If you are an international business development manager, then selecting the right export payment terms for your client is one of the most important decisions that you will make. Whilst you probably won’t make this decision alone, it is you as the international specialist who has to know what are the risks and who is able to consider the necessary factors in order to make the right decision when selecting international payment terms and conditions.
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Why is the choice of export payment term so critical?
Nobody likes the idea of either not getting paid for making a delivery, or not receiving something that they have paid for!
Any decision about payment terms is always a matter of negotiation with both the exporter and importer, with each trying to reduce their risks. If you ask a banker what is the best payment term for an export business they will probably advise you to use a letter of credit. That’s because a letter of credit (L/C) on the one hand is very safe but on the other hand is also rather expensive. So it is the instrument with which the banker will earn the most money. It isn’t necessarily the best solution for you and your client.
So what are the factors that you need to be considering? Of course each company has their own approach to risk minimisation and to approaching relationships and that plays into all the steps of this decision making process.
Selection Factors for International Payment Terms and Conditions
Is the relationship with your buyer a new relationship or is it an established one?
If you have a new partner, then you’re not likely to take that many risks with the payment terms that you’re offering to him. As yet he doesn’t have a track record with you about how his attitude to payments looks and whether he is truly credit worthy.
Of course, you can do things like credit checks using a company such as Dun and Bradstreet, or perhaps through your country’s commercial office in the country where he is based. However, at the end of the day, nothing beats personal experience for you to say “this client always pays on time” or “this client is really reliable in his payments.” (Also don’t forget that there are companies who pay very reliably but perhaps not on the exact day that would be necessary to count as punctual, so don’t get all nervous, just because a payment arrived a day late)
Remember that the payment term you agree for the first deliveries can also change a couple of months down the line where you know each other better.
What kind of order is it?
Is the order to be shipped from stock or are the products custom made?
Are the products a one off shipment or do you expect that this will be an ongoing business relationship?
Of course, if you’re anticipating an ongoing business relationship, then you may be prepared to enter into a more risky payment term than if you know that it is a one off purchase (and therefore you want to be sure of receiving your money from the client).
On the other hand, if you are producing something bespoke for a client, that might be because he needs a specific recipe or he needs a special language version on the packaging then you might for example, ask him to pay for certain things upfront of the production process. For example, if you need to purchase ingredients which otherwise you don’t use for any other market, then you may ask the client to pay for those in advance
You might offer him credit terms on the balance of the payment but for the part which you are not able to use in a shipment to another client, or not able to resell (should he for some reason not accept your delivery), then you may decide that you need to be compensated prior to investing in the production process.
What is the political situation?
If a country is politically unstable then you are probably going to want to have a more stable and secure method of payment. However, you may also find that in such markets foreign currency controls are in place. That may mean that your choice of options for international payment terms and conditions are limited.
For example, Egypt recently legislated to oblige importers to pay using a letter of credit instead of the previously popular cash against documents. (or other methods)
You don’t want to discover that a change in regime means that the products which you delivered last month can now no longer be paid for even if the importer is willing and able to pay your invoice. Or your importer doesn’t want to pay for products that are suddenly unable to be brought into the country due to an overnight law change.
What is the economic situation in the market which you are selling to?
If the economic situation in your target market is extremely difficult or unstable, then this is a factor which will also affect the credit worthiness of your client.
Your client may have the risk of his clients going bankrupt or simply failing to pay without long, difficult court processes.
If your client is delivering his products, all of his range not only the products he buys from you into the market, but retail or perhaps the government contracts which he has don’t pay him back until four or five months after he’s made delivery this will of course have a huge effect on his cash flow. This often happens in pharmaceuticals.
You can usually find lists of both the political risk and the economic risk of certain countries in the form of rankings, which may be published by international banks or credit Institute’s of various kinds.
What kind of credit terms are your competition offering?
It’s really difficult within the market to ask for payment in advance if all of your competitors are offering 90 days open account. ?
