developmental and foreign policy reasons. Under the AID Development Assistance Program funds are available at rates of 2 and 3 percent over 40 years. The AID Economic Development Fund also has funds at similar interest rates. Generally, these funds are available through invitations to bid through the Commerce Daily Bulletin, a publication available from the Government Printing Office, Washington, DC 20402; phone: (202) 712-0600; fax (202) 216-3524; e-mail: inquiries@
usaid.gov; Web site: www.usaid.gov.
The International Development Cooperation Agency (IDCA)
This organization sponsors a Trade and Development Program (TDP), and loans funds on an annual basis so that friendly countries can pro- cure foreign goods and services for major development projects. Often, these funds support smaller firms in subcontract positions.
• Shipping risks. Risk of damage and/or loss at sea or via other transportation.
Most risks allow for a method of avoidance. Of course, there is no insurance for such problems as disputes over quality or loss of markets resulting from competition, but there are management instruments for three aspects of risk: not being paid, loss or damage, and foreign exchange exposure.
Avoidance of Commercial Risk
The sellerwould like to be certain that the buyer will pay on time once the goods have been shipped. The goal is to at least minimize the risk of nonpayment. On the other hand, the buyerwants to be certain the seller will deliver on time and that the goods are exactly what the buyer ordered.
These concerns are most often heard from anyone beginning an import /export business. Mistrust across international borders is natu- ral; after all, there is a certain amount of mistrust even in our own cul- ture. Two keys to risk avoidance is a check of the buyer’s credit rating and reputation, as well as a well-written sales contract. In Chapter 3 you learned that an early step in the process of international trade is to gain contract agreement with your overseas business associate. This should include the method of payment.
Getting Paid
Ensuring prompt payment worries exporters more than any other fac- tor. The truth is that the likelihood of a bad debt from an international customer is very low. In the experience of most international business people, overseas bad debts seldom exceed 0.5 percent of sales. The rea- son is that in overseas markets, credit is still something to be earned as a result of having a record of prompt payment. Use common sense in extending credit to overseas customers, but don’t use tougher rules than you use for your domestic clients.
The methods of payment, in order of decreasing risk to the seller are: open account, consignment, bank drafts (time draft, sight draft),
authority to purchase, letter of credit, and cash in advance. Table 5.1 summarizes and compares the various methods of payment in order of decreasing risk to the exporter and increasing risk to the importer.
Other useful methods that enable paperless trading between companies are Electronic Data Interchange, or EDI (www.EDI.com); Swift (www.swift.com); and Bolero (www.bolero.net).
Open Account
The open accountis a trade arrangement in which goods are shipped to a foreign buyer without guarantee of payment. Though the riskiest, many firms that have a long-standing business relationship with the same overseas firm use this method. Needless to say, the key is to know your buyer and your buyer’s country. You should use an open account when the buyer has a continuing need for the seller’s product or service. Some experienced exporters say that they deal only in open accounts. But they Table 5.1 Comparison of Various Methods of Payment
(In order of decreasing risk to exporter and increasing risk to importer) Goods
Available Usual Time Exporter Importer
Method to Buyers of Payment Risk Risk
Open account Before payment As agreed Most: relies Least on importer
to pay account
Consignment Before payment After sold Maximum: Minor inventory exporter cost
retains title
Time draft Before payment On maturity High: relies on Minimal check of draft importer to of quantity/
pay draft quality Sight draft After payment On presenting If unpaid, goods Little if
draft to are returned/ inspection importer disposed report required Authority to After payment On presenting Be careful of Little if
purchase draft recourse inspection
report required Letter of After payment When documents None None if
credit are available inspection
after shipment report required
Cash After payment Before shipment Least Most
always preface that statement by saying that they have close relationships and have been doing business with those overseas clients for many years. An open account can be risky unless the buyer is of unquestioned integrity and has withstood a thorough credit investigation. The advan- tage of this method is its ease and convenience, but with open-account sales, you bear the burden of financing the shipment. Standard practice in many countries is to defer payment until the merchandise is sold, sometimes even longer. Therefore, among the forms of payment, open- account sales require the greatest amount of working capital. In addi- tion, you bear the exchange rate if the sales are quoted in foreign currency. Nevertheless, competitive pressures may force the use of this method.
