Methods and Instruments of Payment and Pricing Incoterms
METHODS OF PAYMENT 2>+*+ststttttrntttrtrtrrerrrrrrr -25- 2 FINANCING EXPORTERS AND IMPORTERS
Exporting firms often extend credit to importers, but they carefully assess new customers and monitor existing accounts If the risk is deemed too high, the exporter may decline credit requests and suggest alternatives like advance payments or irrevocable confirmed letters of credit Conversely, for creditworthy customers, experienced exporters may offer a usance facility, allowing a payment period of one to two months.
Timely payment is crucial for exporters, as the risk associated with extending credit is a significant factor Exporters have various payment options when selling products internationally, which depend on their assessment of the buyer's trustworthiness In domestic sales, transactions are often conducted on an open account for buyers with good credit, while cash in advance is preferred for those without In export sales, the primary payment methods in international trade include
2 Letter of Credit (Import LC)
1 Advance Payment (Payment in Advance)
An exporter would prefer payment in advance of the shipment A telegraphic transfer is commonly used for international remittances
For the importer, advance payment tends to increase risks Furthermore, Payment in advance is not very common in most countries Buyers are often
Exporters who require advance payment may risk losing business to competitors who provide more flexible payment options This concern arises from the fear that items may not be dispatched if payment is made upfront.
Exporters utilizing e-commerce to sell low-value consumer products directly to end users often accept credit card payments However, when dealing with international credit card transactions, it is crucial for exporters to be vigilant about the risks of fraud and to verify the legitimacy of each transaction.
2 Letter of Credit (Import LC)
A Letter of Credit (LC) serves to safeguard the interests of both buyers and sellers in international trade When importers prefer not to pay in advance, exporters may request that they obtain an LC from a reputable bank This document represents the bank's commitment to pay the exporter on behalf of the importer, contingent upon the exporter meeting all specified terms and conditions Consequently, the exporter gains assurance of payment from the bank, protecting them in case the importer fails to fulfill their payment obligations.
Since payment by this method is made on the basis of documents, all terms of payment should be clearly specified in the LC in order to avoid confusion
Banks charge a fee for opening the LC which is based on a percentage of the amount of payment
Exporters typically anticipate that importers will cover the costs associated with the Letter of Credit (LC); however, some buyers may resist this extra expense In these situations, exporters must either bear the LC costs themselves or jeopardize the opportunity for a sale Additionally, LCs for smaller amounts can be particularly costly due to high fees.
Payment under a Letter of Credit (LC) relies solely on the submission of specified documents, disregarding the actual condition of the goods Key documents required from the exporter include the Bill of Lading, invoice, draft, and insurance policy, all of which must be presented before payment is made Additionally, the LC includes an expiry date, and the bank involved must ensure that all submitted documents meet the stipulated requirements.
An amendment refers to any modification made to a letter of credit (LC) after its issuance, and banks typically charge a fee for this service Importers should actively seek to obtain the necessary amendments to ensure smooth transactions.
LC right at the first instance (Taking concurrence from the exporter on the terms to be included in LC)
Importers can request their banks to use wire (telegraphic) transfer to expedite the payment, if required
A draft, known as a Bill of Exchange, is a financial instrument submitted by the exporter to their bank, which then forwards it to the importer's bank The importer is required to make the payment by the due date, which varies based on whether the Bill of Exchange is classified as a Sight Bill or a Usance Bill.
A Sight Bill of Exchange allows exporters to receive payment before importers take possession of goods at the port, with the payment term being Delivery against Payment (D/P).
The Bill of Lading is transmitted from the exporter to the buyer's bank through the exporter's bank, along with a Sight Draft, invoices, and additional documents required by the buyer, such as a packing list and insurance certificate Upon receipt of these documents, the importer's bank informs the importer.
