FINANCING AND METHODS OF PAYMENT

CHAPTER 11

Introduction

Draft: "A draft is an unconditional order in writing from the drawer to the drawee directing the drawee to pay a specified sum of money to a specified beneficiary at a particular time." (may be issued in connection with a letter of credit) Note: The check you (the drawer) write on your bank (the drawee) is a form of draft; it orders the bank to pay some entity/someone (the beneficiary) a specified sum of money at a particular time. Letter of Credit: "A letter of credit is a guarantee, usually by a bank, that it will pay a specified sum of money to a specified beneficiary when certain conditions are met."

Electronic communications

Advances in electronic communications have had a major impact on

bank interfaces with customers inter-bank operations

Some customers still fill out paper application forms for letters of credit (L/Cs) and other financial transactions. Most companies now conduct much of their banking/financial transactions on-line.

Use Web-based application forms; send EDI (electronic data interchange) files and other files electronically.

Most letters of credit and other forms no longer sent in full-language text in hard copy or electronically; usual procedure now:

over 90% of inter-bank transactions now made through SWIFT (Society for Worldwide Interbank Transfers), a proprietary electronic network owned by banks; forms for most transactions (including inquires, payments) are filled out in language of companys home country; put in a standard for (structured message) for transmission (at 1/5 the cost of sending a fulltext message); and as necessary, receiving bank puts it in to locally-used format for customers/recipients.

Personal relations are still of great importance, but routine transactions are done online.

Export financing methods/terms of payment

The 7 methods discussed in the following sections are listed in order with the highest risk to the exporter, and the lowest risk and cost to the importer, first. Consignment:

Payment is made against clean draft (no documents attached), usually after goods are sold by the importer. Payment is made against clean drafts or against statements of balance. Factors may be willing to purchase accounts receivable, with or without recourse.

Open account

Export financing methods/terms of payment (contd)

Documentary collections

Documents against acceptance (D/A)

The documents which the importer needs to obtain the merchandise are attached to a draft sent through a bank. The bank will not release the documents until the importer has "accepted" them (agreed to pay after a certain number of days from sight [time draft], or at a specified date [date draft]).

Documents against payment (D/P), Sight draft

The documents that the importer needs to obtain the merchandise are attached to a draft sent through a bank. The bank will not release the documents until the importer has paid.

Export financing methods/terms of payment (contd)

Letter of credit At the request of the importer, his/her bank establishes a commercial credit which guarantees payment to the exporter when certain conditions are met (usually presentation of documents for the shipment). The bank actually pays, or agrees to pay, when the exporters draft (demand for payment) is presented, usually with documents attached. COD (Cash on Delivery) Not frequent except for air shipment. Cash with order Advance payment is sometimes demanded by sellers. Long term financing For major projects, large capital equipment sales, special exports. Both financing and insurance against credit and political risk are often available from government and/or private sources.

Payment/financing
Two general categories: (1) letters of credit, (2) drafts or bills of exchange. Letter of credit

L/C defined: a written promise, usually issued by a bank on behalf of its client, that it will pay the beneficiary a specified sum of money when the conditions in the letter of credit are met.. Adds the bank's name and credit to that of the importer. Only as good as the bank that issues it.

Figure 11.2 shows the English language version of an Application for Irrevocable Letter of Credit of the U.S. branch of the large international Dutch bank ABN-AMRO. Figure 11.3 shows how an L/C operates. Figure 11.4 shows a correspondent banks notification and confirmation of an L/C. Figure 11.5 provides an example of an opening banks letter of credit notification.

Payment/financing (contd)
Types of letters of credit Revocable and irrevocable: most issued are irrevocable.

revocable can be revoked any time before payment is made. revocable therefore much less safe for exporter confirmed L/C includes agreement by exporter's bank to pay when conditions are met. gives exporter added assurance. clean will pay against draft (demand for payment) with no documents attached. documentary has documents (required to obtain merchandise) attached.

