Methods of Payment for International Transactions

Here at BlueWhale we want to make sure you get all the information related to shipping & international trade in one huge BlueWhale sized container. This is my first blog post here and I’m going to be writing about payment terms related to international trade.

Payment terms form the backbone of any negotiation, most of the times I’ve seen people shake hands on price but the terms of payment are where it gets stuck. Everyone wants the terms of payment in their favor. In the days of economic slowdown, the sellers have to give the buyers lengthy credit, otherwise there will be no one left to buy, whereas when the market is going strong, they would be able to demand upfront cash. There would be cases where payment is a combination of the different payment methods. E.g. part Advance cash/part LC etc. Apart from market conditions, other major factors which affect the choice of payment terms are size and creditworthiness of parties, demand of products, etc.

There are five primary methods of payment for international trade, these are usually decided at a contract negotiation stage and are as important as price negotiations. Here is a matrix of it with respect to security angle for the exporter/importer.

Payment Risk Diagram

Least Secure Less Secure  Secure More Secure Most Secure
Exporter Consignment Open Account Documentary Collections Letters of Credit Cash-in-Advance
Importer Cash-in-Advance Letters of Credit Documentary Collections Open Account Consignment

I’m here going to list down all the features of each payment term so you exactly know what you are dealing with. People usually don’t read the fine print during each and every negotiation. I made my first mistake and signed off on an LC while negotiating the price. Only to realize that my bank would charge a huge fees for LC, which sent the whole deal out of my favor.

In international trade, it is very important to have all the knowledge in your head when you sit down to make a deal because you never know what kind of information is required when. A bad deal can be harmful for any trader and one can lose a lifetime of earnings in one bad trade. Default in payments are one huge cause of trading failures and court litigation process is very lengthy and cumbersome. If the other party has a good legal team, they might even get away too. But one can’t always go for all the secure methods, as being competitive is very important. And as I stressed earlier, payment terms are a better measurement of competitive character than even price. In this post, I’m going to list the pros & cons from the viewpoint of an exporter.


Applicability Appropriate for:High-risk trade relationships, e.g. An exporter sending goods for the first time to a new importer with low credit rating. Or importer resides in a war-torn country.Export markets, and appropriate for E.g. If sesame seeds are only available in Indonesia, their exporters might be able to command a cash-advance, due to high demand.Small export transactions, e.g. Buying a couple of shoes from china.
Risk Exporter is exposed to no risk as the problem of risk is placed absolutely on the importer.
Pros Payment before shipmentEliminates risk of non-payment
Cons May lose customers to competitors over payment termsNo additional earnings through financing operations

Letter of Credit

Letters of credit (LCs) are one of the most versatile and secure instruments available to international traders. However it is not only limited to international trade and is widely used in domestic trade as well.

An LC is a commitment by a bank on behalf of the buyer that payment will be made to the seller provided that the terms and conditions stated in the LC have been met, as evidenced by the presentation of specified documents.

Since LCs are credit instruments, the importer’s credit with his bank is used to obtain an LC. The importer pays his bank a fee to render this service.

Characteristics of a Letter of Credit

Applicability Recommended for use in higher-risk situations or new or less-established trade relationships when the exporter is satisfied with the creditworthiness of the buyer’s bank
Risk Risk is spread between exporter and importer, provided that all terms and conditions as specified in the LC are followed.
Pros Payment made after shipmentA variety of payment, financing and risk mitigation options available
Cons Lots of documentation involvedHuge fees commanded by banks for LC. This varies upon the negotiations with bank and the customer’s credit rating.Bank is concerned only with the documents and goods receipt. It is not concerned with quality of goods.

Confirmed Letter of Credit

A greater degree of protection is afforded to the exporter when an LC issued by a foreign bank (the importer’s issuing bank) is confirmed by a bank of the choice of exporter, e.g. an Indian bank for an Indian exporter. Exporters should consider getting confirmed LCs if they are concerned about the credit rating of bank or when they are operating in a high-risk market. E.g. US banks LC may not have been good in the aftermath of US economic collapse, as the banks were falling day by day.

Tips for Exporters

  • Consult with your bank before the importer applies for an LC, Consider whether a confirmed LC is needed.
  • Negotiate with the importer and agree upon detailed terms to be incorporated into the LC.
  • Determine if all LC terms can be met within the prescribed time limits.
  • Ensure that all the documents are consistent with the terms and conditions of the LC.
  • Be cautious of discrepancy opportunities that may delay or cause non-payment.

Documentary Collection

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 bank), along with instructions for payment. Funds are received from the importer and remitted to the exporter through the banks in exchange for those documents. D/Cs involve using a bill of exchange (commonly known as a draft) that requires the importer to pay the face amount either at sight (document against payment [D/P] or cash against documents) or on a specified future date (document against acceptance [D/A] or cash against acceptance). The collection cover letter gives instructions that specify the documents required for the delivery of the goods to the importer. Although banks do act as facilitators (agents) for their clients under collections, D/Cs offer no verification process and limited recourse in the event of non-payment. D/Cs are generally less expensive than letters of credit (LCs).

