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Advantages & Disadvantages of Payment Methods
Transcript of Advantages & Disadvantages of Payment Methods
Payment Methods Advantages and Disadvantages Effective Payments Common Payments Clearing payments Effective Commercial Noncommercial P.O. Encashment Credit Check Common CIA L/C Draft Open
Account Other Case Study I Case Study II Simple cash payment Cash against Documents Advantages Disadvantages Relatively simple
No blocked funds
Financial liquidation is „heavy
It does not assure the creditor he will be paid back The payment orders can be:
- Simple by letter, telegramme, telex or phone;
- Simple unconditioned: the payment will be effected by the bank no documents being requested;
- Simple conditioned: the payment is effected against the presenation of some documents justyfying the payment and the identity of the persons or enterprises written down in the documents. A cheque or check (American English) is a document (usually a piece of paper) that orders a payment of money. The person writing the cheque, the drawer, usually has a chequing account where their money is deposited. The drawer writes the various details including the money amount, date, and a payee on the cheque, and signs it, ordering their bank, know as the drawee, to pay this person or company the amount of money stated. 1.Cash in advance/Prepayment occurs when a buyer sends payment in the agreed currency and through agreed method to a seller before the product is manufactured and/or shipped. Upon receipt of payment this seller then ships the goods and all the necessary shipping and commercial documents directly to the buyer. ADVANTAGES DISADVANTAGES -Few arrangements have to be made other than ensuring that funds are available to meet payments when they are due;
-The importer has the control over the timing of settlement and the method by which funds are remitted;
-Inspection of goods is usually possible before payment is made.
The risks of the exporter: the goods sent can be specialized goods and if the importer cancels the order before the payment is made, the exporter cannot sell these goods easily.
The risks of the importer:
-Sometimes the exporter does not send the goods;
-The documents can be wrong;
-The goods are sent with a delay or to a wrong destination
Additional Risks - Goods may not arrive in the required time resulting in loss of sales;
- Poor quality products may be shipped;
- Specifications may not be met;
- Wrong merchandise;
- The goods may not even be shipped resulting in even higher losses.
The Letter of Credit is a document issued by a bank at the order of its client (the buyer) by which the bank commits itself to paying the amount of money specified in the L/C to its beneficiary (the exporter). In order for the seller to receive the due amount, it must prove through documents that the merchandise has been delivered. The Commercial Letter of Credit “At Sight” Letter of Credit Deferred Letter of Credit Letter of Credit with Payment on Acceptance Letter of Credit with Payment by Negotiation Revolving Letter of Credit The Transferable Letter of Credit Red Clause Letter of Credit Back-to-Back Letter of Credit The Escrow Letter of Credit The “Stand-by” Letter of Credit document by which the issuing bank commits itself irrevocably towards the exporter to make the payment by obeying the conditions stated in the commercial L/C. In the case of a Deferred Letter of Credit the payment for the documents, although paid in full, it is not made at the moment when the exporter delivers them to the bank; instead they are made at a later date specified in the L/C. The deferred payment is made, usually, after 30-60 days from the moment the documents are presented. is used in case of short term and very short term sales on credit (between 60-180 days). The characteristic of this payment instrument is the fact that the set of documents comprises one or more bills of exchange, as well as the fact that the payment for the merchandise received is made at the due date of the bill of exchange. - it is issued by the issuing bank, most frequently in that country’s local currency -payment of the bills of exchanges is guaranteed by the issuing bank The issuing bank:
- may no authorise the negotiation of the documents. This type of L/C is also called Direct or Non-negotiable Commercial Letter of Credit;
- may authorize the negotiation at an assigned bank or at any bank. In the latter situation the L/C is also called Freely Negotiable Letter of Credit and it is the most frequently used type of L/C.
- all the shipments are covered by the same L/C;
- the payments are made after each shipment, thus being treated by the banks as a separate deliveries, usually with payment at sight. After making a payment, the value of the L/C is automatically updated, thus the name “revolving” L/C;
- the value of the L/C is given by the value of a shipment and not by the value of the entire shipments altogether. Therefore, the bank commissions are smaller;
- these L/Cs always allow partial payments and deliveries.
