Chapter 3

METHODS AND INSTRUMENTS OF PAYMENT

AND PRICING INCOTERMS

Methods Of Payment
It is common practice that an exporting firm offers credit to
the importer. The exporter evaluates new customers with care
and continuously monitors their old account.
*An export firm may, wisely, decide to decline a
customers request if the risk involved is too great.
*The firm may propose an advance payment on a
documentary sight draft or irrevocable confirmed letter of
credit.
*If the customer is fully credit worthy, the experienced
exporter may allow the customer a month or two to
pay(usance facility).
Major consideration of Exporters:
1. Receiving the entire payment in time
2. The level of risk in extending credit

There are several ways in which an exporter can receive

payments when selling products abroad, depending upon how
trustworthy he/she considers the buyer.
1. Payment in Advance(Advance Payment): An exporter
would prefer payment in advance of shipment. A
telegraphic transfer is commonly used for international
remittances.
Limitations:
For the importer, advance payments tends to increase
risks.
Payment in advance is not very common in most
countries.
Buyers are often concerned that the items may not be
sent if payment is made in advance.

Limitations:
Those exporters who insist in this method of payment as
their sole method of doing business may find
themselves losing out to competitors who offer other
terms of payment.
Awareness:
In the case of international credit card transactions,
exporters should be aware of the dangers of fraud.
They should take care to determine the validity of
transactions.

2. Letter of Credit(Import LC):Letter of credit(LC) is often

used to protect the interest of both the buyer and seller.
-A letter of credit adds a banks promise to pay the exporter on
behalf of the importer provided the exporter has complied with
all the terms and conditions of the LC.
Features:
Payment is on the basis of documents.
All terms of payment should be specified in the LC to avoid
confusion.
Banks charges a fee for opening LC based on a percentage of
the amount of payment.
LC specifies the documents required to be presented by
exporters, such as, Bill of Lading Invoice, draft and insurance
policy.
A modification made to a LC after it has been issued is called
an amendment.

2. Letter of Credit(Import LC): (contd)

Limitations:
-Some buyers may not be agreed to pay the additional cost of
LC fees.
-The LC contains an expiry date.
-Bank charges fee for the amendment service.
3. Bill of Exchange(Draft): An instrument to be submitted by
the exporter along with other documents of his/her bank. The
exporters bank will send this to the importers bank.
Types of Bill of Exchange: The importer will make payment on
or before the due date, depending upon whether the Bill of
Exchange is a
(i)Sight Bill
(ii)Usance Bill

Types of Bill of Exchange

(i)Sight Bill:
A sight bill of exchange is used when the exporter
wishes to get the payment before the importer collects the
goods from the port. The corresponding term of payment is
Delivery Against Payment(D/P).
(ii)Usance Bill(Time draft):
A usance bill of exchange is used when the
exporter extends credit and the facility to use the goods 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.,30days after acceptance). The corresponding term of
payment is Delivery Against Acceptance(D/A).

4. Open Account:
In a foreign trade transaction, an open account can be a
convenient method of payment if the importer is reputed and
has a long and favorable payment record.
Features:
-Exporters simply bill the customer who is expected to pay
under agreed terms at a future date.
-It saves the cost of opening a LC.
Limitations:
-The absence of documents and banking channels.
-The exporter might have to pursue the collection abroad.
-Receivables may be harder to finance.
-There may be political, economic and commercial risks.

Financing Exporters and Importers

The Trade Finance functions of a bank can be broadly
classified as1. Financing Exporters
-Financial assistance to exporters is in the form of:
Pre-shipment Finance
Post-shipment Finance
2. Financing Importers
A LC is both an instrument for settling trade payments and
an arrangement for making payment against documents.
Under this arrangement, a bank, at the request of a
customer, undertakes to pay a third party by a given date,
according to agreed stipulations and against presentation of
documents, the counter value of goods or services shipped.

Parties to LC
1.Applicant the buyer of the goods.
2.Issuing bank the bank that issues the LC
3.Beneficiary ( exporter) the seller of the goods
4.Advising the bank the bank that advises to the beneficiary
5.Confirming bank- the bank which adds guarantee to the LC
opened by another bank.
6.Reimbursing bank the bank authorized to honor the
reimbursement claim in settlement of the negotiation.

-Steps in an import transaction with letter of credit

1.The importer concludes a purchase contract for the buying of
certain goods.
2.The importer requests his bank to open a LC in favor of his
supplier.
3.The importer's bank opens a LC as per the application.
4.The opening bank will forward the original LC to the
advising bank.
5.The advising bank forwards the same to the exporter after
being satisfied.
6.The exporter scrutinizes the LC to ensure that it conforms to
the terms of the contract.
7.In case any terms are not as agreed, the importer will be
asked to make the required amendments to the LC
8.In case the LC is as required, the exporter proceeds to make
arrangement for the goods.

9.The exporter will effect the shipment of goods.

10.The exporter will prepare export documents, including
Exchange bills.
11. The exporters bank verifies all the documents with the
LC.
12. If the documents are in conformity with the terms of LC
& all other conditions are satisfied, the bank will negotiate
the bill.
13. The exporter receives the payment in his bank account.
14.The LC opening bank receives the bill & documents from
the exporters bank.
15.The importers bank checks the documents & inform,s the
importer. The importer then accepts the bill .
16.The LC issuing bank reimburses the negotiating bank, the
amount, if the documents are found in order.

-Types of LC
i. Revocable LC- may be cancelled or amended at any time
without prior notice to the beneficiary.
ii. Irrevocable LC can not be revoked or amended without
the consent of all parties.
iii.Revolving LC- the amount under the revolving LC can
revolve in relation to time or value.
iv. Transferable LC- the seller may request the buyer to open
a transferable irrevocable LC. He may not be the actual
producer of the goods.
v. Read Clause LC it contains a clause providing for
payment in advance for buying raw materials or processing
the goods.

-Instruments

of payments
Credit transfers are instructions from the importer to his/
her bank to debit his/her bank account & to credit the
exporters bank account.
Direct debits are pre-authorized debits on the importers
bank account that are initiated by the exporter.
Payment cards are issued by a bank or card company.
A cheque is a written order from the importer(drawer) to the
exporter(drawee) requiring the drawee to pay the indicated
sum on demand to the drawer or to a third party specified by
the drawer.