PG Paper trades internationally in multiple currencies, in over 55 countries. Agreeing the best payment method with our customers is often a process of negotiation.
This week, our Financial Controller, Beth takes a closer look at a payment method risk ladder – and shares her knowledge and experience of the importance of agreeing a payment option that satisfies both parties on either side of the transaction.
The Payment Method Risk Ladder
Image Source: export.org.uk
Selecting the best payment method can be a process of negotiation between the buyer and the seller. The nature of the relationship between buyer (importer) and seller (exporter) may also determine the settlement method used.
Given the risk involved in international trade, there is often uncertainty over the timing of payments between the seller and the foreign buyer. The seller, unsurprisingly, wants to receive their payment as soon as possible and the importer wants to receive their good as soon as possible, but delay making payment, for as long as possible. Negotiating an agreement that satisfies both parties in terms of risk and cash flow is therefore crucial.
Alongside managing risk and reaching agreements that satisfy both sides involved in a transaction, are payment terms. Considerations such as, market or geographical area also have an impact on the type of payment methods likely to be used.
Detailed below are four of the main payment methods used in international trade. They provide options to the buyer and seller to allow them to reach an agreement on the terms that are suitable for both parties.
The buyer receives the goods and then pays for them, usually with a credit period attached (e.g. 30, 60 or 90 days). This is probably the least secure payment method for the exporter.
This is a more secure option than an open account for the seller, whereby, as the name suggests, the seller’s bank collects the money on their behalf. It is also known as a documentary collection.
This can be a good way of ‘meeting in the middle’ with the buyer, wherein the risk is reduced (but not eliminated) for both parties.
It is also not as time consuming or costly as a letter of credit (see below) and doesn’t take up any credit facilities.
Letter of credit
A letter of credit is essentially a bank’s promise to another bank that they know the company and will act as a guarantor for the transaction. You need both banks’ party to the transaction to agree to act in this way.
Once it is agreed, if the buyer is unable to make payment, the bank will cover and pay the outstanding amount, provided that certain delivery conditions have been met.
This is the most advantageous method the seller has, where the buyer has to pay for the goods before they receive them.
This method is advisable in the following circumstances:
- There is a new relationship with the buyer
- The buyer does not have a strong credit rating
Here at PG Paper we work with our stakeholders to support payment methods that provide the right level of security for both parties whilst taking into consideration the needs of each party.