International trade is one of the most scalable and profitable businesses in the world because commodity trading will forever be carried out between two businesses located in two different countries around the world at a certain price, procedure, quality requirement, and more, where once the first shipment is successful, the importer usually requests that the exporter continues shipping the same commodity to them monthly for a year, 3 years, 5 years, or even for life.
With the great potentials that global commodity trading holds, great risks also abound. Several exporters around the world know they may only get to ship a certain commodity only once to a buyer because there’s a chance the commodity may not fully meet the agreed requirements or that the buyer may get dubious and cause them to lose some money. And so, exporters try to shift everything in their favour to ensure they make money whether they ship a bad commodity or not to their buyers. Many buyers also try to do the same by ensuring they get the chance to only pay when they receive the commodity or not at all, even if the commodity they received meets what was agreed.
While these are risks commodity traders are exposed to, understanding and coming to certain reasonable and agreeable procedures on how both parties can operate safely with each other is key for importers and exporters to succeed in the international trade business.
Every commodity an exporter ships to an importer before receiving payment is a gift, and every payment an importer makes to an exporter before receiving the commodity is a donation. By understanding this risk that both parties are exposed to, safer trade procedures can and should be reasonably agreed to.
This article focuses more on how exporters can ensure they always get paid for every commodity they export and highlights how the exporter will not only guarantee the value of his or her shipment is paid for, but that the importer also gets value for money spent to ensure a repeat long-term trade relationship between both parties.
That said, here are the major ways exporters can always ensure they get paid in an international trade transaction:
1). Cash In Advance:
Cash in advance is perhaps the safest way for an exporter to guarantee they’re paid for the goods they’re selling to the importer. But this is extremely unsafe for the importer.
When cash is paid in advance, many things could go wrong. The exporter who would have been under pressure to ensure the quality of the goods meet the exact standards may relax on their vetting process, and so, ship sub-standard goods to the importer.
Another scenario is the exporter may even disappear, all the same, knowing that they’ve been paid and that the importer would have problems locating them. Exporters who do this are either people who have no long-term vision of how wealthy they could become if they build good trade relationships which could spiral into much more importers requesting the same commodity or more commodities from them, or are simply fraudsters whose plans were always to scam the importer and have them part with their money early on. These types of scams happen everywhere around the world.
If an importer is willing to pay cash in advance to any exporter, the exporter must be someone whom they’ve been doing business with a much safer mode of payment already. And the goal of cash in advance, in this case, should either be to help the exporter grow his or her business for the importer faster or to secure certain volumes of the commodity that many other importers may be looking to purchase from the same exporter through a different stricter form of payment.
Another way the importer can ensure they don’t lose their money in a cash in advance scenario is to ensure that they pay cash in advance only against a successful inspection of the goods at the exporter’s warehouse. Now, the exporter and the importer must have agreed on a mutual reputable inspector and shipping agent to use. And the moment the inspection report turns out successful, the importer would make immediate payment to the exporter’s bank account while there’s a mutually agreed reputable transport company that the trusted and reputable shipping agent is using to immediately load the goods onboard either the truck or the vessel.
When cash in advance is managed this way, the importer can be more confident of getting the goods than losing their money.
But no matter how calculative a cash in advance operation may appear, it’s key to know that cash in advance gives exporters the greatest level of payment security and exposes importers to the greatest level of risk.
2). Letters Of Credit:
Letters of credits are the most mutually secure forms of payment for both the exporter and the importer. Essentially, a letter of credit is a conditional guarantee that a bank will pay a certain sum of money in exchange for an agreed set of verifiable documents. These documents are to be submitted to the bank within a particular timeframe and in accordance to UCP600, which is a Uniform Customs and Practice for Documentary Credits (UCP), with the latest version being UCP600.
Types Of Letters Of Credit (L/C)
There are different types of Letters of Credit in use in the commodity trading business. Depending on what scenario your trade is operating in, any of these Letters of Credit could make a great fit. They are:
- Commercial Letter Of Credit – This is the standard Letter of credit format and may contain all or some of the attributes of the other letters of credit. It is popularly known as the Documentary letter of credit.
- Sight Letter Of Credit – This is a type of letter of credit that strictly commits to pay upon the receipt of the required documents from the exporter. Here the importer’s bank will review the documents submitted and pay the exporter if the documents meet the conditions of the Letter of Credit.
