There's no point in getting involved in international trade if you're not getting paid for your exports. It's up to you as the exporter to choose an appropriate payment method that minimizes payment risk while also accommodating the needs of the buyer.
There are five primary methods of payment in international trade that range from most to least secure. Of course, the most secure method for the exporter is the least secure method for the importer and vice versa. They key is striking the right balance for both sides. This article focuses on documentary collections.
The Advantages of a Documentary Collection
A documentary collection (D/C) is a transaction where the exporter entrusts the collection of payment to the exporter's bank (remitting bank), which sends documents to the importer's bank (collecting bank) along with instructions for payments. Funds are received from the importer and remitted to the exporter through the banks in exchange for those documents.
D/Cs involve using a bill of exchange (commonly known as a draft) that requires the importer to pay the face amount either at sight (also known as document against payment or cash against documents) or on a specified future date ( called document against acceptance or cash against acceptance). The collection cover letter gives instructions that specify the documents required for the delivery of goods to the importer.
Although banks do act as facilitators (agents) for their clients under collections, D/Cs offer no verification process and limited recourse in the event of non-payment. D/Cs are generally less expensive than letters of credit (LCs).
Understanding Documentary Collections
D/Cs are less complicated and less expensive than LCs. Under a D/C transaction, the importer is not obligated to pay for goods before they are shipped.
If structured properly, the exporter retains control over the goods until the importer eight pays the draft amount at sight or accepts the draft to incur a legal obligation to pay at a specified later date.
Although the goods can be controlled under ocean shipments, they are more difficult to control under air and overland shipments, which allow the foreign buyer to receive the goods with or without payment unless the exporter employs agents in the importing country to take delivery of the goods until they are paid for.
The exporter's bank (remitting bank) and the importer's bank (collecting bank) play an essential role in D/Cs. Although the banks control the flow of documents, they neither verify with the documents nor take any risks. They can, however, influence the mutually satisfactory settlement of a D/C transaction.
When to Use Documentary Collections
With D/Cs, the exporter has little recourse against the importer in case of non-payment. Therefore, D/Cs should only be used under the following conditions:
- The exporter and importer have a well-established relationship.
- The exporter is confident that the importing country is politically and economically stable.
- An open account sale is considered too risky, and an LC is unacceptable to the importer.
Typical Simplified D/C Transaction Flow
There are typically seven steps that occur in order to get paid using documentary collections:
- The exporter ships the goods to the importer and receives the documents in exchange.
- The exporter presents the documents with instructions for obtaining payment to the bank.
- The exporter's remitting bank sends the documents to the importer's collecting bank.
- The collecting bank releases the documents to the importer on receipt of payment of acceptance of the draft.
- The importer uses the documents to obtain the goods and to clear them at customs.
- Once the collecting bank receives payment, it forwards the proceeds to the remitting bank.
- The remitting bank credits the exporter's account.
Documents against Payment Collection
With a document against payment collection, the exporter ships the goods and then gives the documents to the bank, which will forward the documents to the importer's collecting bank along with instructions on how to collect the money from the importer.
In this arrangement, the collecting bank releases the documents to the importer only on payment of the goods. Once payment is received, the collecting bank transmits the funds to the remitting bank for payment to the exporter. Table 1 shows an overview of this type of collection:
Documents against Acceptance Collection
With a documents against acceptance collection, the exporter extends credit to the importer by using a time draft. The documents are released to the importer to claim the goods upon his signed acceptance of the time draft. By accepting the draft, the importer becomes legally obligated to pay at a specific date.
At maturity, the collecting bank contacts the importer for payment. Upon receipt of payment, the collecting bank transmits the funds to the remitting bank for payment to the exporter. Table 2 shows an overview of this type of collection:
This article is taken in large part from the Trade Finance Guide: A Quick Reference for U.S. Exporters, which you can download for free by clicking the link below.