H O T T I P
R
elationships between buyer and seller make the difference by reducing mistrust. Make an effort to meet and get to know your trading partner.Consignment
The seller (consignor) retains title to the goods during shipment and storage of the product in the warehouse or retail store. The consignee acts as a selling agent, selling the goods and remitting the net proceeds to the consignor. Like open-account sales, consignment sales can also be risky, and they lend themselves to only certain kinds of merchandise.
Great care should be taken in working out this contractual arrange- ment. Be sure it is covered with adequate risk insurance.
Bank Drafts, Time Drafts, and Sight Drafts
Payment for many sales is arranged using one of many time-tested banking methods. Bank drafts(bills of exchange), time drafts, and sight draftsare each useful under certain circumstances.
Bank Drafts Bank drafts are simply written orders that activate payment either at sight or at “tenor,” which is a future time or date. A bank
draft is a check, drawn by a bank on another bank, used primarily where it is necessary for the customer to provide funds payable at a bank in some distant location. The exporter who undertakes this payment method can offer a range of payment options to the overseas customer.
Time (Date) Draft This is an acceptance order drawn by the exporter on the importer (customer), payable a certain number of days after “sight” (presentation) to the holder. Think of it as nothing more than an IOU, or promise to pay in the future.
Documents such as negotiable bills of lading, insurance certifi- cates, and commercial invoices accompany the draft and are submit- ted through the exporter’s bank for collection. When presented to the importer at the bank, the importer acknowledges that the docu- ments are acceptable and commits to pay by writing “accepted” on the draft and signing it. The importer normally has 30 to 180 days depending on the draft’s term to make payments to the bank for transmittal.
Sight Draft This is similar to the time draft except that the importer’s bank holds the documents until the importer releases the funds. Sight drafts are the most common method employed by exporters throughout the world. Sight drafts are nothing more than a written order on a standardized bank format requesting money from the overseas buyer. While this method costs less than the letter of credit (defined below), it has greater risk because the importer can refuse to honor the draft.
Bill of lading.A document that provides the terms of the contract between the shipper and the transportation company to move freight between stated points at a specified charge.
Commercial or customs invoice.A bill for the goods from the seller to the buyer. It is one method used by governments to determine the value of the goods for customs valuation purposes.
At sight.Indicates that a negotiable instrument is to be paid upon presentation or demand.
Authority to Purchase
This method is occasionally used in the Far East. It specifies a bank where the exporter can draw a documentary draft on the importer’s bank. The problem with this method is that if the importer fails to pay the draft, the bank has “recourse” to the exporter for settlement. If an exporter consents to this method, it is suggested that the authority to purchase specify “without recourse” and so state on drafts.
The major risk with the time, sight, and authority to purchase meth- ods is that the buyer can refuse to pay or to pick up the goods. The method of avoidance is to require cash against documents. Unfortu- nately, this method is slow because banks are slow in transferring funds because they want to use the time float (short-term investment of bank money) to earn interest. Using a wire transfer can get around this.
Letters of Credit (L/C)
Ideally an exporter would deal only in cash, but in reality, few business people are initially able or willing to do business under those terms.
Because of the risk of non-payment resulting from insolvency, bankruptcy, or other severe deterioration, procedures and documents have been devel- oped that help to ensure that foreign buyers honor their agreements.
The most common form of collection is payment against a letter of credit(L/C). The L/C is the time-tested method in which an importer’s bank guarantees that if all documents are presented in exact conform- ity with the terms of the L/C, it will pay the exporter. The procedure is not difficult to understand, and most cities have banks with persons familiar with L/C’s mechanics.
This method is well understood by traders around the world, is sim- ple, and is as good as your bank. Internationally the term documentary creditsis synonymous with the term letter of credit. They involve thou- sands of transactions and billions of dollars every day in every part of the world. They are almost always operated in accordance with the Uniform Customs and Practice for Documentary Credits of the Inter- national Chamber of Commerce, a code of practice that is recognized by banking communities in 156 countries. A Guide to Documentary Operations, which includes all the standard forms, is available from ICC Publishing Corporation, Inc., 156 Fifth Avenue, Suite 417, New York,
NY 10010; phone: (212) 206-1150; fax: (212) 633-6025; e-mail pub@
iccwbo.org; Web address: www.iccbooks.com.
