Methods of International Trade Settlement

1. Methods of International Trade Settlement
Prepared by:
Mr. Mohammed Jasir PV
Asst. Professor
MIIMS, Puthanangadi
Contact No: 9605 69 32 66

2. Introduction
• The exporter that prepares the goods and gets them ready for dispatch, as
agreed with the importer, has to think of the payment terms and a financing
program, as he/she will experience serious difficulties if he/she is not paid.
• Therefore, it is necessary for the exporter to have sufficient information about
the different methods of payment available to him/her
• The main payment methods in foreign trade are
– Cash In Advance
– Open Account
– On Consignment
– Draft Or Documentary Collection
– Letter Of Credit

3. 1. Cash in Advance or Advance Payment Method
• This method allows the buyer to pay cash in advance to the seller
• “Payment before shipment”
• Payment does not guarantee the shipment or delivery of the goods
from the seller
• Risk-free for exporter and risk on the buyer
• Cash in advance is usually a wire transfer or a cheque

4. 1. Cash in Advance
• Cash in advance clearly is risk-free except for consequences associated with the
potential non delivery of the goods by the seller
• Cash in advance is usually a wire transfer or a check
• The Cash in Advance or Advance Payment method allows the buyer to pay cash in
advance to the seller
• Paying in advance gives the greatest protection for the seller and puts the risk on
the buyer
• Payment does not guarantee the shipment or delivery of the goods from the seller
• Therefore, the buyer will rarely pay cash up front before receiving an assurance that
the goods will be shipped and that the quality and quantity of the goods ordered
will be delivered.

5. • Although an international wire transfer is more costly (from U.S. $15 to more than
U.S. $100), it is often preferred because it is speedy and does not bear the danger of
the check not being honoredf
• The check can be at a disadvantage if the exchange rate has changed significantly by
the time it arrives, clears and is credited. On the other hand, the check can make it
easier to shop for a better exchange rate between different financial institutions

6. • For wire transfers the seller must provide clear routing instructions in writing to the
buyer or the buyer's agent.
• These include:
• The full name, address, telephone, and telex of the seller's bank
• The bank's SWIFT and/or ABA numbers
• The seller's full name, address, telephone, type of bank account , and account
number.
No further information or security codes should be offered.

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9. 2. Open Account
• It means that payment is agreed on a future date
• For example, payment could be due 14, 30, or 60 after shipment
• “Payment after shipment”
• It is one of the most common methods
• Many large companies will only buy on open account
• Payment is usually made by wire transfer or cheque
• Very risky for seller (unless long and favorable relationship)

10. 2. Open Account
• It means that payment is left open to an agreed-upon future date
• It is one of the most common methods of payment in international trade
and many large companies will only buy on open account
• Payment is usually made by wire transfer or check
• This can be a very risky method for the seller unless he has a long and
favorable relationship with the buyer or the buyer has excellent credit.

11. • Still, there are no guarantees and collecting delinquent payments is difficult and
costly in countries especially considering that this method utilizes few official and
legally binding documents.
• Contracts, invoices, and shipping documents will only be useful in securing payment
from a recalcitrant buyer when his country’s legal system recognizes them and
allows for reasonable (in terms of time and expense) settlement of such disputes.

12. open account
• An open account transaction means that the goods are manufactured and delivered
before payment is necessary (for example, payment could be due 14, 30, or 60
following shipment or delivery).
• The method provides great flexibility and in many countries sales are likely to be
made on an open-account basis if the manufacturer has been dealing with the
buyer over a long period of time and has established a secure working relationship.

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14. The Process of the “Open Account” Method
• The open account method is a preferred method of payment for the
importer, since it places the risk on the exporter or seller.
• This method cannot be used safely unless the buyer is credit worthy
and the country of destination is politically and economically stable.
• However, in certain instances it might be possible to discount open
accounts receivable with a factoring company or other financial
institution (LatinTrade, 1999).

