions for the buyer. Factors such as the size and nature of the transaction, the buyer’s creditworthiness, and the established relationship between the parties all play a significant role in this decision.
The International Trade Administration’s Trade Finance Guide provides a breakdown of the different payment methods that can be used.
Cash in Advance
With cash-in-advance payment terms, an exporter can avoid credit risk because payment is received before the goods are shipped. For international sales, wire transfers and credit cards are the most used cash-in-advance options available to exporters.
Cross-border escrow services may also be an alternative. This places the funds with a trusted third party
until the specified conditions are met—namely that goods have been sent in exchange for advance payment. The exporter or the importer can pay the escrow fee, or they can split it evenly.
Letters of Credit(LC)
An LC is a commitment by a bank on behalf of the applicant (importer) that payment will be made to the
beneficiary (exporter). Since LCs are credit instruments, the importer’s credit with their bank is used to
obtain an LC. The importer pays their bank a fee to render this service. Unless the conditions of the LC state otherwise, it is always irrevocable, which means the document may not be changed or canceled unless the importer, banks, and exporter agree.
Documentary Collection (D/C)
A documentary collection (D/C) is a transaction whereby the exporter entrusts the collection of payment to the exporter’s bank (remitting bank), which sends documents to the importer’s bank (collecting or presenting bank), along with payment and document release instructions. Funds received from the importer are remitted to the exporter through the banks in exchange for these documents.
With D/Cs, the exporter has little recourse against the importer in case of non-payment. Thus, D/Cs are
typically recommended for use in established trade relationships, in stable export markets, and only for
transactions involving ocean shipments where documents control the delivery of the goods.
An open account transaction is a sale where the goods are shipped and delivered before payment is due,
which in international sales is typically in 30, 60, or 90 days. This is one of the most advantageous options to the importer in terms of cash flow and cost, but it is consequently one of the highest-risk options for an exporter.
Open account terms can assist in winning customers in competitive global markets with the use of either
export working capital financing or export credit insurance.
An ideal tool to support open credit export sales, export credit insurance policies cover a broad range of
commercial and political risk causes of loss. They are custom-tailored to wrap around how the business
operates, sales cycles, terms of sale, etc. Credit insurance is less burdensome than letters of credit and less
costly than export finance, factoring or forfaiting options. Global Commercial Credit, Bingham Farms, MI
specializes in trade credit insurance and is a good resource for information and assistance in securing
Consignment in international trade is a variation of the open account method of payment in which payment is sent to the exporter only after the goods have been sold by the foreign distributor to the end-customer. An international consignment transaction is based on a contractual arrangement in which the foreign distributor receives, manages, and sells the goods for the exporter, who retains title to the goods until they are sold. Payment to the exporter is required only for those items sold.
The WTO estimates that trade finance plays a key role in facilitating and supporting as much as 80 to 90
percent of international trade. The above financing options can help ensure that you get paid for your export sales.
Date Published: February 1, 2024