When determining the terms of payment, the contract usually establishes: the currency of payment, the payment term, the method of payment and the form of settlement, as well as reservations for reducing or eliminating currency risk.
At the conclusion of the contract of sale, it is established in which currency the payment for the goods will be made (the currency of the country of the exporter, importer or third country). The currency in which payment for the goods is made is called the currency of payment. It may coincide with the currency of the price of the goods, and may not coincide. In the latter case, the contract establishes the procedure for converting the currency of the price into the currency of payment. In particular, the exchange rate of which money market (the country of the exporter, importer or third country), the type of means of payment (telegraph or postal transfer), the rate of the seller, the buyer or the average between them will be used for settlements between counterparties. Usually, the translation of the price currency into the payment currency is carried out at the rate in force in the country, where the payment is made. When choosing a currency rate, not only its profitability when transferring to the counterparty’s currency is taken into account, but also the degree of reversibility of the currency, i.e. its exchange for the counterparty’s currency.
The parties usually set specific payment terms in the contract. If the deadlines are not set directly or indirectly, the trade customs adopted in the practice of international payments come into force. For example, payment is usually made a certain number of days after the buyer’s seller has notified that the goods have been placed at his disposal; under other terms of delivery – a certain number of days after the seller notified the buyer of the shipment of the goods.
The method of payment determines when payment is made for the goods in relation to their actual delivery. The main payment methods are cash payment, advance payment and credit payment.
Cash payment is made through the bank before or after the exporter transfers the documents of title or the goods themselves to the buyer. Cash payment provides for payment of the goods in full value in the period from their readiness for export to the transfer to the disposal of the buyer. It can be carried out simultaneously and in parts.
Cash payment one-time involves payment of the full cost of the goods according to one of the following conditions: upon receipt of a telegraph notification of the exporter about the readiness of the goods for shipment; upon receipt of a telegraph notification from the master of the vessel of the completion of loading the goods on board the vessel at the port of departure; against the delivery to the importer of a set of commodity documents listed in the contract; against the delivery of a set of commodity documents with the provision of several preferential days and hours for payment. In this case, the exporter usually requires the importer to provide a bank guarantee against the acceptance of the goods by the importer at the port of destination.
These conditions are given in a certain sequence from the point of view of the interests of the exporter. The most profitable for the exporter is the first condition, for the importer – the last.
Cash payment in instalments involves making payments in several installments in accordance with the terms of the contract, for example, according to the terms of delivery, as soon as the goods are ready for shipment, etc.
Cash payment in installments, depending on the terms of delivery, provides for the payment of the main part of the payment (from 80 to 95%) after the shipment of goods or delivery of shipping documents and the remaining part – after acceptance of the goods by the importer or after the expiration of the warranty period.
Cash payment in instalments as soon as the goods are ready for shipment provides for the payment of certain amounts agreed in the contract (in the form of a certain percentage of the total amount of payment due) as the individual parts of the order are executed. Cash payment in installments is most often used in the supply of large expensive equipment with a long production time, as well as sea vessels.
Payment in advance provides for the payment by the importing buyer to the supplier-exporter of the amounts agreed in the contract against the payments due under the contract before the goods are placed at his disposal, and most often before the start of the execution of the order.
Advance payment can be provided in cash and commodity forms. Advance payment in commodity form is the provision by the customer-importer to the exporter of raw materials or component parts necessary for the manufacture of the ordered equipment (form of lending by the importer of the exporter). The cash advance is determined as a percentage of the total value of the order placed (a means of securing the buyer’s obligations under the contract). The amount of the advance payment can be from 5-10% of the order value to the full amount of the contract. Usually, the advance payment is provided either by a guarantee of the exporter’s bank or by a clause in the contract that in case of failure by the exporter to fulfill the terms of the contract, the advance payment is returned to the importer in full.
In the practice of international trade, advances are most often issued to reputable firms that have proven themselves in the supply of goods with long production times according to individual specifications, as well as in the supply of scarce goods.
Payment on credit provides for the settlement of the transaction on the basis of a firm (commercial) loan provided by the exporter to the importer.
By terms, branded loans are divided into: short-term (up to 1 year), medium-term (up to 5, sometimes up to 10 years) and long-term (over 5 or 10 years). Medium- and long-term loans are provided, as a rule, for the supply of industrial equipment, ships and are usually guaranteed by government authorities or banks of the exporting country. Branded loans are provided in two forms: commodity and monetary. Sometimes there is a combination of these two forms. The provision of a loan in commodity form is most often carried out by deferring or installment payment. When issuing a loan in cash, the contract stipulates in detail its terms: the cost of the loan, determined in percent per annum, the term of use of the loan, the loan repayment period, the grace period during which interest is not repaid on the loan, etc. Medium-term and long-term loans in cash are most often provided subject to the issuance of an advance by the buyer and payment of part of the order in cash.