As soon as the draft is paid, the importer's bank hands over the Bill of Lading that enables the importer to obtain the shipment
A usance Bill of Exchange, also known as a time draft, allows exporters to extend credit to buyers, enabling them to use the goods before payment is due The draft specifies that payment must be made within a set period, such as 30 days after the buyer accepts the draft and receives the goods By signing and marking the bill as 'accepted,' the importer commits to paying within the agreed timeframe This payment arrangement is referred to as Delivery against Acceptance (D/A), where the bank delivers the transport document to the importer in exchange for their acceptance to pay after collecting the goods.
In foreign trade, an open account is a convenient payment method when the importer has a strong reputation and a positive payment history This approach allows exporters to bill customers, who are then expected to pay at a later date according to agreed terms Many multinational companies prefer to make purchases on an open account to avoid the costs associated with opening a letter of credit (LC).
Selling an open account carries inherent risks, as the lack of documentation and banking channels complicates the legal enforcement of claims Consequently, exporters may face challenges when attempting to collect payments from overseas.
Financing receivables can be challenging, particularly because these accounts often lack drafts, making pre-shipment or post-shipment financing difficult Exporters considering sales on open account terms must carefully assess the associated political, economic, and commercial risks.
Financing international trade is an important function of commercial }
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In global import transactions, the primary payment methods include credit transfers, direct debits, cards, and cheques Although electronic money is currently underutilized, it holds significant growth potential and may become more prevalent in the future.
-30- major payment instrument in the days to come (e-money is in the form of pre-paid cards or instruments that can be stored on a PC.)
Credit transfers are directives from the importer to their bank, instructing it to debit their account and credit the exporter’s account In Europe, credit transfers are the most commonly utilized payment method, representing approximately 30% of all non-cash transactions.
Direct debits are pre-authorized transactions initiated by the exporter from the importer's bank account, commonly utilized for recurring payments Meanwhile, Telegraphic Transfer (TT) is the preferred method for transferring funds to facilitate payments.
Payment cards, including debit and credit cards, are issued by banks or card companies A debit card allows the holder to access funds directly from their bank account, while a credit card enables the user to borrow money up to a specified credit limit.
A cheque is a written directive from the importer (the drawer) to the exporter (the drawee, typically a bank), instructing the drawee to pay a specified amount either to the drawer or to a designated third party upon request In certain countries, such as France, Ireland, and Portugal, the use of cheques remains prevalent Additionally, importers may opt for a Demand Draft (DD) for payments, especially when advance payments are required, as DDs are often favored when bank fees for telegraphic transfers (TT) are higher.
International Commercial Terms, known as Incoterms, are a series of international sales terms widely used and accepted throughout the world They divide transaction costs and responsibilities between a buyer and seller
Incoterms define the responsibilities and risks associated with the delivery of products from sellers to buyers, including aspects such as transportation, export and import clearance, cost allocation, and risk management at various stages of the shipping process These terms are inherently tied to specific geographical locations.
Incoterms were devised and published by the International Chamber of Commerce (ICC) and endorsed by the United Nations Commission on International Trade Law (UNCITRAL)
A list of Incoterms are as follows:
1 EXW (Ex Works): export packing, marking crates with shipping marks
2 FCA (Free Carrier): first carrier, this could be any mode of transport, example air, rail, and road
3 FAS (Free alongside Ship): the seller gets goods alongside ship This is used for shipping transport only
4 FOB (Free On Board): dock dues, loading goods on board ship Preparing shipping documents This is used for shipping transport only
5 CER (Cost and Freight): sea freight to bring the goods to the port of destination,
This is used for shipping transport only
6 CIF (Cost, Insurance and Freight): marine insurance (port to port) This is used for shipping transport only
7 DEQ (Delivered Ex Quay): landing charges at port
8 DDP (Delivered Duty Paid): import duty
Incoterms are acknowledged by governments, legal authorities, and practitioners, serving to clarify the responsibilities of parties involved in international trade Their primary purpose is to define costs, determining who bears the expenses; control, specifying ownership of goods during shipment; and liability, outlining who is accountable for damages at various stages of the shipping process.
