Globalization had increased the ease and frequency of trade between countries and across vast distances. The issue of payment in international trade is important when one takes into consideration the different currencies and exchange rates. There is also the matter of security and confidence that the merchant will receive the money. There are several methods for payment in international trade, including documentary collection, cash advance, and a letter of credit. The exact method depends on the type of trade, scope of trade, and the preferences of the trading party.
Documentary collection is a method of payment in international trade whereby an exporter authorizes a bank to collect a payment on his or her behalf. When the exporter’s bank receives the authorization from the exporter, it will prepare and send documents for the transaction to the bank of the importer, requesting for payment and stating how the payment should be made. Part of the documents sent to the importer’s bank includes a draft with the amount owed printed on top. The importer would be asked to pay the amount on the draft to the exporter through the importer’s bank.
Another method of payment in international trade is a cash advance. As the name suggests, a cash advance is a remittance of the payment for the goods before the exporter ships the goods. This type of payment is preferred because it removes the doubt and apprehension of non-payment, which is attached to the other forms of payment. The importer may make a wire transfer to the exporter who will then send the goods to the importer. This type of method of payment in international trade only favors the exporters because the importer may have apprehensions regarding the state of the goods and whether the goods will arrive. Cash advance usually works best when trade partners have traded on several occasions and have built up a mutual trust.
A letter of credit is a secure form of payment in international trade that involves the bank of the importer. The importer’s bank assumes the responsibility for the payment of the goods and also offers protection to the buyer who will not be obliged to pay for the goods until it has entered his or her custody. In an open account, the exporter promises to ship the goods to the importer within a stated period. The importer would not have to make any payments until the goods have been delivered and received.