International Trade

International trade refers to exchange of goods, service and capital across international
boundaries. In other words, international trade means interchange of commodities or services
across the beyond national boundaries. This type of trade contributes growth to the world
economy, in which prices, or supply and demand, affect and are affected by global events. This
sort of trade allows for a greater competition and more competitive pricing in the market. The
competition results in more affordable products for the consumer. The exchange of goods also
upsets the economy of the world as dictated by supply and demand, making goods and services
obtainable which may not otherwise be available to consumers globally.
In the global commerce the buyers and sellers always look for the most appropriate methods and
parties to conduct business. As the market is universal and modern technology provides instant
and most convenient communication facility to choose best buyer or seller; costs, quality, the
terms and conditions, risk factors, payment period, transaction security, flexibility and reliability
becomes the prominent assessment tools while performing international trade.
While selecting the trade partner dealers and parties will always endeavor to make best purchase
sale contract that provides them most suitable conditions and edge. Both the parties will seek for
best product and services in exchange of lowest price which offers lowest risk, secured payment
and shipment.

International Trade Payment

Among all crucial factors that determines the international trade parties and route, International
trade payment method is the distinctly most prominent one. The traders will always hunt to make
the trade under the best conditions for themselves. While the purchaser will choose the most
inexpensive and extensive termed payment type in reimbursing the cost of the goods, the sellers
will select cash payment, which are the most strategic and profitable payment type and the types
of collection with the minimum uncertainty. The exporter that arranges the merchandises and
makes the process to dispatch those according to the contract with the importer needs to consider
the payment terms and a financing program; otherwise the importer might experience severe
troubles if the payment is not reimbursed. Conversely, the exporter needs to be assured that he or
she is paying the right party within the due interval mentioned in the contract in order get make a
smooth purchase of the essential merchandise.

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1) Cash in Advance

Cash in advance is the method in which buyer (importer) pays cash in advance to the seller
(exporter) before the shipment or delivery of the goods. The method is also known as advance
payment method. It provides the highest protection for the seller (exporter) while transfers a
huge risk on the buyer (importer). Though, the seller receives the payment in advance, it does not
assure the shipment or delivery of the goods from seller.

Cash in advance is risk-free except for consequences associated with the potential non delivery
of the goods by the seller. Therefore a buyer bears the greatest risk in this method. The exporter
can avoid credit risk because payment is received before the ownership of the goods is
transferred. Wire transfers and credit cards are the most commonly used cash-in-advance options
available to exporters. However, requiring payment in advance is the least attractive option for
the buyer, because it creates cash-flow problems. Foreign buyers are also concerned that the
goods may not be sent if payment is made in advance. Thus, exporters who insist on this
payment method as their sole manner of doing business may lose to competitors who offer more
attractive payment terms.

Advantages and Risks of Cash in Advance Method

The cash in advance method is advantageous for the seller as there is no risk for him/her.

The cash in advance may be most realistic technique if;

• The buyer lacks creditworthiness
• The buyer is not able to offer sufficient security for payment
• The buyer is located in a region of politic and/or economic instability
• The product is so specialized that it is specifically made for the customer and cannot be
easily sold to another customer.

2) Open Account
An open account transaction is a trade where goods are sent and delivered before payment and
payment is left open to an agreed upon future date. This method replicates extended suppliers
credit. This is one of the most beneficial alternatives to the importer in terms of cash flow and
cost, but it is consequently one of the highest risk options for an exporter. An exporter has little
or no control over the process, except for imposing future trading terms and conditions on the
buyer. 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.
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. Still, there are no guarantees and collecting
delinquent payments is difficult and costly in foreign countries especially considering that this
method utilizes few officials 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. As a consequence, Open Account trading should only be considered
when an exporter is sufficiently confident that payment will be received.
In certain markets, such as Europe, buyers will expect Open Account terms. The financial risk
can often be mitigated by obtaining a credit insurance policy to cover the potential insolvency of
a customer, which provides reimbursement up to an agreed financial limit.

Thus if an international trade payment is done via open account method-

Interest of the importer is protected

Interest of the exporter is not protected

There is insignificant involvement of bank
There is no universal rules and regulation , this is guided by purchase-sell agreement

Advantages and Risks of the Open Account Method

The Open Account method is advantageous for the buyer as there is no risk for him/her

The open account method may be suitable if:

There is long-term relationship and confidence between the buyer and the seller
The seller is under pressure to sell his goods
The buyer has a very good reputation and is well-known in the market
The buyer is solvent Neither cash in advance or open account are appropriate if the exporter
and importer do not know each other very well or do not have strong business confidence on
each other. Besides if they do not want to assume the credit risk or the risk of dealing with
particular country due to different political and economic instability.

3) Documentary Collection
The method in which the exporter (Seller) sends the products and draws a bill of exchange (often
known as draft) on the importer (Buyer) through a reliable bank is known as Documentary
collection. The bill of exchange or draft is an unconditional order to make the payment if certain
terms and conditions are met. Besides, drafts are negotiable instruments that facilitate
international payments through respected intermediaries such as banks. However the
intermediaries do not involve in guaranteeing performance. Such drafts offer more flexibility
than LCs and are transferable from one party to another. A bill of exchange or draft is an order
written by one party directing a second party to a third party. There are four parties involved in
the documentary collection method:
The buyer, collecting/presenting bank (buyer’s bank), the seller and the remitting bank (seller’s
bank).

