International BusinessPayment risk

Professor: Marc Arza marc@futura.cat

1. Payment risk

Although the risk of not being paid is present in any business, national or international, it is higher in the latest because of many reasons. Usually companies work with less information about their counterparts than in their national market and so it is more difficult to know about a business reputation as a non payer or about those companies going through difficult times and a shortage of cash flow. At the same time a company has less resources to chase a debtor than in its national market and the whole process would be slower and much more expensive and so many non payers, specially for small amounts, end upt never paying back their debts to foreign companies.

A business is not finished until it gets paid and securing payment is one of the most important and pressing issues in any international business operation.

- Avoiding payment risk:

- Get information: Learn about the partner with whom starting business- Be careful: Wait until developping a relation to stop playing it safe- Secure payments: Use the different available tools to reduce payment risk

2. International payment options

Some of the most usual international payment options are:

- Cash in advance- Cash against documents- Letter of credit (L/C)- Open account- Mixed payments (mixing options)

3. Cash in advance

A payment is done in advance when the buyer sends the full amount before receiving the product/service it is ordering.

- Zero risk for the exporter- Full risk for the importer- Payment by T/T (wire)- 3-4 days delay

Will require the importer/buyer trusting the seller and will force the importer/buyer to finance the operation on its own.

IBAN (Int'l Bank Account Number):

- Spain: ESkk BBBB GGGG KKCC CCCC CCCC B=bank code, kk=code, G=Branch/office number, K=Check digits, C=acc. number

4. Cash against documents (CAD):

The seller will send the shipment documents to the importer/buyer after having received payment by him. The importer/buyer will be able to check a scanned copy of the documents in order to make sure the shipment has been done and afterwards will send payment so that the seller sends the original documents and the buyer can claim the goods at their arrival to the port. Documents are exchanged for payment.

It is like a bsuiness to business L/C withouth the bank participation. It is cheaper than an L/C although it carries a certain risk for the exporter/seller. If the buyer/importer does not pay after the goods have been shipped the exporter/seller will have to pay the shipment back home to reclaim them. This may be avoided by a mixed payment formula that requires a minimum in advance payment to confirm the order.

5. Letter of credit (L/C)

A letter of credit is a document issued by a bank, which provides an irrevocable payment undertaking to a beneficiary against complying documents as stated in the Letter of Credit.

Letter of Credit is abbreviated as an LC or L/C, and often is referred to as a documentary credit, abbreviated as DC or D/C, documentary letter of credit.

Either the exporter or the importer will contact their bank an open the L/C which will be sent to the bank of the counterpart describing the conditions (documents and payment). Once the L/C is agreed, having gone through the necessary amendments, the exporter will produce the goods and organize shipment. Immediately after the exporter will send the necessary documents to its bank which will send them to the other bank which, after checking the documents will authorize payment and give the documents to the importer so that goods can be claimed once reaching the port.

5. Letter of credit L/C

5. Letter of credit L/CAn L/C may have different clauses:

- Revocable / Irrevocable: A revocabel letter can be cancelled by the part that opened it at any moment before payment.

- Confirmed: When a second bank guarantees payment in case the importer/buyer bank does not or can not pay the required quantity.

- Transferable: The part receiving payment can transfer the L/C to a third party that will receive payment from the buyer/importer. Used by traders and middlemen.

- At sight / At maturity: Payment done when receiving goods (at sight) or after the agreed period (at maturity) of, for example, 60 days.

5. Letter of credit (L/C)

The following are some of the documents most usually required when using an L/C:

- Certificate of origin- Certificate of quality- Weight certificate- Pre-shipment inspection certificate- Packing list- Fumigation certificate- (...)

6. Open account and other payment methods

Open account is the reverse to cash in advance. When payment by open account is agreed the exporter will produce and ship the goods and the importer will only pay after having received the goods.

All risk is on the exporter as payment could be easily avoided. It is only advisable for long established relations.

It causes financial difficulties to the exporter but may be a great commercial tool.

Other payment mechanisms are:

Consignment sales: Sending the goods to the importer who will stock them and pay only after having sold them himself. As if the importer was a foreign warehouse for the exporter.

Countertrade: Exchanging goods for other goods instead of being paid in money.

7. Mixed payments and export insurance

Very often payment methods are mixed to fit the importer/exporter needs. Including, for example, a percentage in advance to secure the order compromise (showing real interest from the buyer) and other mechanisms as an L/C for the rest of the payment. Example: “20% cash in advance + 80% irrevocable L/C”

One of the main tools protecting businesses from failed payments are export insurances: paying a fee to an insuring company in order to protect against failed payment the exporter may recover a percentage of the unpaid debt (usually bellow 100%). It is an attractive tool as it helps rate costumers (insurance companies deny coverage to companies with bad payment records or weak finances). At the same time, failing to pay to an insured company will affect the credit rating of those companies and will be an incentive for them to pay.

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8. Case V