There are various methods for making payments in international market. These are: 1. Advance Payment 2. Payment against Open Account System 3. Consignment Account 4. Bills of Exchange 5. Documentary Credit or Letter of Credit or L/C.
Method # 1. Advance Payment:
Here the exporter receives the bank draft or bank advice before the contractual obligation of shipment is fulfilled. This method is obviously the most advantageous from exporter’s point of view. But this form is very rarely adopted in foreign trade. The exporter may be willing to impose the term as a precondition only when he knows that- (i) the goods are in heavy demand, and (ii) the goods are tailor-made for the customer, or (iii) goods are rare. Even in such cases, compromises are very often made.
A notice is required to be sent when goods are ready. Sometimes a percentage is paid in advance and the balance on delivery of goods. In many cases, exchange control restrictions of the importing country do not permit to make any payment in advance. The exporter may insist upon advance payment if political conditions in the importing country are unstable or credit standing of the importer is poor.
Method # 2. Payment against Open Account System:
Under this method, the exporter sends documents relating to transfer of title and possession of goods direct to the buyer (importer) with a covering letter asking for the invoice value to be remitted to him. The importer remits the amount involved immediately. In case a credit period is allowed, the importer will make the payment at the expiry of the credit period. This method is very simple and avoid many complications and additional charges.
The entire risk in this case is of exporter. But this method of payment presupposes that- (a) there is long established relationship between the importer and the exporter and exporter has faith in him, (b) the exporter has the necessary financial strength to bear the risk, (c) there is no exchange regulations in the importing country otherwise payment may not be received in time, and (d) the foreign exchange regulations of exporting country should permit such an arrangement. In India, the Reserve Bank of India has permitted this facility for inter-company transactions against ‘Round Sum Remittances’.
Thus, under this method of payment, the burden of finance is borne by the exporter and it also carries the real risk for the exporter. Generally, this method is not followed unless parties are well-known to each other and there is a keen competition among the sellers.
The various methods of payment under this system are as follows:
(a) By Mail Transfer:
Money used in importer’s country is sent by importer to exporter by post which is deposited by exporter in his bank account. The bank deposits the money in his account in the form of home currency. Payment can also be made by the importer in the form of currency being used in exporter’s country after buying it from exchange brokers.
(b) By Cheque/Bank Drafts:
Payments can also be made with the help of Banker’s cheque or draft by the Importer. Exporter receives the amount after depositing such cheques/drafts in his bank accounts. Bank draft is widely used and is the most popular mean for foreign payments.
(c) By Cash Transfers/Internet/E-mail:
Cheque or draft is usually dispatched by post or through courier. But there is likelihood of it being lost in transit or it may be late in reaching its destination. Therefore payment can be made by cable transfer. However internet and E-mail services have come into existence in place of cable transfer due to revolution in telecommunication system during the last decade. So it has become simple and easy to make international payments now as banks can transfer money without any hurdle.
3. Consignment Account:
Under this method the exporter makes shipment of goods to foreign consignee without making any claim for payment for the goods shipped but retains the title of the goods with him as also the risk attached thereto. The payment under such contracts will be made only when goods are sold.
Under such contracts, the risk is of great amount because- (i) his payment will be due on a date of sale and date of sale is quite uncertain; (ii) if the consignee fails to sell the goods, he may return the goods without any liability and at exporter’s expense; (iii) the price to be realised is also uncertain; and (iv) the consignee may not observe the terms of consignment agreement. Thus everything is uncertain until the payment is received.
Two points in this connection may be noticed:
(i) Shipment on consignment basis is done only to trusted agents.
(ii) The exporter will have to declare the expected value of consignment to meet the requirements of the Foreign Exchange Regulations Act.
Method # 4. Bills of Exchange:
In international marketing Bills of Exchange are also a popular mode of payment.
According to Indian Negotiable Instrument Act, “A bill of exchange is an instrument in writing, an unconditional order signed by the maker directing to pay a certain sum of money only to or to the order of a certain person or to the bearer of the instrument.”
There are three aspects to every bill of exchange:
1. Drawer or Maker:
Drawer is the person who writes the bill of exchange on some person and then sends this bill to him for acceptance.
2. Drawee or Acceptor:
Drawee refers to the person who accepts this bill.
3. Payee:
Payee is the person who receives the payment for the bill. If the drawer himself is the payee then the bill of exchange has only two aspects, the drawer and the drawee.
Foreign exchange bill is an order instrument which is in written form without any condition. The writer of this instrument orders another person to pay a certain amount to him or to the bearer of that instrument after a certain period.
Features of Foreign Exchange Bill:
1. It contains an order.
2. This order is without any condition.
3. It is not oral but in written form.
4. The writer who is an exporter signs on this instrument.
5. There is an order for the importer to make payment to a certain person whose name is written on the instrument.
6. Order is given with the implied understanding that the written amount will be paid after a certain period, when it is presented for payment.
