A SALE IS NOT A SALE UNTIL YOU GET PAID
An obvious statement perhaps but so many exporting companies have experienced bad debts or even worse, bankruptcy. Why? Because of the lack of a good credit control system and not taking into consideration the correct method of payment for each and every export order. It is often said its easier to obtain an order from an overseas buyer than get paid by the same buyer!
CABO LOGISTICS recently visited a clients warehouse where it was very busy. Teams of warehouse staff loading two forty foot containers destined for Freetown, Sierra Leone. “I don’t get it” said the warehouse manager, “we are shipping non-stop from here but management is laying off eight of my staff at the end of this month”. We however, understood, they were shipping BAD DEBTS which resulted in a negative cash flow and redundancies. A sale is not a sale until you get paid.
Let us examine various methods of payment in International Trade and comment on each:
1. Cash before delivery. Would you pay for goods you have not seen?
This method of payment should only be used when there is a long standing business relationship between the buyer and seller and mutual trust.
2. Deposit with order. Again, would you give a deposit for goods you have not seen?
However, this method of payment is common when capital goods are involved . For example, you manufacture and sell heavy milling machines, it would not be unusual in this type of sale for you to ask for a deposit of 25% to show “good faith” and to help you with your manufacturing costs.
Generally speaking these methods of payment are not acceptable or practical in most International trade transactions, so we turn to other acceptable and proven methods of payment such as:
1) Cash against documents or documentary collection
2) Bill(s) of exchange or Draft(s)
3 Documentary letter of credit.
CASH AGAINST DOCUMENTS
Please refer to your document library for a cash against documents flow chart.
The following illustrates a CAD transaction:
a) The seller ships the order to the buyer and forwards the commercial documentation together with the collection schedule (instructions) to his bank (the remitting bank).
These documents could include the following:
Commercial invoice, packing list, a full set of Bills of Lading or possible Master Air Waybill or maybe a Certificate of origin.
b) The remitting bank forward the documents and collection schedule to the collecting bank in the buyers country, the collecting bank is usually nominated by the buyer.
c) The collecting bank advises the buyer that the documents are in their possession and invite the buyer to examine the documents.
d) The buyer checks the documents to make sure they comply with his original instructions.
e) The buyer pays the invoice value and in return receives the documents from the bank (cash against or in exchange for documents).
f) The buyer then forwards the documents to his import agent with instructions to clear the goods through customs.
DOCUMENTARY LETTER OF CREDIT
The second and most popular method of payment in International Trade is a letter of credit, sometimes given its full title Documentary Letter of credit or its shortest version a L/C.
In many aspects a letter of credit has a bad press “too difficult”, “takes too long to get paid”, “the bank never pays me on first presentation” etc. To an extent these comments have a certain validity but we must qualify these statements.
Letters of credits are an easy form of payment ONLY IF the parties involved, the buyer and seller understand how a letter of credit works and what is required by both parties.
WHY TRADE UNDER A LETTER OF CREDIT?
To answer this question let us look a typical buying and selling transaction.
In essence the seller delivers the goods to the buyer and looks to the buyer for payment, that is the seller assumes that the buyer has the funds available to pay for the goods.
With a letter of credit the seller delivers the goods to the buyer but looks to a BANK, not the buyer for payment. That’s the reason why a seller requests a letter of credit from their buyer, they are saying, “Ok, I will deliver the goods to you and I want to make sure I will get paid no matter what happens to your company. I can sleep well at night knowing if you go into liquidation or become bankrupt, I will still get paid” (by a bank).
What are the benefits for the buyer and seller when they trade under a letter of credit?
BUYER: The buyer receives STIPULATED documents which will enable them to clear their goods through customs with the minimum financial exposure and in the quickest possible time.
SELLER: The seller receives a CONDITIONAL guarantee that a bank will pay their invoice value IF their presentation is compliant with the conditions in the letter of credit and conform to UCP 600.
DEFINITION OF A LETTER OF CREDIT
What exactly is a letter of credit? The short answer is as follows:
A letter of credit is a CONDITIONAL GUARANTEE that a BANK will pay a sum of money, within a time frame, against STIPULATED DOCUMENTS in compliance with UCP 600.
REMEMBER: A Letter of credit deals in STIPULATED DOCUMENTS only, not in GOODS or SERVICES.
(art 5 UCP 600)
The issuing bank is not interested if the goods arrive at the sellers warehouse damaged, partially lost, or even if the goods do not comply with the quality ordered by the opener. That is a matter between the opener and the beneficiary.
The issuing bank has a stand alone contract with the beneficiary to pay if the beneficiary present STIPULATED documents required in the letter of credit and subject to UCP 600 and within the stipulated time.
TYPES OF LETTERS OF CREDIT
So far we have spoken about a letter of credit, which is the same as saying, ‘I am going to buy a car.’ What make of car? What model? Likewise, there are different types of letters of credit.
If you look at your letter of credit, top left you will read, “Documentary Credit IRREVOCABLE”.
We are now going to look at the different types of letter of credits available.
IRREVOCABLE: This is the standard letter of credit. It CANNOT be cancelled or amended by the opener or beneficiary without mutual consent thus giving both parties security. This type of letter of credit offers the beneficiary the best protection. The beneficiary can order in goods from a third party or raw material and go into production knowing that the letter of credit cannot be cancelled without their permission and consent.
An irrevocable letter of credit is addressed in art. 3 of UCP6000.
STANDBY LETTER OF CREDIT
A standby letter of credit is comparatively new to trade outside the USA. It has its roots in the USA where banks issue them in lieu of bank guarantees which in turn are not part of the USA banking system. As the name suggests this type of letter of Credit “stands by” and only comes into effect IF the suppliers invoice has not been paid within the stipulated period. Here is a practical example:
“Supplier A” sells goods on a 30 day credit arrangement. The supplier is mindful that a sale is not a sale until they are paid so “supplier A” requests a standby Letter of credit from the buyers BANK.
The standby letter of credit states that if the buyers invoice is not paid within the stipulated time (30 days), the Standby Letter of Credit will “come alive” and pay the supplier against presentation of COPY documents such as Invoice, Bill of lading or Air Waybill, certificate of origin etc. (remember the ORIGINAL documents have been sent to the Buyer with the original 30 day invoice.
If the invoice is paid within the stipulated 30 days, the Standby letter of credit does not see the light of day it just fades away.
A client of CABO LOGISTICS uses standby Letters of Credit in cash against documents transactions instead of a bill of exchange drawn on the buyer’s bank. No problem, but more expensive than a bill of exchange. i.e opening bank charges.
UCP600 THE RULES OF THE GAME
Notice at the bottom of your letter of credit it states:
“This document credit is subject to UCP600 revised 2007”. ( UCP 600 are the rules of the game).
It is important that you purchase a copy of UCP 600 and read the rules:
Buy UCP 600 From ICC UK (hard copy or ebook): ICC UK
Buy UCP 600 From ICC EU (hard copy or ebook): ICC EU
Buy UCP 600 From Amazon USA (hard copy): Amazon