Monday Export Class with Dr Godwin Oyefeso

MONDAY EXPORT CLASS with Dr Godwin Oyefeso

(SUCCESSEDGE EXPORTERS NETWORK)

Topic: TERMS OF PAYMENT (Part 1)

INTRODUCTION

In international trade, the growing competition is not confined to quality, price and delivery schedule but extends to terms of payment. International trade has been not only highly competitive, equally sensitive. Credit facilities extended to the importers, many a time, tilts the choice of exporter. Importer may prefer that exporter who can afford credit even though the price is relatively higher. When all the factors stand on the same footing between competing exporters, it is all the more choice of the importer to finalise with that exporter who extends credit on favourable terms. Here, the role of institutional credit comes into full play.

Amount and Time of Credit

The extent of credit needed depends upon the terms of sale. Exporter who has finalised the terms of sale on CIF basis requires more funds to finance the export transaction, in relation to FOB contract when no advance payment is received from the importer. So, sale terms influence not only the amount of credit, but also when the credit must be extended to the exporter to facilitate successful completion of export transaction. In some cases, credit may be extended to the exporter by importer, through letter of credit, even to purchase raw materials to manufacture goods, meant for export. Export transactions are deemed to be complete only when the export proceeds are fully received from the importer.

The terms of payment play an important role in export business. How and when the exporter has to receive payment are decided during early negotiations between the exporter and importer. Many exporters are able to clinch the deal based on attractive payment terms though they may not be totally competitive from the viewpoint of price or quality. Payment terms are determined by a host of factors, including the exchange control regulations of the country, financial competence of the exporter, monopolistic conditions of the product and above all bargaining strength of the parties. According to exchange control regulations in our country, the full value of export proceeds must be received within a period of six months from the date of shipment. Any extension of the period requires the prior approval of Reserve Bank of India.

There are five methods of receiving payment from overseas buyers. Choice of method, largely, depends on the bargaining muscle of the trading partners. Different methods of payment carry varying degrees of risk to the exporter.

What Factors Determine Terms of Payment?

The following factors are usually taken into consideration, while deciding the terms of payment:

Exporter’s knowledge of the Buyer.
Buyer’s financial
Degree of security of payment, if advance payment is not
Speed of
Cost of remittance, which normally depends on speed of remittance.
Competition faced by the exporter.
Exchange restrictions in the importer’s

Methods of Receiving Payment

Payment in Advance

This is most favoured method of payment from the viewpoint of the exporter. This mode does not have any credit or transfer risk to the exporter in executing the contract, whatsoever. When the conditions in the importer’s country are unstable and there is no guarantee of receipt of payment, even after successful execution of the contract, advance payment is always insisted by the exporter. If an order from abroad is received, exporter may prefer to forego the order however attractive the price terms may be, unless advance payment is received.

Exporter receives payment from the importer, in advance, before execution of the order. Receipt of payment can be at the time of receiving the order, initially, or later, in installments, but before final execution of the order. Payment may be received by means of demand draft, mail transfer or telegraphic transfer in the currency specified in the contract of sale. Even in this mode of payment, slight risk exists in the form of exchange risk from the date of contract till the date of receipt of payment. Risk appears to be an integral of life, at least the slightest! However, importer seldom accepts this method of payment. Importer does not accept the mode unless there is heavy demand for those goods in his country or the goods are tailor- made to the specific requirements of the importer. In those circumstances only, exporter can dictate the advance payment. When the importer is unknown or his creditworthiness is doubtful and not acceptable to the exporter and the importer requires those goods, there is no alternative to the importer, other than making advance payment. Normally, importing country’s exchange control restrictions do not permit this type of advance payment. Even when advance payment is allowed, a part payment is made at the time of acceptance of order, another part, in stages, while the manufacturing is in progress, after verification and balance before shipment, finally.

This methods works out to be the cheapest mode of contract to the exporter as there would be no commission charges as banks do not charge while crediting the demand draft/ mail transfer/telegraphic transfer amount to the account of the exporter.

II. Documentary Bills

When the exporter is unable to get the advance payment from the importer, the next best alternative mode of payment is ‘Documentary Bills’. The exporter is unwilling to part with the documents of title till he receives the payment and the importer is not prepared to part with payment and assume the risk until he is sure of receiving the goods. Under those circumstances, ‘Documentary Bills’ is a bridge, as documents are routed through the bank. It provides the required solution as it satisfies the claims of both the parties. In this system of payment, banks act as a media to reconcile the conflicting requirements of the exporter as well as importer.

