There are many ways to make and receive payment in international trade. Due to the physical distances between buyer and seller, and the fact that the transaction may have taken place without the two parties actually meeting, minimizing exposure to risk is on the minds of both parties. The buyer wants to make sure they receive their order in acceptable condition and on time, and the seller needs to know they will get paid for it. Below is a table of the most popular payment methods for trade:
TT or Cash Advance
T/T is the easiest payment from and is typically used when samples or small quantity shipments are transported by air.
T/T is also used between buyers and sellers who have already established a mutual trust, as this negates the risks associated with this, the fastest and cheapest form of payment.
Documents like air waybills, commercial invoices and packing lists will be sent to you along with the shipment in the same aircraft.
As soon as the shipment arrives, you, with documentation, can clear the customs and pick up the goods. Shipping happens only after money is safely in seller's bank account.
It usually takes 3-4 days for such a wire transfer anywhere in the world.
Allocation of risk: 100% buyer risk
Allocation of risk: 100% buyer risk
Letter of Credit (L/C)
The L/C is a guarantee, given by the buyer's bank, that they will pay for the goods exported, provided that the exporter can provide a given set of documents in accordance with clauses specified in the L/C and in a timely manner.
The technical term for letter of credit is "Documentary Credit."
Letters of credit deal in documents, not goods. Thus, the process works both in favor of both the buyer and the seller.
Simply put, a letter of credit is a letter written by the importer's bank to the exporter. It verifies that the payment will be guaranteed when the bank is presented with concrete documents (bills of lading and freight documents).
Most letters of credit are "irrevocable" once the importer has had them sent, which means it cannot be changed unless both the buyer and seller agree.
Allocation of risk: Evenly shared Escrow
Escrow is a legal arrangement (and most commonly a payment arrangement) whereby money is delivered to a third party (called an escrow agent) to be held in trust (“in escrow”) pending the fulfillment of condition(s) in a contract, whereupon the escrow agent will deliver the payment to the proper recipient. Typically, escrow is used when the Buyer and Seller are unknown to each other.
In an international trade context, after the Buyer and Seller have agreed to the transaction, the buyer puts the payment in escrow by paying the escrow agent, which both parties have agreed to use. The seller sends the shipment and upon acceptance by the buyer, the escrow agent releases the payment to the seller.
Allocation of risk: Evenly shared
Document Against Payment/Bill of Exchange (D/P)
The exporter ships the goods, and then gives the documents (including the bill of lading necessary to claim the goods at the foreign port) to his bank, which will forward them to a bank in the buyer's country, along with instructions on how to collect the money from the buyer.
When the foreign bank receives the documents, they will contact the buyer and provide documents to the buyer only when the buyer pays. Allocation of risk: Mainly with supplier
Open Account
Opposite situation to T/T: The exporter receives payment only after the buyer has received and inspected the goods.
Allocation of risk: 100% Seller's risk
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