This payment instrument is used especially in subcontracting transactions and, when used, the beneficiary (the first beneficiary) has the right to request the bank having to deal with payment/acceptance/negotiation to make it partially or fully usable for one or more recipients (secondary recipients). In essence, the transferable L/C is a regular L/C which also contains the terms “transferable” or “this L/C is transferable”. Advantages Disadvantages - allows a company to develop its business without having to invest its own funds;
- allows a great diversity of export transactions even outside the company’s field of business.
- since on the Romanian territory the current legislation does not allow local companies to pay each other with foreign currency, the only “legal” method that can be used to do otherwise is through a Transferable Letter of Credit;
- banking costs are higher than those of a regular L/C and they are fully covered by the recipient of the L/C;
- there are risks arising from the involvement of third parties due to the possibility they may not deliver good quality merchandise, fail to follow the terms and the conditions imposed to them in the L/C. If such events do take place, this causes great problems in the relationship between the applicant and the main beneficiary. This is because, by not following the conditions stated in the second L/C, the conditions stated in the first L/C will automatically not be followed as well;
- there is no possibility o maintain a complete confidentiality of the transaction; by mentioning the term “transferable” the applicant knows that the merchandise will be delivered by a third party.
- it involves a thorough preparation of the entire operation, promptitude and a strict coordination of all the terms and conditions in the two L/Cs.
-used in subcontracting transactions, when the exporter has several local suppliers that must be paid immediately for the merchandise acquired from them;
- used in the production activity meant for export, when the producer does not have the financial resources to manufacture the products, and it is financed by the importer that shows interest for that particular merchandise. The advantage of the Red Clause L/C rest in the exporter’s ability to obtain a prepayment before the merchandise is delivered. For the importer the Red Clause L/C has disadvantages because, although the prepayment is made by the exporter’s bank, the promise for payment belongs to the issuing bank. Therefore, if the exporter fails to deliver the merchandise after it had already received the prepayment, the issuing bank must return the corresponding sum to the paying bank and in turn demands the importer for the payment. - although the two letter of credit are totally independent, they are correlated by the subcontractor from the point of view of the value and of the terms.
- the transactions is confidential- usually the real exporter does not know who the real importer is;
- the documents requested from the real exporter must be “neutral” and issued at the order of the subcontractor’s bank;
- the packaging of the merchandise must also be neutral;
- the documents of the merchandise, such as the invoice, are exchanged by the person who initiated this transaction at its bank;
- the bank must give its approval to accommodate the transaction.
-it incorporates the value clause, by which the issuing bank may monitor the funds in order to cover the deliveries by compensation;
-it also incorporates a warranty clause; this way the issuing bank promises that, in case the funds in the escrow account are not used to cover the compensation export, it will make the payment, in foreign currency, in favor of the L/C’s beneficiary.
The main advantage of the Escrow L/C comes from the fact that, if the applicant does not deliver the merchandise through compensation in the time interval indicated in the L/C, the issuing bank will pay the equivalent value of the documents offered by the beneficiary of the L/C (the first exporter). Often, it will also pay an interest for the time period between the moment when the documents were presented and the moment when the actual payment took place. As any other L/C, the Stand-by letter of credit has advantages as well as disadvantages. Its advantages are the following:
- the firm commitment of the bank that it will pay up, which gives the company the possibility to guarantee in a transaction with another client the payment will be made.
- the possibility to adapt to different payment obligations of the exporter or of the importer.
- it is regulated in the Publication 500, meaning it is known by all contracting parties and does not have any special characteristics of another country’s the banking system.