7. Only a certain amount is ordered to be paid.
8. The bill is actually written in favour of a specific person, but the same person can order the amount to be paid to some other person as desired by him.
Thus Foreign Exchange Bill is a commercial instrument which is being used in practical commercial transactions. Goods are sold on credit in foreign trade. Therefore Time Bills are used in such transactions. Some countries have the provision for 3 days of grace in these bills.
For example, a bill for the duration of 3 months which is to be honoured on April 15, will be actually transacted upto April 18.
Foreign Exchange Bill—How to Write?
The following facts are to be kept in mind while writing a Foreign Exchange Bill:
1. Date:
Date is written on the right hand side of the bill. Date is essential to be written as it helps in ascertaining the maturity period. Although date can be written later on too, the same fact should be brought to the notice of the importer and he should agree to it.
2. Amount:
The amount should be written on the left hand side of the bill in figures and the same should also be written in words in the main part of the bill. There should be no difference in these two amounts i.e., in figures and words.
3. Stamp:
Stamp is to be affixed just below the amount written in figures in the time bill. The value of the stamp is according to the amount of the bill. Government has fixed the rates and value of stamps to be affixed as per the bill amount. Demand bill needs no stamp.
4. Tenor of the Bill:
When will the payment of the bill be made, is usually made clear in the bill. The exporter can demand payment anytime during working hours in case of demand bill. But payment for time bill will be made only after a certain period. This period is usually mentioned on the bill. Days of grace are also added to the time period written on the bill. Thus maturity date is arrived after adding days of grace in usual time period.
5. For Value Received:
Such words are added in the end of the bill which means that importer has received proper amount of goods or services in exchange of payment of the bill. The importer promises to make payment for the value received. Although use of this sentence is not necessary from legal point of view, still it is practically used in such bills.
6. Names of Parties:
The name of the exporter is written on the right hand side while importer’s name is written on the left hand side in the end of the bill.
7. Acceptance of the Bill:
Acceptance of the bill is accorded either by the importer or by the bank. In case of new customer the exporter prefers the acceptance through the bank because it ensures safety in matter of payment. Moreover, discounting of bill also becomes easy when a bill is approved by the bank.
There are three copies to be prepared in case of Foreign Exchange Bill to avoid delay in transactions due to long distance. There is every likelihood of letters getting lost in transit when these are dispatched abroad. Due to this risk, these three copies are sent by different mails. Debtor accepts that copy which reaches him first of all, while other copies which reach him later on are considered useless. Every copy makes a mention of other copies so that the receiver comes to know which copy he has received.
Method # 5. Documentary Credit or Letter of Credit or L/C:
Foreign payments can also be made with the half of credit instruments. When an exporter desires payment gradually with delivery of goods, credit instruments as means of payments are used. In this process credit means confidence. The word “Credit” is used in wide perspective. However in Economics, credit means postponement of payment.
“The term ‘credit’ is now applied to that belief in a man’s probability and solvency which will permit of his being entrusted with something of value belonging to another whether that something consists, of money, good, services, or even credit itself as when one may entrust the use of his good name and reputation.”
“Letter whereby one person (usually a merchant or banker) promises another person (who is either named in the letter or to whom it is intended that the letter shall be shown and who is known as beneficiary) that he will reimburse the beneficiary any amount for which he may give credit to a third person (usually a customer of the person giving the letter), either by the shipment of goods or payment of money, in respect of a commercial transaction into which the beneficiary has entered or intends to enter, with the third party.”
Thus, credit means those instruments which are being used as credit money. Such instruments are the basis of credit and facilitate exchange of loan between the parties. These act as medium of exchange for buying and selling of goods and services. Therefore credit instruments perform functions similar to money in circulation.
In the process of credit instruments, a bank writes a credit instrument on other banks or on its own branch with the instruction that payment of a certain amount may be made to the presenter of credit instrument. A person intending to send a particular amount, deposits the same amount in any bank and the bank issues him a credit-instrument.
This instrument mentions the names of those institutions from where the person can have the amount on depositing that credit instrument. Credit instrument contains the information pertaining to the bearer of the instrument like photo, signature or any special identification mark etc. The bank dispatches all such information to its branches also. The bearer of the credit instrument takes delivery of amount with the help of those instruments.
According to Gide, “Credit is an exchange which is complete after the expiry of certain period of time after payment.”
Letter of credit includes the following:
1. Buyer
2. Seller
3. Amount
4. Particulars
5. Conditions
6. Period, and
7. Important Documents.
Characteristics of Credit Instruments:
(i) Credit instruments is a certificate which is written by the banker of Importer on the Exporter’s banker.
(ii) This ensures the payment of a certain amount.
(iii) The conditions of sale are written on it.
(iv) Payment of the amount is possible only on fulfillment of the conditions.