This video talks about the 4 Methods of Payment used in International Trade which are Open Account, Advance Payment, Documentary Collection & Documentary Credit.
What is International Trade ?
International trade is the exchange of goods and services between countries and allows us to expand our markets for goods and services that otherwise may not have been available to us .
In International Trade, there are 2 parties involved which are the Exporter and the Importer. From the Exporter to Importer, there are movement of goods and shipping documents. From the Importer to Exporter, there are movement of money. From these 3 movements of goods, shipping documents and money, there are 4 methods of payment which are
- Open account
- Advance payment
- Documentary Collection
- Documentary Credit
We shall look at each of these methods of payment in more detail.
- First of all there is a sales contract between the Exporter and the Importer.Once the contract has been signed the Exporter will then ship out the goods to the Importer
- The exporter then prepares relevant shipping documents like bill of lading, invoice and packing lists and will courier these documents direct to the importer. So once the Importer receives the documents and when the goods arrive at the port, the Importer will be able to clear the goods from the port.So the goods are available to the Importer before payment.And, is there any risk to the Importer? Certainly none.
- Once the Importer has received the goods, the Importer will then make payment to the exporter.The timing of the payment will depend on the sales contract, and there is certainly risk to the exporter to ship the goods first before receiving payment.
So this is the situation where the Exporter needs to rely on the Importer to pay as agreed and for this to work the Exporter needs to know and trust the Importer very well.
So this is the essence of open account. Now let us look at what is advance payment.
Advance payment is the direct opposite of open account.
First of all there is a sales contract which mentions that advance payment is the method of payment.
- Once the contract is signed the Importer will make payment to the Exporter. The time of payment is before shipment and is there any risk to the Exporter? Certainly none. Because the Exporter has received payment first.
- So after the Exporter has received payment, the Exporter will then ship out the goods
- After shipment of goods, Exporter will prepare the relevant shipping documents which the Exporter will courier directly to the Importer. When the Importer receives the documents, the Importer will be able to clear the goods from the port. The goods are available to the Importer only after payment. The risk is to the Importer is that the Importer would have to rely completely on the Exporter to ship out the goods as ordered
For this method to work, the Importer must know and trust the Exporter, so this is in essence advance payment
Documentary Collection Method
We have a problem, the Exporter is new to the Importer and the Importer is new to the Exporter and there is no trust between both of them so the exporter will certainly want advance payment and the importer will want open account.
They cannot compromise so they need the bank to come into the picture. For this the bank had invented 2 methods to solve the problem: Documentary Collection method as well as Documentary Credit method
Under Documentary Collection method – you have got Sight and Usance. For Sight Documentary Collection it’s called D/P,for Usance it’s called D/A. D/P means Documents against Payment and D/A means Documents against Acceptance.