Lecture 5

(Chapter 5 Of Ram Gopal

Terms of Payment
INTRODUCTION
 In international trade, the growing competition is not confined to
quality, price and delivery schedule but extends to terms of payment.
 International trade has been not only highly competitive, equally
sensitive.
 Credit facilities extended to the importers, many a time, tilt the choice
of exporter.
 Importer may prefer that exporter who can afford credit even though
the price is relatively higher.
 When all the factors stand on the same footing between competing
exporters, it is all the more choice of the importer to finalise with that
exporter who extends credit on favourable terms.
 Here, the role of institutional credit comes into full play.
 Amount and Time of Credit
• The extent of credit needed extended to the exporter by
depends upon the terms of sale. importer, through letter of credit,
Exporter who has finalized the even to purchase raw materials to
terms of sale on Cost, Insurance, manufacture goods, meant for
and Freight (CIF) basis requires export.
more funds to finance the export • Export transactions are deemed
transaction, in relation to Free on to be complete only when the
Board (FOB) contract when no export proceeds are fully received
advance payment is received from from the importer.
the importer.
• So, sale terms influence not only
the amount of credit, but also
when the credit must be extended
to the exporter to facilitate
successful completion of export
transaction.
• In some cases, credit may be
 Amount and Time of Credit
• The terms of payment play an exchange control regulations of the
important role in export business. country, financial competence of the
How and when the exporter has to exporter, monopolistic conditions of
receive payment are decided during the product and above all bargaining
early negotiations between the strength of the parties.
exporter and importer. • According to exchange control
• Many exporters are able to clinch regulations in our country the full
the deal based on attractive value of export proceeds must be
payment terms though they may not received within a period of six
be totally competitive from the months from the date of shipment.
viewpoint of price or quality. • Any extension of the period requires
• Payment terms are determined by a the prior approval of Reserve Bank
host of factors, including the of India.
What Factors Determine Terms of
Payment?
a) Exporter’s knowledge of the Buyer.
b) Degree of security of payment, if advance payment is
not considered.
c) Speed of Remittance.
d) Cost of remittance, which normally depends on speed
of remittance.
e) Competition faced by the exporter.
f) Exchange restrictions in the importer’s country.
Methods of Receiving Payment
1. Payment in Advance
2. Documentary Bills
3. Documentary Credit under Letters of Credit
4. Open Account with Periodic Settlement
5. Shipment on Consignment Basis
 1. Payment in Advance
This is most favoured If an order from Afghanistan
method of payment from the is received, Indian exporter
viewpoint of the exporter. may prefer to forego the
This mode does not have any order however attractive the
credit or transfer risk to the price terms may be, unless
exporter in executing the advance payment is received.
contract, whatsoever. Exporter receives payment
When the conditions in the from the importer, in
importer’s country are advance, before execution of
unstable and there is no the order.
guarantee of receipt of Receipt of payment can be
payment, even after at the time of receiving the
successful execution of the order, initially, or later, in
contract, advance payment is installments, but before final
always insisted by the execution of the order.
exporter.
 1. Payment in Advance
 Payment may be received by means of importer requires those goods, there is
demand draft, mail transfer or no alternative to the importer, other
telegraphic transfer in the currency than making advance payment.
specified in the contract of sale.  Normally, importing country’s exchange
 Even in this mode of payment, slight risk control restrictions do not permit this
exists in the form of exchange risk from type of advance payment. Even when
the date of contract till the date of advance payment is allowed, a part
receipt of payment. Risk appears to be payment is made at the time of
an integral of life, at least the slightest! acceptance of order, another part, in
 However, importer seldom accepts this stages, while the manufacturing is in
method of payment. Importer does not progress, after verification and balance
accept the mode unless there is heavy before shipment, finally.
demand for those goods in his country  This methods works out to be the
or the goods are tailor- made to the cheapest mode of contract to the
specific requirements of the importer. In exporter as there would be no
those circumstances only, exporter can commission charges as banks do not
dictate the advance payment. charge while crediting the demand
 When the importer is unknown or his draft/mail transfer/telegraphic transfer
creditworthiness is doubtful and not amount to the account of the exporter.
acceptable to the exporter and the
2. Documentary Bills
When the exporter is unable to get the advance
payment from the importer, the next best alternative
mode of payment is ‘Documentary Bills’.
The exporter is unwilling to part with the documents
of title till he receives the payment and the importer
is not prepared to part with payment and assume the
risk until he is sure of receiving the goods.
Under those circumstances, ‘Documentary Bills’ is a
bridge, as documents are routed through the bank.
It provides the required solution as it satisfies the
claims of both the parties. In this system of payment,
banks act as a media to reconcile the conflicting
requirements of the exporter as well as importer.
 Forms of Documentary Bills
• Documentary Bills can be in the payment, he can get title to the
form of Sight Bill and Acceptance goods and possession.
Bill. Method of payment depends • Documents against Acceptance
on the form of bill used. (D/A): Under this method, exporter
• Documents against Payment draws usance bill on the importer.
(D/P): : Under this method, Usance period may be 30 to 180
exporter draws a sight bill on the days. Usance period days as the
importer and hands over the export proceeds are to be collected
relative documents specified in the within a maximum period of 180
contract to his banker with the days as per Exchange Control
instructions to deliver the restrictions. The essence of the
documents only on payment. The transaction is the exporter is not
documents are sent to the only willing to ship the goods but
correspondent’s bank, where the also prepared to part with the title
importer is located, with the and possession of goods, before
instructions given by the exporter. payment is received and even
When the importer makes the extending the agreed period of
credit. cannot exceed 180
Collection of Bill
In this case, either D/P bill or D/A bill is sent to the correspondent’s
bank for collection of proceeds from the importer.