The disadvantage is determined by the banks’ attitude. They are very careful when issuing a stand-by L/C. Also, compared for example with the direct exchange of documents, the cost of the compensation transaction is higher. A draft, sometimes also called a bill of exchange, is analogous to a foreign buyer's check. Like checks used in domestic commerce, drafts carry the risk that they will be dishonored. However, in international commerce, title does not transfer to the buyer until he pays the draft, or at least engages a legal undertaking that the draft will be paid when due. In a foreign transaction, an open account can be a convenient method of payment if the buyer is well established, has a long and favorable payment record, or has been thoroughly checked for creditworthiness. With an open account, the exporter simply bills the customer, who is expected to pay under agreed terms at a future date. Some of the largest firms abroad make purchases only on open account. Consignment sales Countertrade Documentary Drafts:
A draft, sometimes also called a bill of exchange, is analogous to a foreign buyer's check. Like checks used in domestic commerce, drafts carry the risk that they will be dishonored. However, in international commerce, title does not transfer to the buyer until he pays the draft, or at least engages a legal undertaking that the draft will be paid when due.
A sight draft is used when the exporter wishes to retain title to the shipment until it reaches its destination and payment is made. Before the shipment can be released to the buyer, the original ocean bill of lading (the document that evidences title) must be properly endorsed by the buyer and surrendered to the carrier. It is important to note that air waybills of lading, on the other hand, do not need to be presented in order for the buyer to claim the goods. Hence, risk increases when a sight draft is being used with an air shipment.
Time Drafts and Date Drafts:
A time draft is used when the exporter extends credit to the buyer. The draft states that payment is due by a specific time after the buyer accepts the time draft and receives the goods (e.g., 30 days after acceptance). By signing and writing "accepted" on the draft, the buyer is formally obligated to pay within the stated time. When this is done the time draft is then called a trade acceptance. It can be kept by the exporter until maturity or sold to a bank at a discount for immediate payment.
A date draft differs slightly from a time draft in that it specifies a date on which payment is due, rather than a time period after the draft is accepted. When either a sight draft or time draft is used, a buyer can delay payment by delaying acceptance of the draft. A date draft can prevent this delay in payment though it still must be accepted.
When a bank accepts a draft, it becomes an obligation of the bank and thus, a negotiable investment known as a banker's acceptance. A banker's acceptance can also be sold to a bank at a discount for immediate payment.
From: Handelskreditbank Ltd.
P.O.Box 2080, Frankfurt
To: Invest Bank Bucharest, Romania
Date: 15 march 2004 Doc Credit no. T2/91210
By order Trading Co Lindenweg 4 Frankfurt we issue an irrevocable documentary transferable credit no. T2/91210.
Beneficiary: Impex SRL, Caderea Bastiliei 20 Bucharest
Amount: DEM 250.000
Validity: 15 May 2004
available with you at sight against presentation of the following
- signed commercial invoice, 3 - fold
- insurance policy, covering “all risks”, for 110% of the invoice value
- air consignment note (original no 3) on the form an airline company, duly signed or stamped by the carrier or his agent, evidencing dispatch to Trading Co Lindenweg 4 Frankfurt covering one or several deliveries from a Romanian airport to CTP Frankfurt airport of
“200 musical instruments ABY at the unit price of DEM 1250”
Partial deliveries are allowed
Transshipment is forbiden
Confirmation instruction: without
This credit is subject to Publication no. 500 ICC Paris 1993
From: Frankfurter Bank
To: Invest Bank Bucharest
Our ref/T2 – 50288
We hereby open our irrevocable stand-by letter of credit no. T2 50288
By order of: Berger Co., Straussstrasse, 6300, Zug
In favour of: Impex SRL, Caderea Bastiliei 20, Bucharest
For an amount of: about USD 100.000
Payable with us
Valid until 11.11.2004 for presentation of documents with us
Available against presentation of:
- copy of commercial invoice;
- copy of clean on board Bill of Lading;
- beneficiary written statement certifying that Berger Co. have failed to fulfil their payment compensation obligation with regard to the following shipment:
about “xy” cotton
from: Egyptian port to: Constanta
Shipment latest September 28th 2004
Beneficiary written statement to contain declaration that the original shipping documents have been sent by them directly to Berger Co., in accordance with their instruction.
This stand-by letter of credit is subject to UCP 500 A; written confirmation will not follow.
Please advise beneficiaries without adding your confirmation.