Loans are also repaid in cash and commodity form. In recent years, transactions have become widespread, providing for the payment of a loan provided by the exporter in the form of supplies of equipment of a complete enterprise for the development of raw materials of the importing country, supplying part of the products (in the amount of 20 – 40%) produced at the built enterprise. These deals are called “production sharing” deals.
The forms of settlement used in trade with foreign partners are very diverse and are associated with the use of various types of bank and credit means of payment. Cash marks are not usually used in international commercial transactions.
The main forms of payment are: cash collection, letter of credit, on an open account, by telegraph and postal transfers, cheque, fun. The vast majority of settlements on international commercial transactions are carried out in cash collection and letter of credit forms. All of these forms of calculation are closely interrelated and often intertwined.
The collection form of payment or collection of commodity documents (English – collection of payment, French – encaissement; German – -Inkasso) involves the transfer by the exporter of an order to his bank to receive from the importer a certain amount of payment against the presentation of the relevant shipping documents, as well as bills, checks and other documents to be paid.
Cash collection operation consists of the following stages:
1) the exporter shall transmit to his bank the collection order and the shipping documents attached to it;
2) the exporter’s bank that has accepted the collection order shall send it together with the shipping documents to the correspondent bank in the importer’s country;
3) the correspondent bank in the importer’s country shall present shipping documents to the importer-payer and issue them to him against the payment amount specified in the collection order;
4) the payment amount received from the importer shall be transferred by the importer’s bank to the account of the exporter’s bank, and this bank shall credit it to the exporter’s account.
When selling goods on credit, the exporter attaches to the collection order an urgent draft (bill of exchange) issued in the name of the importer or to the bank that agreed to accept it. Commodity documents are issued to the importer against the acceptance of the draft. The accepted draft is sent to the exporter through his bank. In practice, it is not uncommon for the importer’s bank to issue commodity documents to the importer before they are paid (so that he can receive the arrived goods), taking on the risk of non-payment. For this, the bank charges a fee from the importer.
The collection form of payment is convenient for the exporter, as it gives him a guarantee that the goods will not be placed at the disposal of the buyer until he has made its payment. At the same time, it has two significant drawbacks for the exporter: firstly, the postponement of payment by the exporter (the interval between the shipment of goods and the presentation of documents to the bank and the receipt of currency) and, secondly, the importer may refuse to pay (from the redemption of shipping documents) or be insolvent by the time the importer’s bank receives shipping documents.
In order to eliminate these shortcomings and speed up the collection operation, the following conditions apply in practice:
– payment by the importer of the goods is made against the telegraph notification of the exporter’s bank about the acceptance of shipping documents for collection and their sending to the importer’s bank;
– payment is made by a third party (usually a bank) at the expense of the importer’s funds on deposit. In this case, the bank assumes responsibility to the exporter for the timely and proper payment of the shipping documents submitted by him;
– provision by the importer of the bank’s guarantee of payment within a certain amount or sending the goods by the exporter to the bank.
Letter of credit form of payment. A letter of credit (French: lettre de credit; German: Akkreditiv) is an obligation of a bank to make a payment to the exporter in the amount of the value of the delivered goods against the documents submitted by the exporter at the direction and at the expense of the buyer-importer.
The operation with a letter of credit, as well as a collection operation, consists of four stages:
1) the importer shall, for an agreed number of days before the start of delivery or after receiving the exporter’s notification of the readiness of the goods for shipment, instruct his bank to open a letter of credit in the exporter’s bank (or in another agreed bank) for a certain amount and for a specified period in favor of the exporting supplier. In the order to open a letter of credit, the importer informs the bank of the list of documents upon presentation of which the exporter can be paid the amounts from the letter of credit;
2) the importer’s bank shall open a letter of credit with the exporter’s bank (or in another agreed bank), after which the exporter’s bank shall notify the exporter of its opening and, if necessary, confirm the letter of credit. If during the term of the letter of credit it is not used, with the consent of the buyer or under the terms of the contract, the letter of credit may be extended (prolonged) for a certain period or withdrawn by the buyer;
3) the exporter, having shipped the goods, presents to the bank in which the letter of credit is opened documents certifying the delivery of the goods, the list of which is contained in the contract, and receives the due amount of payment against these documents;
4) the exporter’s bank shall send the commodity documents to the importer’s bank, and the importer shall hand them over to the importer, who shall reimburse him for the amount of the letter of credit.
Depending on the conditions, the following types of letters of credit are distinguished: confirmed and unconfirmed, revocable and irrevocable, divisible and indivisible, renewable.
The confirmed letter of credit contains the obligation of the bank in which the letter of credit is opened to pay the exporter the amount of payment due, regardless of whether he will receive compensation from the bank of the importer who opened the letter of credit.