In case of D/P bill, importer has to make payment to get the
documents. In case of D/A Bill, on receipt of advice from the bank,
importer accepts the usance bill by writing the words ‘Accepted’ with
his signature on the usance draft. Then only, importer gets documents
of title to goods from the bank. He can get possession of goods and
even sells the goods to get the necessary funds to make payment on
the due date. In this case, the exporter is extending credit to the
importer, apart from assuming the commercial risk of default in
payment as the importer may not pay on the due date, after taking
delivery of goods. Soon after the payment is received from the
correspondent bank, exporter’s account will be credited when the bill
is sent on collection basis.
Purchase/Discounting of Bill

• When the exporter is in need • Different terms ‘Purchase’ and

of funds, at the time of ‘Discount’ are used, in
handing over the documents, separate contexts, to serve
he can request the banker to the same purpose.
purchase/discount the bill and • However, in case the importer
allow the proceeds to be fails to pay the bill, the
credited to his account. exporter’s account will be
• If it is a sight bill, bank debited.
purchases and if it is usance
bill, bank discounts the bill.
• In both the cases, payment is
made to the exporter, on
presentation of documents.
3. Documentary Credit under Letters of Credit
 This method of payment has bank makes the payment to
become highly popular in him, once the stipulated
recent times. conditions are complied with.
 The greatest attraction to the  Above all, an important
exporter is elimination of advantage from the viewpoint
credit and payment risks. of the exporter, he can obtain
Exporter is not concerned with the payment from a bank, at
the creditworthiness of the his own centre.
borrower while entering into  The documentary bills finance
the contract. a large part of overseas trade.
 In other words, the credit of
the banker is substituted for
that of the importer. There is
no payment risk as negotiating
Documentary Bill vs Documentary Credit
under Letters of Credit

• Documentary Bills: Under this payment.

method of payment, bank opens no • If importer fails to make payment
letter of credit. Bank functions as on due date, exporter has no
an agent for collection of the bill. alternative other than filing a civil
The role of bank is that of medium suit against importer as it is not
only. legally possible to get back
• There is no commitment on the possession of goods. In case of D/P
part of bank for any payment, bill, if importer fails to make
whatsoever. payment, exporter gets back the
document of title to goods.
• In case of D/A bill, importer gets
documents of title to goods, on • There is no risk in case of
acceptance of the bill. Exporter gets nonpayment, an important
payment only if importer makes advantage from the viewpoint of
the exporter.
Contd…..
• Documentary Credit under once the documents
Letters of Credit: Letter of specified in the letter of
credit is opened by bank, credit are presented.
at the instance of the • Exporter is not concerned
applicant (importer). with the creditworthiness
• Here, the bank that has of the importer. Neither
opened the letter of credit credit risk nor political risk-
assumes the responsibility in fact, no risk exists for
to make the payment, on receipt of payment if the
presentation of the exporter, scrupulously,
documents specified in the follows conditions in the
letter of credit. letter of credit.
• So, exporter is sure of
receiving the payment,
 4. Open Account with Periodic Settlement
 Under this form of payment, of documentary evidence to
exporter sends the goods, establish the obligation on the
directly, to the overseas buyer part of the importer to make
along with invoice. The the payment.
exporter does not draw any bill  If no credit arrangement is
of exchange on the importer. agreed, the buyer has to make
 This form of payment is made payment, immediate to the
when the exporter and receipt of goods.
importer are inter-connected  However, in most of the cases,
companies like holding importer makes the payment
company and subsidiary only on the expiry of the
company or where the stipulated credit period agreed.
relationship between them is
long standing and absolute  It is desirable for the exporter
trust exists between the two. to enter into this manner of
payment only when the
 There is real risk to the exporter bonafides of the importer is
as there is no proof in the form beyond doubt.
Contd…..

• This method of payment is simple and involves no additional

costs. This form of payment is possible only when the
exporter is financially strong as he is meeting the credit
requirements of the buyer.
• It presupposes that there are no exchange control restrictions
in the importer’s county.
• Otherwise, the importer may not be able to remit the amount
when the amount falls due for payment.
 5. Shipment on Consignment Basis
 Under the consignment basis, the seller tea, coffee, wool etc.
ships the goods to his agent or  There is a certain advantage to the
representative. exporter to secure better realisation as
 Exporter retains legal title to the goods the buyers would be having an
though the physical possession is with opportunity to inspect the goods and
the agent. may be willing to pay a higher price if
 As and when agent sells the goods, he they are satisfied with the quality of the
makes the remittance to the principal product.
who is the exporter.  At the time of sending the goods on
 There is no financial security to the consignment, the exporter has to declare
exporter if the agent is dishonest, not the selling price of the goods in the GR
sincere or fraudulent in working as no form. If the value of the goods is not
document of evidence in the form of Bill ascertainable, the exporter has to declare
of Exchange is available to protect him that value, at which they can be sold,
from default. In case goods are not sold, having regard to the prevailing market
the agent will send back the goods to the conditions at that time. FERA provisions
exporter, at the risk and cost of later. indicate that the exporter shall not sell
the goods at a price lower than the
 However, this form of payment declared value unless exporter takes prior
arrangement is common in respect of permission of RBI forsuch sale.
those goods, which cannot be
standardised in respect of quality such as