Characteristics of a Documentary Collection

Applicability Recommend for use in established trade relationships, in stable export markets and for transactions involving ocean shipments
Risk Riskier for the exporter, though D/C terms are more convenience and cheaper than an LC to the importer
Pros Bank assistance in obtaining paymentThe process is simple, fast, and less costly than LCs
Cons Banks’ role is limited and they do not guarantee paymentBanks do not verify the accuracy of the documents

Key Points

  • Under a D/C transaction, the importer is not obligated to pay for goods before shipment.
  • If structured properly, the exporter retains control over the goods until the importer either pays the draft amount at sight or accepts the draft to incur a legal obligation to pay at a specified later date.
  • Although the goods can be controlled under ocean shipments, they are more difficult to control under air and overland shipments, which allow the foreign buyer to receive the goods with or without payment unless the exporter employs agents in the importing country to take delivery until goods are paid for.
  • Although the banks control the flow of documents, they neither verify the documents nor take any risks. They can, however, influence the mutually satisfactory settlement of a D/C transaction.

When to Use Documentary Collections

With D/Cs, the exporter has little recourse against the importer in case of non-payment. Thus, D/Cs should be used only under the following conditions:

  • The exporter and importer have a well-established relationship.
  • The exporter is confident that the importing country is politically and economically stable.
  • An open account sale is considered too risky, and an LC is unacceptable/unavailable to the importer.

Difference between Types: Against payment and against acceptance.

Event Documents against Payment Collection Documents against Acceptance Collection
Time of Payment After shipment, but before documents are released On maturity of draft at a specified future date
Transfer of Goods After payment is made at sight Before payment, but upon acceptance of draft
Exporter Risk If draft is unpaid, goods may need to be disposed of or may be delivered without payment if documents do not control possession Has no control over goods after acceptance and may not get paid at due date

Open account transaction

An open account transaction in international trade is a sale where the goods are shipped and delivered before payment is due, which is typically in 30, 60 or 90 days. Obviously, this option is advantageous to the importer in terms of cash flow and cost, but it is consequently a risky option for an exporter.

It is possible to substantially mitigate the risk of non-payment associated with open account trade by using trade finance techniques such as export credit insurance and factoring. Exporters may also seek export working capital financing to ensure that they have access to financing for production and for credit while waiting for payment.

The buyer may also reject the shipment due to lack of funds or otherwise and in that case the exporter will have no choice but to find a different buyer and pay for stocking the goods or take the return shipment, both of which are costly options.

Characteristics of an Open Account Transaction

Applicability Recommended for use (a) in low-risk trading relationships or markets and (b) in competitive markets to win customers with the use of one or more appropriate trade finance techniques
Risk Substantial risk to the exporter because the buyer could default on payment obligation after shipment of the goods
Pros Boost competitiveness in the global marketHelp establish and maintain a successful trade relationship
Cons Significant exposure to the risk of non-paymentAdditional costs associated with risk mitigation measures

Key Points

  • The goods, along with all the necessary documents, are shipped directly to the importer who has agreed to pay the exporter’s invoice at a specified date, which is usually in 30, 60 or 90 days.
  • The exporter should be absolutely confident that the importer will accept shipment and pay at the agreed time and that the importing country is commercially and politically secure.
  • Open account terms may help win customers in competitive markets and may be used with one or more of the appropriate trade finance techniques that mitigate the risk of non-payment.

Trade finance techniques

Open account terms may be offered in competitive markets with the use of one or more of the following trade finance techniques:

  • Export working capital financing,
  • Government-guaranteed export working capital programs,
  • Export credit insurance, and
  • Export factoring.

However, some other techniques such as Forfaiting are not available.

These financing techniques will perhaps be discussed in more detail on another post focussing entirely on finance. At a later date. A link shall be posted here when that post is live.


In this system, the goods are exported to a Distributor or 3rd party logistics agent in the importing country who then helps makes sales.

Applicability Recommended for use in competitive environments to enter new markets and increase sales in partnership with a reliable and trustworthy foreign distributor
Risk Significant risk to the exporter because payment is required only after the goods have been sold to the end customer
Pros Help enhance export competitiveness on the basis of greater availability and faster delivery of goodsHelp reduce the direct costs of storing and managing inventory
Cons Exporter is not guaranteed paymentAdditional costs associated with risk mitigation measures

Key Points

  • Payment is sent to the exporter only after the goods have been sold by the foreign distributor.
  • Exporting on consignment can help exporters enter new markets and increase sales in competitive environments on the basis of better availability and faster delivery of goods.
  • Consignment can also help exporters reduce the direct costs of storing and managing inventory, thereby making it possible to keep selling prices in the local market competitive.
  • Partnership with a reputable and trustworthy foreign distributor or a third-party logistics provider is a must for success.
  • The importing country should be commercially and politically secure.
  • Appropriate insurance should be in place to mitigate the risk of non-payment as well as to cover consigned goods in transit or in possession of a foreign distributor.
  • Export working capital financing can help exporters of consigned goods have access to financing and credit while waiting for payment from the foreign distributor.

Trade financing techniques available

Exporting on consignment payment system may require the use of one or more of the following trade finance techniques:

  • Export working capital financing,
  • government-guaranteed export working capital programs, and
  • Export credit insurance.