- Standby Letter Of Credit (SBLC) – A Standby Letter of Credit is simply a Bank Payment of last resort in the event that the importer does not pay for the goods exported. Here, the SBLC is simply a collateral that guarantees payment from the buyer’s bank to the seller’s bank if the seller can prove to the buyer’s bank that the buyer has not made payment for the goods sold. In some instances, a Standby Letter of Credit can be a great choice, but in many scenarios, it is a bad option for either the buyer or the seller. In another article, I’ll explain the Standby Letters of Credit in-depth and highlight the benefits and risks involved.
- Revocable or Irrevocable Letter Of Credit – This is a letter of credit that is revocable or irrevocable by the issuing bank depending on which condition was specified. Essentially, the irrevocable or revocable letter of credit is a part of every other letter of credit, and by default, a letter of credit is irrevocable unless stated otherwise.
- Confirmed or Unconfirmed Letter Of Credit – A confirmed Letter of Credit is one where the issuing bank provides a second security/guarantee of payment through a second bank. The benefit of this is if the issuing bank refuses to make payment upon fulfilment of the L/C terms, the exporter can go to the confirming bank and claim payment. An unconfirmed L/C is the opposite as there’s no confirming bank in the mix. But essentially, the confirmed or unconfirmed Letter of Credit is a part of every other Letter of Credit.
- Transferrable or Non-Transferrable Letter Of Credit – A Transferable Letter of Credit is one that allows an exporter to transfer all or a part of the payment to another exit seller. This mostly happens when the exporter is an intermediary for the real seller. A non-transferrable Letter of Credit is the direct opposite, meaning it cannot be transferred. But still, the transferred or untransferred clause can be a condition in every other Letter of Credit.
- Revolving Letter Of Credit – A revolving Letter of Credit is one that is issued for multiple transactions in place of issuing different Letters of Credits for each transaction. Here, based on when the terms of the L/C are met, the L/C is automatically renewed for the next shipment.
- Green Clause Letter Of Credit – A green clause Letter of Credit is one that pays in advance to the exporter when a condition like a proof of warehousing the goods is met. This type of L/C is usually given by an importer to help an exporter finance the export. It is termed green clause because it is mostly printed in green on the document.
- Red Clause Letter Of Credit – A red clause letter of credit, just like the green clause L/C, partially pays the exporter before the goods are shipped or the services are performed. But instead of showing proof of warehousing, the payment advance could be made against a written confirmation from the exporter to the importer or even against the issuing of a proforma invoice. This type of L/C is usually given by an importer to help an exporter acquire and export the goods. It is termed red clause because it is mostly printed in red on the document.
- Usance or Deferred Payment Letter Of Credit – A deferred Letter of Credit ensures that the exporter will receive payment after a certain period of time. The bank in this scenario may review the documents at an early period but the payment to the exporter is only made after the agreed period has elapsed. It could be after 30, 60, or 90 days from the time of shipping. The deferred payment letter of credit is also called a usance Letter of Credit.
Now, the most secure conditions for an exporter to include in the Letter of Credit asides the negotiated documents to be submitted are that it should be Irrevocable & Confirmed. When these two are included, it means that the L/C cannot be revoked or amended after the exporter has loaded and shipped the product, and that it being a confirmed L/C means that in the event that the issuing bank refuses to pay, the confirming bank will make the payment for the goods exported.
In some cases you’d want the L/C to also be transferable and revolving, such that if you receive a transferable L/C from your buyer, your bank could go on to transfer the L/C to an exit supplier whom you’re buying from, so the supplier can provide the goods and get paid when the buyer’s bank makes payment. But most buyers would refuse this as it shows the exporter is not the real supplier. The L/C can also be negotiated to be revolving so that after every successful shipment and payment, the L/C is automatically reissued by the bank to the supplier without the bank having to go through the entire process again which could take over a month.
Asides the above-mentioned conditions, an L/C can have all or some of the conditions in it.
But while letters of credits may appear like the most secure mode of payment for both the buyer and the seller, it still poses great risks to both the buyer and the seller. Some scenarios are:
- Banks only deal in documents and not in goods and services. And so, if the exporter can find a way to manipulate inspection reports from his or her source port on FOB basis and chooses even to ship a vessel or container full of rubbish instead of what was agreed between the buyer and the seller, the buyer’s bank would pay the seller the agreed amount on the L/C based on the conditions that the required documents have been submitted and successfully verified before the buyer even has the chance to see the product.
