The payment method eventually chosen by the parties will be the method that best meets their commercial transactions needs at the lowest possible cost. However, such needs are affected by multiple factors including the level of trust, goals and country risk.
When the risk is low, the parties may opt for appropriate and low cost debt settlement mechanisms.
Cheque or bank transfer
The customer may make an advance payment prior to receiving the goods; or the supplier may deliver the goods and offer the customer deferred payment with no need to guarantee it. In both cases payment may be made by cheque or bank transfer.
Sometimes the supplier seeks to keep control over the shipped goods until payment is made or a payment arrangement agreed. In this case, the supplier can entrust collecting the commercial documentation to a bank.
This is known as documentary collection or remittance. If there is no payment or promise of payment, the supplier continues to control the documentation. However, goods may have already arrived at destination, so the supplier must return it to the country of origin or find an alternative customer.
Letter of credit
A letter of credit guarantees the supplier the payment for the goods before they are shipped and even before launching production. In turn, the customer will be assured that payment will only be required when the supplier provides sufficient supporting documentation of goods dispatch. The letter of credit is, therefore, a guarantee for both parties.
Other payment methods
- Open account: credit relationship in which the customer pays upon receipt of goods or on a deferred payment basis.
- Cash in advance: payment method in which an order is not processed until full payment is received in advance.
- Collection: collecting (remitting) an amount; it can be either documentary or clean.
- Documentary credit: also known as letter of credit.
Commercial documents and payment methods
One feature of clean payments is that the commercial documents usually accompanying the dispatch of goods (invoice, transport documents, certificate of origin, etc.) are sent directly to the customer; the bank intervenes in no way.
Conversely, in collection and documentary credit, the commercial documents are part of the payment method, i.e. the intervention of a banking institution is needed. That’s why they are called documentary payment methods. In international business transactions, commercial documentation serves, among other purposes, to:
- Prove the existence of a binding contract—transport, insurance…
- Enforce compliance with the contractual obligations—freight, place of delivery, risks covered, origin of the goods…
- Itemise and describe the goods—price, quality, packaging, weight, brands…