Incoterms are subject to changes every 10 years and are currently a total of 11
1 Determine the critical points of the transfer of risk of the seller to the buyer in the process of shipment (risk of loss, deterioration, robbery, etc )
2 Specify who is going to subscribe the contract of carriage
3 Distribute the logistic & administrative expenses between the seller & buyer at various stages of the process unloading, and inspection of the goods
Confirm and fix respective obligations for the achievement of the formalities of exportation and importation
Obligations in Trade e Seller’s Obligations © Must provide the goods & the commercial invoice in conformity with the contract of sale
Determine who is responsible for packaging, marking, operating, loading, |
In a sales contract, the buyer is obligated to cover the costs associated with checking operations, including quality control, measuring, weighing, and counting goods According to Incoterms, there are different groups that define shipping responsibilities: Group F indicates that the seller does not pay for the primary shipping costs, while Group C specifies that the seller is responsible for shipping expenses Group E outlines that the seller's obligations are fulfilled once the goods are ready for departure from their facilities, and Group D states that the seller's responsibility ends when the goods arrive at a designated location.
4 RISK TRANSFER POINT FROM SELLER To BUYE
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Group E - Departure e EXW- Ex Works o The seller has the goods ready for collection at their premises
(factory, warehouse, plant) on the date agreed upon o This trade term places the greatest responsibility on the buyer and minimum obligations on the seller
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In Group F of Incoterms, the seller is responsible for delivering goods cleared for export to the first carrier at a specified location under FCA (Free Carrier) For FAS (Free Alongside Ship), the seller must position the goods alongside the ship at the designated port, also ensuring they are cleared for export Under FOB (Free on Board), the seller is tasked with loading the goods onto the buyer's nominated ship, with costs and risks being shared at the ship's rail.
Group C shipping terms include CFR (Cost and Freight) and CIF (Cost, Insurance, and Freight), where the seller covers costs and freight to the destination port, with risk transferring to the buyer once the goods cross the ship's rail CPT (Carriage Paid To) serves as the multi-modal equivalent of CFR, transferring risk when goods are handed to the first carrier Similarly, CIP (Carriage and Insurance Paid To) is the containerized transport equivalent of CIF, where the seller pays for both carriage and insurance until the destination, with risk passing upon handover to the first carrier.
Bac e DDP (Delivered Duty Paid) indicates that the seller is responsible for all transportation costs and assumes all risks until the goods are delivered and duties are paid DAT (Delivered At Terminal) signifies that delivery occurs when the goods are provided to the buyer after unloading from the arriving mode of transport DAP (Delivered At Place) means that the seller delivers the goods to the buyer, who is ready to unload, with the seller covering all associated costs and risks during transportation.
Types of Transport e Any Mode of Transport (Seven Incoterms): CIP, CPT, DAP, DAT, DDp,
EXW, FCA e Sea and Inland Waterway Transport Only (Four Incoterms): CFR, CIF, FAS, `
It is very important to understand the different modes of payment, such as
Advance payments and payment instruments such as Letters of Credit empower managers to make informed decisions in international trade This chapter also explores the significance of International Commerce Incoterms and their impact on pricing The insights provided will assist exporters and importers in negotiating terms and conditions effectively, as well as enhancing their marketing strategies.