Forms of Documentary Bills

Documentary Bills can be in the form of Sight Bill and Acceptance Bill. Method of payment depends on the form of bill used.

Documents against Payment: Under this method, exporter draws a sight bill on the importer and hands over the relative documents specified in the contract to his banker with the instructions to deliver the documents only on payment. The documents are sent to the correspondent’s bank, where the importer is located, with the instructions given by the exporter. When the importer makes the payment, he can get title to the goods and possession.

Documents against Acceptance (D/P): Under this method, exporter draws usance bill on the importer. Usance period may be 30 to 180 days. Usance period cannot exceed 180

days as the export proceeds are to be collected within a maximum period of 180 days as per Exchange Control restrictions. The essence of the transaction is the exporter is not only willing to ship the goods but also prepared to part with the title and possession of goods, before payment is received and even extending the agreed period of credit.

Collection of Bill: In this case, either D/P bill or D/A bill is sent to the correspondent’s bank for collection of proceeds from the

In case of D/P bill, importer has to make payment to get the documents. In case of D/A Bill, on receipt of advice from the bank, importer accepts the usance bill by writing the words ‘Accepted’ with his signature on the usance draft. Then only, importer gets documents of title to goods from the bank. He can get possession of goods and even sells the goods to get the necessary funds to make payment on the due date. In this case, the exporter is extending credit to the exporter, apart from assuming the commercial risk of default in payment as the importer may not pay on the due date, after taking delivery of goods. Soon after the payment is received from the correspondent bank, exporter’s account will be credited when the bill is sent on collection basis.

Purchase/Discounting of Bill: When the exporter is in need of funds, at the time of handing over the documents, he can request the banker to purchase/discount the bill and allow the proceeds to be credited to his

If it is a sight bill, bank purchases and if it is usance bill, bank discounts the bill. In both the cases, payment is made to the exporter, on presentation of documents. Different terms ‘Purchase’ and ‘Discount’ are used, in separate contexts, to serve the same purpose. However, in case the importer fails to pay the bill, the exporter’s account will be debited.

Consequences of Non-Payment in Case of D/P Bill: When importer fails to make the payment, on presentation by the correspondent’s bank, exporter may have to pay additional charges by way of warehouse charges and insurance charges, at the port of destination as the goods will be lying in the foreign port. If the importer finally refuses to take delivery of goods, alternative buyer may have to be procured or distress sale may become necessary. If nothing materialises, goods may have to be brought back to the country. This course of action results in heavy loss to the exporter.

Consequences of Non-Payment in Case of D/A Bill: There are greater risks associated in case of D/A Bill, compared to D/P Bill. In case of D/A Bill, importer makes payment only on the due date. From the date of delivery of goods till date of payment, exporter has to bear credit risk as importer has, already, taken delivery of goods. If the importer fails to make the payment, exporter has no alternative but to file only a civil suit that is beset with costs and realisation difficulty.

Common Risk: In both the cases, documents against payment and acceptance, there is a common risk-transfer risk-if there is shortage of foreign currency or exchange control

restrictions in the importer’s country. However, institutional facilities are available in all countries to cover political risk related to inability to receive the remittance from the importer’s country, even after payment by the importer. In India, Export Credit Guarantee Corporation of India LTD (ECGC) offers this facility.

III. Documentary Credit under Letters of Credit

Main Attraction: This method of payment has become highly popular in recent times. The greatest attraction to the exporter is elimination of credit and payment risks. Exporter is not concerned with the creditworthiness of the borrower while entering into the contract. In other words, the credit of the banker is substituted for that of the importer. There is no payment risk as negotiating bank makes the payment to him, once the stipulated conditions are complied with. Above all, an important advantage from the viewpoint of the exporter, he can obtain the payment from a bank, at his own centre. The documentary bills finance a large part of overseas trade.

Definition: According to Article 3 of Uniform Customs and Practices relating to Documentary credits, Documentary Letter of Credit has been defined as “any arrangement whereby a bank acting at the request and in accordance with the instructions of a customer (the importer) undertakes to make payment to or to the order of a third party (the exporter) against stipulated documents and compliance with stipulated terms and conditions”.

Method: At the request of the importer, bank makes a commitment to the exporter to make payment, under certain circumstances and up to a limit, provided the stipulated documents in the letter of credit, requested by the importer, are presented and found to be in order. Exporter may draw the draft on the importer or importer’s bank. The documents usually required are full set of bill of lading, invoice and marine insurance policy.

TO BE CONTINUED……

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Till then, you will succeed