An L/C is a document issued by a bank at the importer’s or buyer’s request in favor of the seller. It promises to pay a specified amount of money upon receipt by the bank of certain documents within a speci- fied time or at intervals corresponding with shipments of goods. It is a universally used method of achieving a commercially acceptable com- promise. Think of a letter of credit as a loan against collateral wherein the funds are placed in an escrow account. The amount in the account depends on the relationship between the buyer and the buyer’s bank.
Typically, if you don’t already have an account, the bank will require 100 percent collateral. With an account, the bank will establish a line of credit against that account. For instance, if you have $5,000 in your account and the transaction is expected to cost $1,000, your account will be reduced to $4,000 and the line of credit will be established as $1,000.
Commercial letter of credit charges are competitive, so you should comparison shop. Typically they are like those shown in Table 5.2.
Table 5.2 Typical Letters of Credit Charges
Type of Credit Typical Charges
Import and domestic 1⁄8of 1% of transaction with a minimum of $75 to $100 Amendments:1⁄8of 1% flat, minimum $70
Payment fee: 1⁄4of 1% flat, minimum $90 per draft
Acceptance fee: Per annum fee (360-day basis), minimum $75 for each draft accepted
Discrepancy fee: $40
Export Advising: $60
Confirmation: Subject to country risk conditions, minimum $75 Amendments: $55
Assignment of proceeds/transfers: 1⁄8of 1% of the transaction with a minimum of $75
Discrepancy fee: $45
Payment/negotiation: 1⁄10of 1%, minimum $85–$95.
Standby letters Issuance fee: An annual percentage (360-day basis) based on credit risk considerations, minimum $250
Amendment fee: Risk-related fee is charged, minimum $250 Payment fee: 1⁄4of 1% flat, minimum $90 per draft
Collections—documentary Incoming: sight, $75; time, $95 Outgoing: sight, $75; time, $95
Standby L/Cs Sometimes when dealing with an open account, the exporter requires a standby L/C.This means just what the name implies;
the L/C is not to be executed unless payment is not made within the specified period, usually 30–60 days. Bank handling charges for standby L/Cs are usually higher than those for a commercial (import) L/C.
Issuing, Confirming, and Advising Banks Letters of credit are payable either at sightor on a timedraft basis. Under a sight L/C, the issuing(buyers) bank pays, with or without a draft, when it is satisfied that the presented documents conform to the conforms. An advising bank (most often the confirmingor seller’s bank) informs the seller or beneficiary that an L/C has been issued. Under a time (acceptance) L/C, once the associated draft is presented and found to be in exact con- formity, the draft is stamped “accepted” and can then be negotiated as a “banker’s acceptance” by the exporter, at a discount to reflect the cost of money advanced against the draft.
Once the buyer and the seller agree that they will use an L/C for payment and they have worked out the conditions, the buyer or importer applies for the L/C to his or her international bank. Figure 5.1 is an example of a letter of credit application.
Types of L/Cs There are two types of letters of credit: revocable and irrevocable. Revocable credit means that the document can be amended or canceled at any time without prior warning or notification of the seller. Irrevocablesimply means that the terms of the document can be amended or canceled only with the agreement of all parties.
Confirmation means that the U.S. bank guarantees payment by the foreign bank.
Using the application as its guide, the bank issues a document of credit incorporating the terms agreed to by the parties. Figure 5.2 is an example of an L/C.
Figure 5.3 shows the three phases of documentary credit in their simplest form. In Phase I, your (issuing) bank notifies the seller through an advisingbank or the seller’s (confirming) bank that a credit has been issued. In Phase II, the seller then ships the goods and presents the documents to the bank, at which time the seller is paid. Phase III is the settlement phase in which the documents are then transferred to the buyer’s bank, whereupon the buyer pays the bank any remaining
Figure 5.1 Request to Open a Letter of Credit (L/C)
To: Importer’s international bank
Request to open documentary credit (commercial letter of credit and security agreement) Date __________
We undertake to execute the Bank’s usual form of indemnity.
