In domestic trade, you can visit a customer who does not pay. In export, the buyer is in another country with another legal system, and chasing a bad debt is slow and expensive. The payment term you agree on decides how much of that risk you carry.
There are five common methods. They are listed here from safest for the exporter to riskiest.
1. Advance payment
The buyer pays before you ship, usually by bank transfer. It may be the full amount or a part, such as 30 percent with the order and the balance before dispatch or against a copy of the bill of lading.
This is the safest method for the exporter and is common for small orders, customised goods and first-time deals. Buyers are often reluctant to pay 100 percent in advance to a new supplier, so a part advance is a fair middle ground.
2. Letter of Credit (LC)
A Letter of Credit is a promise from the buyer's bank to pay you, provided you present documents that match the terms of the LC. You are relying on a bank rather than on the buyer, which makes it a strong option for larger orders.
An LC at sight is paid when compliant documents are presented. A usance LC is paid after an agreed period, such as 60 or 90 days. If you are unsure about the buyer's bank or country, you can ask your own bank to add its confirmation.
The weakness of an LC is paperwork. Banks check documents strictly, and a small mismatch in a name, date or description is a discrepancy that can delay payment. Read the LC carefully the day you receive it and ask for an amendment if you cannot meet any condition.
3. Documents against Payment (D/P)
After shipping, you send the documents through your bank to the buyer's bank. The buyer's bank releases them only when the buyer pays. Because the buyer needs the original bill of lading to collect sea cargo, they cannot take the goods without paying.
The risk is that the buyer may refuse to pay or simply not turn up. Your goods are then sitting at a foreign port, running up storage charges, and you must find another buyer or bring them back. Banks only handle the documents in this method; they do not guarantee payment.
4. Documents against Acceptance (D/A)
This works like D/P, except the buyer receives the documents by signing a promise to pay on a future date, for example 60 days later. The buyer gets the goods first and pays later.
You are giving credit to the buyer, and if they do not pay on the due date, the goods are already gone. Use D/A only with buyers you know well, and preferably with credit insurance.
5. Open account
You ship the goods and send the documents directly to the buyer, who pays after an agreed period. It is the easiest method for the buyer and the riskiest for the exporter. Large retail chains often insist on it, and it is normal between companies with a long trading history. It is not suitable for a first order with an unknown buyer.
How to reduce payment risk
A few habits protect you, whichever method you use.
- Check the buyer before agreeing terms: website, company registration, trade references and time in business
- Consider export credit insurance from ECGC, which covers non-payment for commercial and political reasons
- Start with a small trial order so that any loss is limited
- Put the payment term, currency, bank details and due dates in a written contract or proforma invoice
- Confirm any change of bank details by phone, because email fraud is common in international trade
Rules to know as an Indian exporter
Export proceeds must come into India through a bank authorised to deal in foreign exchange, and within the time limit set by the Reserve Bank of India. Ask your bank for the current limit, as it is revised from time to time. Once the money arrives, your bank issues an e-BRC, which you need for incentive claims.
The exchange rate can move between the day you quote and the day you are paid. For larger orders, ask your bank about a forward contract to lock in the rate.
What should you use for a first order?
For a first deal with a new buyer, ask for an advance, at least in part, or a Letter of Credit at sight. Move to D/P once a few shipments have gone smoothly, and consider credit terms only when the relationship is established and insured. A buyer who refuses every secure option on a first order is a risk worth walking away from.
This article is general information for readers starting out. Rules, fees and procedures change, so confirm the current requirements with the relevant authority, your bank or a qualified adviser before acting.