16. 3. On Consignment
• In this method, the importer is called the consignee
• “Consignee” is responsible for paying for the goods when they are
sold
• “Payment after resale”
• The seller does not receive payment until the importer sells or
resells the goods
• Ownership with seller
• Very risky to the Seller and no control available to the exporter
• Obtaining sales proceeds or return of the merchandise if it is not
sold can be difficult

17. 3. On Consignment
• With consignment sales, the seller does not receive payment until the
importer sells or resells the goods
• The product stays with the importer until all the terms of the sale
have been satisfied
• In the consignment method, the importer is called the consignee and
he/she is responsible for paying for the goods when they are sold
• Consignment sales are very risky and there is no control available to
the exporter
• Obtaining sales proceeds or return of the merchandise if it is not sold
can be difficult

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20. 4. Draft or Documentary Collection
• This method is used when all other methods are not acceptable
• Here the exporter ships the goods and draws a draft or bill of exchange
on the importer through an intermediary bank
• Bill of exchange: A written order to a person requiring them to make a
specified payment to the signatory or to a named payee
• Bank as an intermediary
• “Draft – Shipment – Payment”
• The documents needed are specified before the title for the goods is
transferred

21. Parties Involved in the Documentary Collection Method
There are four parties involved
• The buyer
• Collecting/presenting bank (buyer’s bank)
• The seller
• Remitting bank (seller’s bank)

22. 4. Draft or Documentary Collection
• The Draft or Documentary collection method is employed when either
the cash in advance method is not acceptable to the buyer, or the open
account method is not acceptable to the seller
• With the Draft or Documentary Collection Method, the seller or exporter
ships the goods and draws a draft or bill of exchange on the buyer or
importer through an intermediary bank
• The draft is an unconditional order to make a payment in accordance with
certain terms
• The documents needed are specified before the title for the goods is
transferred (LatinTrade, 1999)

24. 5. Letter of Credit
• The Letter of Credit has been a keystone of international trade for many years
• It continues to play an important role in world trade today
• Why LoC is mostly using?
• Simple answer “that the seller will not ship without a bank's assurance of
payment”

25. What is a Letter of Credit?
• The Letter of Credit is a specialized, technical tool that is applied when
paying for a shipment of goods or services from one party to another
• A Letter of Credit is a document issued by a bank at the buyer’s request
in favor of the seller; it guarantees that the buyer will pay the agreed
amount of money to the seller within a specified period of time,
provided that the seller conforms to the product specifications and
document requirements of the buyer

27. The Parties
• Four Parties
• Applicant: Usually the buyer (importer)
• Beneficiary: Generally the seller (exporter)
• Issuing Bank: The Applicant’s bank
• Advising Bank: The bank, usually in the Beneficiary’s country

28. The Parties
• The parties concerned with a Letter of Credit are described below:
• Applicant: The party that organizes for the Letter of Credit to be issued, usually the
buyer (importer) in a commercial transaction or the borrower in a financial
transaction.
• Beneficiary: The party named in the Letter of Credit in whose favor the Letter of
Credit is issued, it is generally the seller (exporter) in a commercial transaction or
the creditor in a financial transaction.
• Issuing Bank: The Applicant’s bank that issues its undertaking to the Beneficiary in
the form of a Letter of Credit.
• Advising Bank: The bank, usually in the Beneficiary’s country, which informs the
Beneficiary that another bank has issued a Letter of Credit in their favor.

29. How LoC is Issuing?

30. How Payment in LoC?

33. Documentary Credits
( Letter of Credit )

34. Documentary Credits ( Letter of Credit
• Documentary credit is as assurance of payment by the bank
• It is an arrangement under which the bank, at the request of the buyer or
on its own, undertakes to make payment to the seller provided specific
Documents are submitted
• Documentary Credits are similar to bank guarantee.
• Documentary Credits in Popular Language : Letter of Credit (Lc)

35. Parties in documentary credits
• Applicant of Letter of Credit
• LC Issuing Bank
• Beneficiary party
• Advising Bank
• Second Beneficiary
• Confirming Bank
• Negotiating Bank
• Reimbursing Bank