Type of Credit: Irrevocable, i.e., cannot be canceled without beneficiary’s agreement.
Revocable , i.e., subject to cancellation.
Method of Advice: [ ] Airmail [ ] E-mail/FAX, short details [ ] E-mail/FAX, full details
Beneficiary’s bank: _______________________________________
In favor of beneficiary: Company name and address.
Amount or sum of:
Availability: Valid until _______in_______ for negotiation/date place acceptance/payment.
This credit is available by drafts drawn at _____ sight/
accompanied by the required documents.
Documents Invoice in three copies.
required: Full set “clean on board” bills of lading to order of shipper, blank endorsed. In case movement of goods involves more than one mode, a “Combined
Transport Document” should be called for.
Negotiable Marine and War risk insurance for % (usually 110%) of invoice value covering all risks.
Please open for my/our account a documentary credit (letter of credit) in accordance with the undermentioned particulars.
We agree that, except so far as otherwise expressly stated, this credit will be subject to the Uniform Customs and Practice for Documentary Credits, ICC Publication #290.
(Continued)
monies in exchange for the documents. Thus, on arrival of the goods, the buyer or importer has the proper documents for entry.
Special Middleman Uses of Letters of Credit
There are three special uses of commercial letters of credit for the import /export middleman: transferable, assignment of proceeds, and back-to-back L/Cs. Figure 5.4 compares the risks involved with using each method.
Transferable L/C Figure 5.5 shows pictorially how the transfer- able L/Cworks. The buyer opens the L/C, which states clearly that it is transferable, on behalf of the middleman as the original beneficiary who in turn transfers all or part of the L/C to the supplier(s). The transfer must be made under the same terms and conditions as those in the Figure 5.1 (Continued)
Certificate of Inspection Other
Documents: Certificate of origin issued by Chamber of Commerce in three copies.
Packing List Quantity and
description of goods Price per unit:
Terms and relative port
or place: CIF/C&F/FOB/FAS/__________________________
Place ____________________________________________________
Dispatch/
Shipment From ___________________ to ________________
Special Instructions (if any):
original L/C with the following exceptions: amount, unit price, expira- tion date, and shipping date. In this instance the buyer and supplier are usually disclosed to each other.
Assignment of Proceeds The assignment of proceeds method is shown in Figure 5.6; Figure 5.7 shows a typical letter of assignment.
Figure 5.2 Sample Letter of Credit (L/C)
Name of issuing bank Documentary Credit No. ______
Place and date of issue Place and date of expiration
Applicant Amount
Credit available with
[ ] Payment [ ] Acceptance [ ] Negotiation
Shipment from _________ Against presentation of Shipment to ____________ documents detailed herein
[ ] Drawn on _______________
Bank Invoice in three copies
Full set “clean on board” bills of lading to order of shipper, blank en- dorsed. In case movement of goods involves more than one made, a
“Combined Transport Document” should be called for.
Negotiable Marine and War risk insurance for ________________%
(usually 110%) of invoice value covering all risks.
Certificate of Inspection
Certificate of origin issued by Chamber of Commerce in three copies.
Packing List
Documents to be presented within _______ days after date of issuance of the shipping document(s) but within the validity of the credit.
We hereby issue this Documentary Credit in your favor.
Issuing Bank
Note that the proceeds of all letters of credit may be assigned. In this instance the buyer opens the L/C as the beneficiary and relies on the middleman to comply so that the beneficiary can be paid. Any discrep- ancy in middleman documents will prevent payment under the L/C.
Figure 5.3 The Three Phases of a Letter of Credit (L/C)
Phase I: Issuing a Credit
Buyer
Makes credit application Seller
Informs seller credit has been
issued
Issuing bank Advise/
confirm bank
Contract 1
Credit 3
4 2
Phase II: Presentation
Buyer
Money Seller
Documents
Issuing bank Advise/
confirm bank
Goods 5
Documents 8 6 7
9 Money Phase III: Settlement
Buyer
Documents Seller
Money
Issuing bank Advise/
confirm bank
Goods 11
10