Confirmed and unconfirmed:

Clean and documentary:

Payment/financing (contd)

Transferable and non-transferable:

transferable allows part or all of proceeds to be assigned by the beneficiary to a third party; non-transferable does not. Assignment of proceeds may be made in some cases. used where transactions are more or less continuous. may limit amount outstanding at any one time or to be paid in a given time period.

Revolving letters of credit:

Deferred payment credit used where the payments are to be made in installments. Standby letter of credit: an irrevocable L/C issued in connection with something other than the movement of goods. See Figure 11.6 for an example.

Payment/financing (contd)
Drafts (demand for payment) Draft: "A draft is an unconditional order in writing from the drawer to the drawee directing the drawee to pay a specified sum of money to a specified beneficiary at a particular time." (may be issued in connection with a letter of credit) Drafts may be used under an L/C or by themselves. When used alone (not under an L/C) may be called bills of exchange Use Figure 11.7 to show process. Figure 11.8 shows international collection instructions and receipt. Figure 11.9 shows an example of a draft drawn under an L/C.

Payment/financing (contd)

Documents may be delivered against payment (D/P) or against acceptance (D/A).

Acceptance:

a time draft or bill of exchange which has been accepted (signed to agree that payment will be made at the time specified). Signed by buyer makes it a trade acceptance. Signed by a banker makes it a banker's acceptance. Banker's acceptances, and some trade acceptances, may be sold at a discount to obtain immediate cash.

Payment/financing (contd)

Types of draft
Clean

or documentary. Sight and time drafts or date drafts. See Figure 11.10. With or without recourse: without recourse means the bank (or factor) will purchase drafts (accounts receivable) without requesting repayment if the drawee (buyer) does not pay when due.

Export credit insurance

Available through governmental insurance or private insurers. May cover commercial risks as well as political risk and risk of non-convertibility of currency. Based on co-sharing of risks, spread of risks, reduction of risk.

Countertrade

Trade agreements in which the seller agrees to a reciprocal purchase obligation for all or part of the value of sale. Appeals to buyers in countries short of hard currency. Significant now; likely to become increasingly important. Table 11.2 lists some objectives of sellers and buyers in international countertrade.

Countertrade (contd)
Pure barter Goods or services for goods or services. May involve more than two companies and two countries. Now facilitated by specialized corporate barter companies. Online barter is now operating in the U.S. and can be expected to develop internationally. Clearing arrangements An agreement to exchange a number of products and/or services, some not easily sold on the open market, during a given period of time. Counter-purchase A sale for cash or credit with an agreement by the exporter to, in turn, buy products and/or services from the importer or a third party.

Countertrade (contd)
Switch trading An agreement in which the exporter accepts payment in goods or services which the exporter does not really want, but which can be sold for the exporter to some third party by a specialist called a switch trader. Buy back or compensation agreement Seller takes part of goods produced by buyer in payment. Offsets Seller assists in or arranges marketing or provides some other benefit to buyer (such as agreement to buy parts which will be used in product sold to buyer). Concluding comment Countertrade may be arranged by in-house organizations or by outside specialists. Which form is best depends upon the circumstances.

Outline of Payment Procedures

Letter of Credit

Regular or Ordinary letter of credit

Revocable: transferrable, non-transferable Irrevocable

Confirmed transferable Unconfirmed non-transferable

Revolving letters of credit

Revocable: transferrable, non-transferable Irrevocable

Confirmed transferable Unconfirmed non-transferable

Cumulative, noncumulative

Outline of Payment Procedures (contd..)

Drafts (bills of exchange)

Payer
Bank

of draft

draft payable on presentation to the branch or correspondent of issuing bank (similar to a cashiers cheque) Letter of credit draft, drawn under the authority of issuing banks letter of credit and so indicated on the face of the draft Commercial draft (trade bill)

Outline of Payment Procedures (contd..)

Documentary
Documents

drafts

against acceptance

Time drafts, payable a specified time after sight Time drafts, payable a specified number of days after a date drawn (also called date drafts)

Documents

against payment

Sight drafts, payment due on presentation Time drafts, payment due on a specified date

Clean

Drafts

Sight drafts Time Drafts