1 What are the different methods of payment to be made by an importer?
2 If you are an importer, would you prefer to pay in advance? Discuss the pros and cons of advance payment?
3 Discuss the various types of LCs
4 Elucidate the steps involved in opening a Letter of Credit
5 Distinguish between FOB, CIF, and C&F Incoterms
Specify whether the following statements are True/False
6 It is necessary to hire a C&F agent in the export/import process
-36- kS unti| the | he business of exports and imports failure to comply with documentary ts may lead to financial loss
Shipping bill is a document required to seek permission of customs to export
Ex-factory price means the goods delivered to an importer at his country’s port
10 Cost and freight means the price quoted by the seller includes the payment of freight charges
For each of the following statements, choose the most appropriate option
11 The characteristic of a Letter of Credit is: (a) It is an undertaking of a bank (b) It is an undertaking to make payment
(c) Itis an undertaking given on behalf of a person (d) All of the above
12 The most widely used mode of payment by importers is: (a) Payment by Letter of Credit (b) Documentary collection (c) Deferred payment (d) Cash in advance
Export Marketing 1 MARKETING-THE CONCEPT 2 INTERNATIONAL MARKETING 3 EXPORT MARKETING GOING GLOBAL
Business Risk Management and CoYerage
RISK MANAGEMENT IN EXPORT-IMPORT BUSINESS
Risk is an aspect of any organization's operation When it is recognized, understood, and managed, risk itself can set the stage for sustainable growth
Companies must recognize and address risks in their operations by implementing a systematic risk management approach Effectively identifying and reducing market, financial, and operational risks while aiming for high growth can be challenging A well-structured risk management process enables companies to align their risk and return objectives, helping to overcome obstacles and achieve strategic goals.
Risk is an inherent aspect of every business, particularly in the international market Achieving success largely relies on the careful assessment and minimization of these risks While it is impossible to eliminate all risks, implementing an effective risk management system can significantly mitigate their impact.
TYPES OF RISKS 3 QUALITY AND PRE-SHIPMENT INSPECTION
The different types of risks are as follows:
* Risks arising out of foreign laws
The general causes for commercial risks are:
* Lack of knowledge about foreign markets
+ Inadaptability of the product + Longer transit time
To minimize commercial risks in a changing business environment, exporters must utilize forecasting techniques and closely monitor shifts in consumer preferences and fashion trends Staying attuned to the global economy is essential, as it enables businesses to anticipate challenges and respond swiftly to emerging situations The key to success lies in effective forecasting and timely action.
Political Risk Some of the common causes for political risks are:
+ Changes in political power and hence policies + Coups, civil wars, and rebellion
* Wars between countries + Capture of cargo during war
To mitigate political risks in international trade, careful selection of export destinations is essential Insurance companies may provide coverage for these risks with the payment of an additional premium, and the Export Credit Guarantee Corporation (ECGC) also offers protection against certain political risks Additionally, businesses face challenges from foreign laws, which can differ significantly from domestic regulations, leading to costly and complex litigation.
In case of any disputes arising out of contracts, these risks can be avoided by the appointment of an arbitrator at the time of contract
Most goods are transported by sea, exposing them to various transit risks, including storms and explosions, which fall under cargo risk Financial losses from these maritime perils can be significant for cargo bearers To mitigate these risks, it is essential to obtain coverage specifically designed for perils associated with marine transport.
These are natural occurrences or manmade mishaps Natural occurrences earthquakes, storms, lightning, entry of sea water into the vessel, among
Fire, smoke, collisions etc., are examples of manmade mishaps includg
These are incidental perils These perils are caused due to falls in loading, ca ying, and unloading
These perils relate to losses due to war, including civil war
Selling on credit is increasingly prevalent in international trade, where fierce competition among exporters has made importers highly sought after Consequently, importers often dictate the terms of transactions However, this trend occurs alongside rising insolvency rates and balance of payment challenges faced by many countries.
Two issues of prime importance in relation to credit risk are
1 The exporter must have sufficient funds to offer credit to the buyers abroad
2 The exporter should be prepared to take credit risks
Credit risks emerge when goods are sold on credit, primarily due to the potential inability of buyers to make payments by the due date Additionally, even if payments are made, unforeseen circumstances in the buyer's country, such as civil unrest or war, may prevent funds from reaching the exporter.