- The importer may not advise the exporter fully on the requirements of the L/C. And once the shipment has sailed, the exporter may have problems fulfilling the full terms of the L/C, causing the importer’s bank to withhold payment from the exporter.
- The exporter may also not understand UCP600, and so, may make a non-compliant presentation of documents to the importer’s bank, only to realise that payment for the goods sold cannot be received.
It’s key to know that while an L/C can secure both parties in an international trade transaction, either party can get really dubious with the issued L/C. The first party to watch out for is the importer because he or she may put some very ridiculous terms on the L/C that are impossible to meet, only causing the exporter to have a cargo en route a destination with no means of receiving payment or turning the shipment around.
The second party to watch is the exporter because if the exporter can meet the terms of the L/C documents to be submitted without actually having the right goods onboard, the importer could also lose money paid.
With this, it is key to know that a report on TradeFinanceGlobal shows that 50% of the letters of credits received in the UK, for instance, are unworkable and that 70% of the Letters of Credits are rejected for payment from the bank.
But in all, a Letter of Credit is most useful when there is little to no reliable credit information about a foreign buyer. But then, the exporter also has to be satisfied with the creditworthiness of the importer’s foreign bank.
So How Can An Exporter Fully Guarantee They Will Get Paid In An International Trade Transaction?
To do this, the exporter would need to have either built trust with the importer overtime to be able to receive cash in advance based on strictly monitored terms between both parties or the exporter can opt to work with a letter of credit under carefully negotiated terms.
With Letters of Credit being the safest for both the exporter and importer in any global commodity trade transaction, the verbiage/terms of the L/C must be agreed to up front by both the exporter’s bank and importer’s bank. Every part of it must be analysed to determine the degree of risk involved, and once it has been mutually and fully negotiated, a letter of credit would end up being the most secure form of payment for every exporter and importer in an international trade transaction.
A Key Point To Note
Under no circumstance should an exporter ever agree to receive payment for goods after the bill of lading has been printed and sent without a form of payment guarantee backing it. The reason is in countries like Nigeria, the bill of lading for a container based shipment is never printed until the vessel has sailed. Meaning that the exporter would have gone through the hassle of raising money to fund the shipment, load it, then ship it. After which he or she then goes on to mail the shipping documents to the importer’s bank before the importer chooses to make payment for the goods or not.
If this scenario is followed, an importer can choose not to make payment and there’s nothing the exporter can do about it because the vessel would have sailed and the bill of lading would have been printed and sent to the importer without any form of payment guarantee involved. Meaning the importer can clear the goods upon arrival and disappear or even claim the goods were substandard and force the exporter to take a major pay-cut on the goods shipped.
Now there’s a way to try to guarantee payment outside of a Letter of Credit for this, and it is called “Documentary Collection”. But this is in no way a real secured guarantee of payment because the importer can still refuse to pay. A documentary collection can only be used if the two banks involved have a very strong relationship regarding its use, but still, it is extremely risky and is not advisable for any party to use even if the importer has a very good credit history.
To Sum It Up
Desperacy to record a sale should never cause any exporter to risk their investments for any importer. If the importer refuses to work with a mutually negotiated Letter of Credit for the transaction, then the only option should be a cash in advance or no transaction. A lot of importers are far too dubious and will cost any foolish and desperate exporter their investment.
If you want to succeed in commodity trading anywhere around the world, understanding how to secure payments for your goods is one of the most important things. Until you get paid, you’ve not made a sale. Secure your payments every time and you would eventually become successful.
About The Author
This is an article written by Stan Edom, the Editor In Chief of Startuptipsdaily.com and the founder of Globexia Limited, a global commodity trading firm that exports solid minerals & agricultural products from Nigeria, and facilitates the global trade of oil & gas commodities.
This article along with others are written to help exporters and importers around the world to have a better understanding of the commodity trading business and to improve their chances of becoming successful in the industry.
If you’ll like to contact Stan Edom for questions or inquiries, you can reach him on +2348080888162 or via email at firstname.lastname@example.org.
What are your thoughts on how exporters can secure payment for goods sold in an international trade transaction? Let me know by leaving a comment below.
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