Exam 10: Managing Money

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To protect their own interests in international trade, exporters prefer cash in advance, i.e., receiving payment before shipment or delivery of goods. Especially when dealing with an unfamiliar buyer or a buyer with shaky credit, cash in advance can avoid potential default risk. Also, if a seller needs significant investment to fulfill an order, it may demand certain prepayment.
Importers tend to favor methods that allow payment after shipment. An open account is an arrangement in which the exporter ships goods first and bills the importer later. Consignment is a variant of an open account in which the exporter gets paid after its foreign distributor has sold goods to the end buyer. Sales on an open account offers flexible payment dates and credit terms to the buyer.
A more widely accepted payment method is letter of credit (or L/C). The letter of credit is a promise made by a bank on behalf of the buyer that the bank will honor the payment obligation if the seller presents the documents specified in the L/C. L/C involves one or more banks as the intermediary, thus mitigating the lack-of-trust problem between importers and exporters. The exporter is guaranteed payment under conditions set forth in the L/C. For the importer, payment is made only after the presented documents meet the requirements. The issuing bank actually lends credit to the importer by assuming the payment commitment. It charges a fee for L/C, which is relatively expensive compared to other payment methods.
A draft, also known as the bill of exchange, is a written order by one party (the drawer or maker) to another party (the drawee) to make a certain amount of payment to the exporter or designated beneficiary. It can be payable upon presentation (a sight draft) or on a specified future date (a time draft). The drawee accepts a draft by signing it, thus converting it into a binding contract and negotiable instrument. This instrument can be used with or without L/C. When L/C is not used, the drawee is the importer. When L/C is used, the drawee is the issuing bank of the L/C.

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Letter of Credit (or L/C) is a commonly accepted payment method in international trade. It is a promise made by a bank on behalf of the buyer that the bank will honor the payment obligation if the seller presents the documents specified in the L/C. Basically, the L/C process include the following steps:
1. The importer and the exporter reach a sales agreement and agree to use L/C
2. The importer applies L/C with the issuing bank
3. The issuing bank issues L/C and forwards it to the exporter's advising bank
4. The advising bank notifies the exporter about L/C
5. The exporter ships goods and prepares documents according to L/C
6. The exporter sends the required documents through the advising bank
7. The issuing bank makes payment to the exporter through the advising bank
8. The issuing bank releases documents to the importer
9. The importer pays the issuing bank
"10. The importer claims goods from the shipping company
Using L/C reduces the risk of payment delay or default for the exporter. The issuing bank actually lends credit to the importer by assuming the payment commitment. The L/C serves as a contract between the issuing bank and the exporter. The exporter is guaranteed payment under conditions set forth in the L/C. The L/C also provides benefits for the importer. It requires the exporter to conform to specific requirements, such as the quantity and quality of products and the timeliness of shipment. Payment is made only after presented documents meet the requirements. The banks are responsible for checking the documents. If there is any oversight, the importer can refuse to pay. The issuing bank charges the importer a fee for L/C. The major drawback is that the fee, although negotiable, is relatively expensive compared to other payment methods."