This would have a huge impact on the cash flow of your client. It also impacts the credit terms which he is able to offer to his clients and therefore his competitiveness on the market as well as the speed at which he is able to grow your sales (or not!).
Remember though that under the motto of “all’s fair in love & war” (international trade falls into this category!), your buyer may be exaggerating the situation slightly in order to get a better deal from you.
Do you have a risk of short term price changes?
If you look at the markets at the moment, which have been very turbulent in the last weeks due to the war in the Ukraine, then many manufacturers (not only in the food and beverage space) have a situation where they need to make short term price changes due to fluctuations in the cost of raw materials and energy. If you have this kind of a situation, you need to think how that is going to affect the credit terms which you want to offer or need to offer to your clients.
If you’re offering very long credit terms to a customer and the associated costs of your product change drastically within the period of his credit term then the money which you receive from the client at the end may not actually be enough for you to take and to grow your business with going forward.
One other point which isn’t to be forgotten is the question of exchange rates and how volatile the currency is in the market that you’re dealing with. If you’re offering extremely long payment terms, or anything over 30 days in markets at a time when there are huge problems with currency (for example, as has been the case in Turkey in recent months), then you or your importer probably also need to think about how you can insure the value of the exchange rate in order for both of you not to lose out hugely.
What is the usual practice in the country in which you are selling?
There are some countries such as in the Middle East or in Africa, where working with a letter of credit is a very typical method of payment for larger shipments. This is also true for China and Vietnam or the Philippines.
However, there are other countries where perhaps documentary collection could be a more usual term of payment. And in this case, if you require your client to pay via a letter of credit, they may look at you strangely because you’re adding additional costs into the business process.
Also, if you asking for your client to pay in advance or on 30 days, when actually what is usual in the market is a 60 or 90 day payment process or perhaps even longer, then this is also something which whilst advantageous for you is a disadvantage for your importer.
What is usual in your industry?
For example, in the oil and gas industries, then payment by a letter of credit is quite usual. Whereas in textiles a documentary collection of some kind is often used.
What do you need to consider with cash flow?
What are the financial strengths and the financial needs of both parties? These will have a massive impact on the payment term which you choose at the end of the day.
If you suddenly offer a 60 day credit term to your number one export market after a period of a letter of credit which was paid at sight, then this can have a massive impact on the cash flow of your business which may not be manageable. If you make that kind of change from one day to the next, you may find yourself in a situation where you’re not able to cover your bills on time. And the same goes for your importer, if you suddenly shorten a payment term for some reason.
What are the main terms of payment in international trade?
I will go into the risks and benefits of the various international payment terms in a later post. However, for today, I would just like to define a little bit what are the most common payment terms in international trade.
The order that I have listed here goes from “safest for the exporter, most risk for importer” through to “most risk for exporter, safest for the importer”.
- Payment in Advance (also called cash in advance).
- letter of credit
- documentary collection.
- payment on open account.
- payment on consignment.
So I will define all of those in a bit more detail to ensure understanding.
Cash in advance is exactly what it says.
In this case the client pays you, the exporter, in advance of you shipping the goods. This is a payment term which obviously is really advantageous for the exporter. And in most cases you probably will only use this in the event of having a very bespoke product for a client. Eg where he needs to pay you in advance for you to buy certain raw materials or to go through a certain production process (these are probably products that you couldn’t sell to another market).
Or in the event that you have a new customer and he doesn’t have a track record with you yet. So you want to ensure that you receive the money before you trance transfer the goods to him.
If you’re using a cash in advance payment term, then it is worth remembering or ensuring that you actually have the money on your account or that you have at the very least received a swift copy prior to loading the goods onto the truck or container at your warehouse. It’s easy for the team preparing the documents to release the order as a truck arrives, without checking that the money is truly on the account.