Types of Documentary Collection There are two basic types of drafts:

1. Documents against Payment (D/P)
2. Documents against Acceptance (D/A)

Documents against Payment (D/P) In document against payment method, after the shipment
the exporter sends a sight draft, through his bank to the importer's bank, along with the agreed
upon documentation such as the original bill of lading, invoice, certificate of origin etc. The
buyer is then expected to pay the draft when he sees it and thus receive the documentation that
gives him ownership title to the goods that were shipped. Usually this method is used when
payment is expected from the buyer immediately, otherwise known as "at sight". This process is
often referred to as "Cash against Documents". The buyer's bank is instructed to release the
exporter's documents only when payment has been made.

Documents against Acceptance (D/A) A document against Acceptance is alike to a Document

against Payment (D/P) apart from that it demands payment after a specified time or on a certain
date after the buyer accepts the draft and receives the goods. By signing and writing "accepted"
on the draft, the buyer is contractually obligated to pay as directed on the draft. This method is
also popular with names “A time draft “or “date draft.” This method is used when a credit period
has been agreed between the exporter and buyer. The buyer is able to collect the documents
against their undertaking to pay on an agreed date in the future, rather than immediate payment.

4) The Commercial Letter of Credit

Documentary letter of credit or Documentary credit, in other words Letter of credit (LC) is the
most popular mode of international payment as it offers the most convenient features and one of
the most secure instruments available to international traders. In consequence, it represents 44%
of total export-import transaction around world. A Letter of Credit is a document guarantying
that the buyer will pay the agreed amount of money to the seller within a definite period of time,
issued by a bank at the buyer’s request in favor of the seller; under the condition that the seller
conforms to the product specifications and Page | 22 document requirements of the buyer. It is a
bank-to-bank commitment of payment in favor of an exporter (the Beneficiary), guaranteeing
that payment will be made against certain documents that, on presentation, are found to be in
compliance with terms set by the buyer (the Applicant). The Letter of Credit is a particular,
technical instrument that is applied when paying for a shipment of goods or services from one
party to another. The LC functions to equally allocate risk between buyer and seller since the
seller is guaranteed of payment when the terms and conditions of the LC are met and the buyer is
reasonably assured of receiving the goods ordered. Trade involves buyers and sellers seeking to
exchange goods or services despite their differences in language, national custom, credit
procedures, and accounting practices. Historically, merchants have looked for ways of lessening
these differences and smoothing the progress of trade. The special protection and opportunities
offered by Letters of Credit relate to both domestic and international trade. LC is governed by a
set of rules from the ICC. In this case, the document is called; "Uniform Customs and Practice"
and the latest version is document number 600. In short, it is known as UCP600 and, again, over
90% of the world's banks adhere to this document.

Explanation:
1. Buyer and seller agree on a commercial transaction.
2. Buyer applies for a letter of credit.
3. Issuing bank issues the letter of credit (LC)
4. Advising bank advises seller than an LC has been opened in his or her favor.
5. Seller sends merchandise and documents to the freight forwarder.
6. Seller sends copies of documents to the buyer.
7. Freight forwarder sends merchandise to the buyer's agent (customs broker).
8. Freight forwarder sends documents to the advising bank.
9. Issuing bank arranges for advising bank to make payment.
10. Advising bank makes payment available to the seller.
11. Advising bank sends documents to the issuing bank.
12. Buyer pays or takes loan from the issuing bank.
13. Issuing bank sends bill of lading and other documents to the customs broker.
14. Customs broker forwards merchandise to the buyer.

Both the exporter and importer benefit from the distinctness of a Letter of Credit. Conversely, both
the buyer and seller need to know that letter of credit do not provide the following services: It
does not offer a complete guarantee of payment to anyone. A Letter of Credit promises payment
only if its terms and conditions are met by showing the required documents. The value of such a
guarantee depends upon the solidity of the bank offering its undertaking and the macroeconomic
stability of the country where the bank is situated. It does not provide an assurance that the
goods portrayed in the presentation of documents have been delivered. Banks don’t deal with
goods and services; they deal with documents related to the Letter of Credit. The quantity and
quality of the goods shipped depends upon the trustworthiness and reliability of the exporter that
has manufactured or packaged the goods and organized the delivery.

Parties involved in Letter of Credit: The main parties that directly concern the LC are:
1. LC issuing bank (on Behalf of Importer)
2. The Beneficiary (Exporter)
Other parties that facilitate the procedure or take interest in Letter of Credit are:
1. The Applicant or The Buyer
2. The Confirming Bank
3. The Advising Bank
4. The Nominated Bank
5. Negotiating Bank
6. The Reimbursing Bank
7. The Claiming Bank
8. The Presenter
9. The Transferring Bank,

Risk Comparison among the Different Modes of International Payment Page | 42

Risk is one of the most crucial factors which decide the modes of payment while conducting
international trade. Thus based on portrayed method payment risk diagram is presented in the
preceding figure:
Conclusion
It is already visible and pointed out that letter of credit is most widespread and conveniently used
one among all these portrayed modes of international trade payment as it protects the interest of
the both importer and exporter, regulated by UCP600 and bank has significant involvement .
Besides this provide the assurance of payment and confirms that the merchandise transported to
the concerned party. Conversely Documentary collection protects the interest of the importer,
better protects the exporter comparing to open account, and regulated by URC522 but the
involvement of bank is less significant. To add, cash in advance or open account protects interest of
either seller or buyer, has no universal regulation. However, having all those facilities and problems,
mode of payment is decided on seller and buyers’ negotiation and common practice for certain
merchandise and territory.