36. Types of Letter of Credit
 Irrevocable LC
 Revocable LC
 Confirmed / Advised LC
 Unconfirmed LC
 Transferable LC
 Stand-by LC
 Back to Back LC
 Payment at Sight LC
 Deferred Payment LC
 Red Clause LC

37. • Irrevocable LC. This LC cannot be cancelled or modified without consent of the
beneficiary (Seller).This LC reflects absolute liability of the Bank (issuer) to the other
party.
• Revocable LC. This LC type can be cancelled or modified by the Bank (issuer) at the
customer's instructions without prior agreement of the beneficiary (Seller). The
Bank will not have any liabilities to the beneficiary after revocation of the LC.

38. • Confirmed and unconfirmed/Advised letters of credit
– When a buyer arranges a letter of credit they usually do so with their own bank,
known as the issuing bank. The seller will usually want a bank in their country to
check that the letter of credit is valid.
– For extra security, the seller may require the letter of credit to be confirmed by
the bank that checks it. By confirming the letter of credit, the second bank
agrees to guarantee payment even if the issuing bank fails to make it. So a
confirmed letter of credit provides more security than an unconfirmed one.
– In case of unconfirmed LC, the advising bank forwards an unconfirmed letter of
credit directly to the exporter without adding its own undertaking to make
payment or accept responsibility for payment at a future date, but confirming its
authenticity

39. • Stand-by LC. This LC is closer to the bank guarantee and gives more flexible
collaboration opportunity to Seller and Buyer. The Bank will honour the LC when the
Buyer fails to fulfill payment liabilities to Seller.
• Back-to-Back LC. This LC type considers issuing the second LC on the basis of the
first letter of credit. LC is opened in favor of intermediary as per the Buyer's
instructions and on the basis of this LC and instructions of the intermediary a new
LC is opened in favor of Seller of the goods.

40. • Transferable letters of credit
– A transferable letter of credit can be passed from one beneficiary (person
receiving payment) to others. They’re commonly used when intermediaries are
involved in a transaction.
• Stand-by LC
– A standby letter of credit is like a guarantee that is used as support where an
alternative, less secure, method of payment has been agreed.
– It is an assurance from a bank that a buyer is able to pay a seller. The seller
doesn't expect to have to draw on the letter of credit to get paid.

41. • Revolving LC
– The revolving credit is used for regular shipments of the same commodity to
the same importer.
– It can revolve in relation to time or value.
– If the credit is utilised it is re-instated for further regular shipments until the
credit is fully drawn.
– If the credit revolves in relation to value once utilised and paid the value can
be reinstated for further drawings.
– Revolving letters of credit are useful to avoid the need for repetitious
arrangements for opening or amending letters of credit.

42. • Back to Back LC
– A back-to-back letter of credit can be used as an alternative to the transferable
letter of credit. Rather than transferring the original letter of credit to the
supplier, once the letter of credit is received by the exporter from the opening
bank, that letter of credit is used as security to establish a second letter of credit
drawn on the exporter in favor of his importer.
– Many banks are reluctant to issue back-to-back letters of credit due to the level
of risk to which they are exposed, whereas a transferable credit will not expose
them to higher risk than under the original credit
– This LC type considers issuing the second LC on the basis of the first letter of
credit. LC is opened in favor of intermediary as per the Buyer's instructions and
on the basis of this LC and instructions of the intermediary a new LC is opened in
favor of Seller of the goods.

43. • Payment at Sight LC. According to this LC, payment is made to the seller
immediately (maximum within 7 days) after the required documents have been
submitted.
• Deferred Payment LC. According to this LC the payment to the seller is not made
when the documents are submitted, but instead at a later period defined in the
letter of credit. In most cases the payment in favor of Seller under this LC is made
upon receipt of goods by the Buyer.

44. • Red Clause LC. The seller can request an advance for an agreed
amount of the LC before shipment of goods and submittal of required
documents. This red clause is so termed because it is usually printed in
red on the document to draw attention to "advance payment" term of
the credit.

45. Thank You..