An unconfirmed letter of credit does not contain the above obligation. In this case, the exporter’s bank pays the exporter only if the importer’s bank transfers the appropriate amount to it under the letter of credit.
A revocable letter of credit may be canceled (revoked) ahead of schedule at the direction of the importer or independently by the bank that opened it, in the event of a deterioration in the financial situation of the importer and concerns about payment of shipping documents. A revocable letter of credit is very rare in practice, as it is unprofitable for the exporter.
An irrevocable letter of credit may not be canceled (revoked) or modified by the importer’s bank before the deadline without the consent of the exporter in whose favor it is opened. An irrevocable letter of credit is an obligation of the bank that opened it and guarantees the exporter the payment of the amounts due to him.
The divisible letter of credit provides for the payment to the exporter of certain amounts agreed in the contract after each partial delivery.
An indivisible letter of credit assumes that the full amount due to the exporter will be paid upon completion of all deliveries. Such a letter of credit is usually used for the supply of technologically closely coupled equipment in separate batches, when the lack of delivery of one or more batches makes it impossible to use previously delivered equipment. An indivisible letter of credit protects the interests of the buyer.
For the exporter, the most interesting is the irrevocable, confirmed, divisible letter of credit.
A revolving (revolver) letter of credit assumes that, within the total period of use of the letter of credit, its amount is restored as soon as the importer reimburses the bank that opened the letter of credit produced under it to the exporter. Payments of such a letter of credit are usually used when the importer makes regular purchases of goods from the exporter or when there is a periodic delivery of certain consignments of goods at agreed intervals.
The letter of credit form of payment has certain advantages over the collection form. For the exporter, they consist, firstly, in a guarantee of payment for the shipped goods by the bank that opened the letter of credit, and with a confirmed letter of credit – also by the bank that confirmed it; secondly, in the receipt of payment immediately after the delivery of the goods and the presentation to the bank of shipping documents confirming this delivery.
The importer, in turn, has a guarantee that the payment will be made in favor of the exporter only after the latter presents shipping documents certifying the shipment of goods.
Settlement on an open account (French: compte ouvert; German: offenes Konto) involves the submission by the exporter to the importer of shipping documents, bypassing the bank, and the transfer by the importer of the amounts of payment due to the exporter to the open account within the terms specified in the contract (monthly, quarterly, by half-year). Settlement on an open account is one of the forms of commercial credit. This form of calculation is usually used between firms that are in long-term business relations and carry out deliveries systematically, in small batches; between the parent company and its overseas subsidiaries; with intermediary firms in the implementation of commission and consignment operations. Calculation by telegraph and postal transfers (English – remittance; French – remise; German – Geldanweisung) involves the transfer by the transferor of an order to the bank to transfer a certain amount of payment in favor of the transferee. The bank that accepted such an order shall execute it through its correspondent, who is located in the country of the transferee. The settlement of the transfer is considered to be made after the currency is issued to the recipient or when it is credited to his account. This form of calculation is usually used in cases where the provision of currency to the transferee is not associated with any conditions (transfer of shipping documents to the bank, etc.). Most often, the calculation by transfer is used when paying debts on loans and credits, providing advances, settling claims, returning excessively received amounts and other operations. The cheque form of calculation (English – check or cheque; French – cheque; German – Scheck) is carried out by issuing an order by the cheque writer to his bank to pay a certain amount to the cheque holder from the available funds of the cheque writer or transfer this amount to his account. A check can be transferred by one person to another by adding a transfer inscription (endorsement) to it.
There are the following types of checks: registered – issued in favor of a certain person and not subject to transfer by endorsement; order – issued by endorsement; bearer – transferred by simple transfer or endorsement.
A cheque may be issued in a foreign currency if the cheque holder has a bank account in that currency or if his bank has accounts in foreign currency with its foreign correspondents.
The promissory note form of payment is carried out by using a promissory note – simple or transferable. A promissory note is the obligation of one person (the promissory note holder) to pay a certain amount to another person (the promissory note holder) at the appointed time and in a certain place.
In the practice of international trade, a bill of exchange (English – draft, bill of exchange; French – lettre de change; German- Wechsel) is more often used. A bill of exchange is an order of one person (tracer) addressed to another person (tracer) to pay a certain amount to a third party (remittant) within the appointed period. The tracer is both a creditor to the tracerate and a debtor to the remittance. The purpose of issuing a bill of exchange is to settle both debt claims.
Reservations to reduce or eliminate currency risk – fixing the price of export goods in a more stable currency with subsequent payment in a more “soft” one; multi-currency clause providing for price adjustment in case of exchange rate change; index clause and moving price clause; conclusion of forward transactions by the bank at the request of the applicant.