Coup, or an insurrection may block or delay the payment for goods exported
However, this can be avoided by using the services of an insurance agency
Almost all countries have public sector organizations to cover the credit risk for exporters In India, the Export Risks Insurance Corporation (ERIC) was set up in
1957 in order to provide export credit insurance support to Indian exporters ERIC was renamed Export Credit & Guarantee Corporation Limited {ECCC) in 1964
The Corporation's name was again modified to the present Export Credit Guarantee
Corporation of India Limited in 198 ECGC functions under the Ministry of
Commerce and has a Board of Directors representing Government, Banking,
Types of Cover Issued by ECGC
Standard policies: They are ideally suited to exporters in 3 order to cover payment risks
The ECGC has designed four types of Policies for shi pment made on short-term credit:
+ Shipments (Comprehensive risks) policy + Shipments (Political risks) policy + Contracts (Comprehensive risks) policy + Contracts (Political risks) policy They cover political and commercial risks
Commercial risks encompass buyer insolvency, prolonged payment defaults, and the buyer's refusal to accept goods, even when the exporter is not at fault, as outlined in specific policy conditions.
Political risks can arise from government-imposed restrictions in the buyer's country that hinder or delay payment to exporters Such risks include factors like war, revolution, or civil unrest, new import restrictions, and the cancellation of valid export licenses or the introduction of new licensing requirements after the contract date.
Bu the ECGC does not cover risks arising from contractual disputes or due to causes inherent to the nature of goods
Specific policies: These are specifically designed to protect Indian exporters from risks involved in
(a) exports on deferred payment contracts;
(b) services rendered to foreign parties; and
(c) construction works and turnkey projects undertaken abroad ẤP: ing risks in
Financial guarantee: A financial guarantee is issued to a bank for covering ris extending credit at pre-shipment as well as post-shipment stages
Foreign Exchange Risk ur when the invoice is prepared in foreign
Foreign exchange risks occ’ pees, the exporter will
: iates in terms of ruj currency If the foreign currency depreciates 1n te
Exporters may receive a lower amount in rupees due to fluctuations in foreign currency exchange rates When an export bill is negotiated under a letter of credit, the bank assumes the risk of currency fluctuations If there is a change in the exchange rate between the submission of the bill for collection and its realization, the exporter may either lose or gain based on the trend of these fluctuations To mitigate foreign exchange risk, exporters can utilize forward contracts or opt to invoice in Indian rupees.
Transferring risks to third party
Exporters can mitigate certain risks by transferring them to specialized third parties known as insurance agencies These agencies offer coverage for a variety of risks associated with exporting.
Physical risk General insurance company
Product liability risk General insurance company
Foreign exchange risk Commercial bank
Exporters can mitigate credit risk by transferring it to the ECGC, while also securing policies from general insurance companies to cover physical and product liability risks Additionally, they can manage foreign exchange risk by utilizing forward or option contracts with banks.
3 QUALITY AND PRE-SHIPMENT INSPECTION
Quality is crucial for gaining and maintaining market share in the competitive international arena In export business, the quality of products significantly influences success Developing countries often struggle with quality issues, which can hinder their ability to compete effectively in global markets.
Therefore, improvement of quality is one of the prerequisites in driving exports
Quality control (QC) is a set of procedures intended to ensure that a product or service adheres to defined quality criteria or meets the requirements of the client
An effective quality control (QC) program begins with an enterprise identifying the specific standards that its products or services must adhere to Subsequently, the company should determine the level of QC measures to implement, such as the percentage of units to be tested from each lot It is also essential to gather real-world data reflecting past performance, including the failure rates of units.
Corrective action is essential when there are excessive unit failures or instances of poor service A strategic plan should be developed to enhance the production or service process Additionally, the quality control (QC) process must be continuous to verify that any necessary remedial efforts yield satisfactory outcomes.
Pre-shipment inspection is conducted by specialized agencies according to the buyer's specifications and export quantities Many governments require that items in the compulsory inspection category undergo this process to ensure quality However, exporters with a strong track record, such as those with export house status, are allowed to perform self-certification inspections.
Advantages of Pre-shipment Inspection
Pre-shipment inspection enhances transparency in trade by ensuring that goods meet contract specifications, while also providing governments with a reliable method to monitor and regulate foreign trade through precise statistical data.
Mechanism for Enforcement of Quality