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International trade is a complex process that involves the exchange of goods and services between different countries. In order to make it run smoothly, there are a number of different methods of payment that can be used.
In this article, we will look at the five most popular methods of payment in international trade and provide some tips on how to choose the best one for your needs.
What Are International Payment Methods?
International payment methods are the different ways in which buyers and sellers can send and receive money when they are trading goods or services between different countries.
The payment methods specify the risk limits according to the risks and advantages of the payment terms. Each business agreement will involve different payment terms, which are often negotiable between the buyer and seller.
The 5 Most Popular Payment Methods in International Trade
The payment methods used in international trade vary depending on the degree of trust between the importer and the exporter, the risks undertaken by the parties, and the payment method accepted by the markets according to the product types.
However, there are five payment methods that are most popular in international trade:
- Cash In Advance (CIA)
- Letter of Credit (L/C)
- Cash Against Documents (CAD)
- Acceptance Credit
#1 Cash In Advance (CIA)
Cash In Advance (CIA), also known as advance payment or pre-payment, is one of the most secure methods of payment from the perspective of the seller. With this type of payment, the buyer sends the full amount of the invoice to the seller before the goods are shipped.
This means that the buyer takes on all of the risk in the transaction as they are effectively paying for goods that they have not yet received. From the perspective of the seller, however, this is one of the best methods of payment as it guarantees that they will receive their money before they have to ship the goods.
#2 Letter of Credit (L/C)
A Letter of Credit (L/C) is a formal document issued by a bank that guarantees that the buyer will make a payment to the seller, provided that the seller meets all the requirements specified in the letter.
The risk diagram below shows payment methods with a two-way risk-trust relationship for buyers and sellers. While the letter of credit is the most reliable payment method for both the seller and the buyer, it's not suitable for companies with no credibility or for low-cost trades due to the costs involved.
However, it should be noted that this type of payment is not without its risks, as the seller is not paid until they have met all the requirements specified in the letter, which can be quite extensive.
#3 Cash Against Documents (CAD)
When importing or exporting goods, businesses often use a method of payment called cash against documents (CAD). Under this arrangement, the buyer pays the seller after they have received the documents that prove ownership of the goods, such as the bill of lading or the bill of exchange.
Essentially, funds are held in escrow until the documents are received. This type of payment is often used when the buyer and seller do not know each other well, or when the buyer wants to protect themselves against the risk of non-delivery.
#4 Acceptance Credit
Acceptance credit is when an importer takes out a loan from a bank to pay for the goods they have purchased. The loan is then repaid by the importer to the bank, with interest, over time.
Acceptance credit is popular because it allows importers to finance their purchases and spread out the cost of repayment over time.
There are three main types of acceptance credit:
- Letter of Credit with Acceptance Credit — a form of payment that allows the shipping documents to be paid on the policy maturity by releasing the shipping documents, following the acceptance of the policy presented with these documents by the importer's bank or the correspondent bank
- Against Documents with Acceptance Credit — in this form of payment, the importer pays the exporter on the policy maturity, after the subsequent bank delivers the shipping documents and the attached policy
- Against Goods with Acceptance Credit — after the importer receives the goods and accepts the policy, they pay the exporter on the policy maturity
Consignment is a method of payment for goods whereby the seller does not receive payment until after the buyer resells the goods.
While the exporter (seller) retains ownership of the goods until they are sold, it's important to note that the buyer has control over the goods during this time. If the buyer does not resell the goods, the exporter will not be paid.
Consignment can be a risky method of payment for an exporter, as they are relying on the buyer to actually sell the goods in order to receive payment. On the other hand, the advantage of consignment for the seller is that they only have to pay for the goods once they are sold.
How to Choose The Right Payment Method
When engaging in international trade, it is important to choose the right payment method in order to protect both parties involved.
There are a few factors to consider when choosing a payment method, such as:
- the value of the goods being traded
- the type of goods being traded
- the level of risk that each party is comfortable with
- the cost and time of shipping
Choosing the right payment method is a balancing act between minimizing risk and maximizing efficiency.
Which Payment Method is The Best?
Ultimately, there is no single “best” payment method for all international trade transactions. The best payment method is one that meets the needs of both the buyer and the seller while minimizing risk.
However, the most reliable method for the seller is cash in advance, while the most advantageous method for the buyer is consignment.
Stay Competitive By Choosing The Right Payment Method
The shipping industry is increasingly competitive, and companies are looking for any advantage they can get. Knowing which payment method to choose is one way to stay ahead of the competition.
If you’re a seller, offering the buyer their preferred payment method can increase your chances of winning the sale.
If you’re a buyer, choosing a payment method that minimizes your risks and maximizes your negotiating power can help you get the best possible terms from the seller.
Either way, it’s important to have a good understanding of the different payment methods available so that you can make the best choice for your business.