A letter of credit is one of the most secure payment methods which is available to anyone exporting
This is a commitment by the bank on behalf of the buyer that payment will be made to the exporter as long as the terms and conditions which are stated in the letter of credit are met. You might use this if you are uncertain about the credit worthiness of the customer, but know that their bank is reliable.
The banks check the documents and as long as these are correct the payment is made.
As long as the buyer has specified the right terms within the L/C then this also offers security to the buyer as he doesn’t have to pay until after the goods have been shipped (the bill of lading transferring ownership is a key document with an L/C payment).
A documentary collection is where the exporter entrusts the collection of the payment to its bank. So, the exporter’s bank sends the documents that the buyer needs to the importer’s bank with instructions that they can release the documents to the buyer for payment. The payment from the importer goes to his bank then it’s remitted to the exporter’s bank and then goes to the exporter of course, in exchange for the documents (the bill of lading is again a key document here).
This involves using what is called a bank draft and that requires the importer to pay the amount of the invoice either at sight where it’s called documents against payment (or cash against documents), or on a specific date in the future. So that might be 30 days after sight, for example, and that is known as documents against acceptance.
The collection letter gives very specific instructions, stating which documents are required for the transfer of ownership of the goods. The banks act as facilitators in this case, but there’s no verification of the documents. So it’s a less secure transaction than using a letter of credit but it’s also a much less expensive option.
An open account transaction is the one that usually many importers would like to have from the very beginning. They would like to have for example, a 60 day credit term right from the start because this is better for their cash flow. And the usual terms are either 30, 60 or maybe even 90 days. In the past I had 90 days for example, when working with Greece. (Insofar as I wasn’t working with a documentary collection).
This is something that the importer will often press for depending on what the competition is offering. So if you as an exporter and not offering competitive terms, then you may lose out in theory, when compared to a competitor of yours.
However, if you as an exporter are offering open account terms to an importer with whom you’ve not got any kind of track record, then you have to be aware that you’re either taking quite a large risk of non payment or bankruptcy from your buyer, or you need to think about having some kind of credit insurance in place to make sure that you actually receive your payment.
This is almost like an open account delivery, but the importer doesn’t actually have to pay for the goods until after he’s sold them. So the exporter delivers the goods into a country and the goods are stored in a warehouse which both parties have access to. The importer then sells from that warehouse so he’s selling goods and receiving payment on goods which actually belong to you as the exporter.
On a monthly basis he then has to send you a list of “this is what I’ve sold, and this is the money for what I’ve sold”. Of course this is a huge statement of trust for you as an exporter to to give this payment term to your business partner. It probably isn’t something that very many exporting companies are willing to do.
It’s certainly something where you should ensure that you have appropriate insurance in place and where you do regular inventories of the stock which is held. This is especially important for any kind of advertising materials because advertising materials tend to evaporate into thin air if you have a consignment arrangement with partners.
The main points to consider when selecting an international payment term
When you as an international business development manager are thinking about which payment terms you want to offer to your clients, then you have to consider what is usual in your company and what can your company afford?
Then you have to also consider what can your buyer afford? If they are offering their clients 120 days credit terms because of an economic crisis in the country, then you probably will need to support them at least part of the way with some kind of credit term. So maybe you say that they can have a letter of credit with a 60 or 90 day payment term on that credit. And that will be guaranteed by the bank if you’re not willing to go as far as an open account payment. You probably do need to actually offer them some kind of support though if they’re going to grow your brand and be motivated to put focus on your products in the market.
Depending on how the relationship between the two of you is and your negotiating power, this will affect whether it’s possible to have the payment term of your choice or not. In the end it comes down to which risks both sides are prepared to carry, but selecting the right international payment terms and conditions can help avoid headaches in the future.
If the company you are working for is risk averse, then it is worth looking into the costs of credit insurance because this may allow you to better support your international partners in their growth trajectory. It can be a reasonable price for peace of mind, but that is a subject for another post.
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