Exporting From India Series: Understanding Export Payment Terms in Export Compliance in India

Export payment terms dictate how and when an exporter gets paid for goods sold internationally. Choosing secure and efficient payment terms is critical for mitigating risks, ensuring smooth transactions, and maintaining good relationships with buyers. Different terms offer varying levels of risk and convenience for both exporters and importers, depending on factors like trust, market conditions, and buyer reliability.

Here’s a detailed explanation of the most common export payment terms and their implications.

1. Letters of Credit (LC)

A Letter of Credit (LC) is a financial instrument issued by a buyer’s bank guaranteeing that the seller (exporter) will receive payment, provided specific conditions outlined in the LC are met. It’s one of the most secure payment methods for international trade.

How It Works

1. The buyer requests an LC from their bank (issuing bank).
2. The issuing bank provides the LC to the seller’s bank (advising bank).
3. The seller ships the goods and provides the required documents (e.g., Bill of Lading, Commercial Invoice, Packing List) to their bank.
4. The advising bank verifies the documents and forwards them to the issuing bank.
5. The issuing bank releases payment to the seller if all conditions are met.

Advantages for Exporters

• Bank Guarantee: Payment is secured as long as the terms of the LC are fulfilled.
• Risk Mitigation: Reduces the risk of non-payment due to buyer insolvency or disputes.

Challenges for Exporters

• Complex Documentation: The exporter must provide precise and error-free documentation.
• High Costs: Banks charge fees for issuing and processing LCs, making it an expensive option.

When to Use

• When dealing with new buyers or buyers in politically unstable countries.
• When large transactions are involved.

2. Advance Payment

In this method, the buyer pays the exporter either in full or in part before the goods are shipped.

How It Works

1. The buyer transfers the payment directly to the exporter’s account.
2. Upon receiving the payment, the exporter ships the goods and provides proof of dispatch to the buyer.

Advantages for Exporters

• Low Risk: Exporters receive payment upfront, eliminating the risk of non-payment.
• Improved Cash Flow: Payment is received before production or shipment, which helps with operational costs.

Challenges for Exporters

• Buyer Hesitation: New buyers may be reluctant to pay in advance without assurance of delivery.
• Competitive Disadvantage: Advance payment terms can deter potential buyers, especially in competitive markets.

When to Use

• For small transactions or when dealing with highly trusted buyers.
• When exporting customized or high-value goods.

3. Open Account Terms

In an open account transaction, the exporter ships the goods and extends credit to the buyer, allowing them to pay at a later date (e.g., 30, 60, or 90 days after delivery).

How It Works

1. The exporter ships the goods to the buyer.
2. An invoice is sent to the buyer specifying the payment due date.
3. The buyer pays the exporter within the agreed timeframe.

Advantages for Exporters

• Market Competitiveness: Buyers prefer open account terms as it reduces their upfront financial burden.
• Encourages Repeat Business: Building trust with buyers by offering favorable terms can lead to long-term relationships.

Challenges for Exporters

• High Risk: There’s no payment guarantee, and the exporter bears the risk of buyer default.
• Cash Flow Issues: Delayed payments can impact the exporter’s working capital.

Risk Mitigation for Exporters

• Use Export Credit Insurance: Policies provided by entities like the Export Credit Guarantee Corporation of India (ECGC) protect against non-payment risks.
• Offer terms only to financially stable buyers with a reliable payment history.

When to Use

• For long-term buyers with proven reliability.
• In highly competitive markets where offering credit terms is necessary to secure contracts.

4. Other Payment Terms and Methods

A. Documentary Collection (DC)

In this method, the exporter’s bank acts as an intermediary to collect payment from the buyer in exchange for shipping documents.

1. The exporter ships the goods and submits the documents to their bank.
2. The bank sends these documents to the buyer’s bank.
3. The buyer makes the payment to their bank to receive the documents needed to claim the goods.

Types of DC:

• Documents Against Payment (D/P): Payment is made immediately upon document receipt.
• Documents Against Acceptance (D/A): Payment is deferred (e.g., 30 or 60 days after acceptance).

Advantages: Lower costs compared to LC.
Challenges: No guarantee of payment, as banks don’t bear any financial risk.

B. Escrow Services

An independent escrow agent holds funds from the buyer and releases them to the exporter once agreed conditions are met.

• When to Use: For high-value transactions or when both parties are new to each other.

C. Online Payment Platforms

Platforms like PayPal or Stripe facilitate faster payments for small-scale exports but may have higher transaction fees and limited support for large transactions.

Choosing the Right Payment Term

Exporters should choose payment terms based on the following factors:

1. Buyer’s Financial Stability:

   • New buyers or those with uncertain creditworthiness may require secure terms like LC or advance payment.

2. Country Risk:

   • For buyers in countries with political instability or currency fluctuation risks, secure methods like LC are preferable.

3. Transaction Value:

   • High-value transactions often justify the cost of LCs, while smaller transactions might work well with advance payment or open accounts.

4. Relationship with Buyer:

   • Established trust with repeat buyers can make open account terms viable.

5. Market Competition:

   • In competitive markets, flexible terms like open accounts or deferred payments may help secure contracts.

Risk Mitigation Strategies for Exporters

1. Export Credit Insurance: Protects exporters against the risk of non-payment due to buyer default, political risks, or currency issues.
2. Partial Advance Payments: Request part payment upfront and the remaining through secure terms like LC.
3. Diversify Payment Methods: Avoid relying solely on one payment term, especially open accounts, to spread risks.

Conclusion

Understanding and selecting the right payment terms is crucial for mitigating risks and maintaining financial stability while exporting. By evaluating factors like buyer reliability, transaction value, and market conditions, exporters can choose secure options such as Letters of Credit, Advance Payments, or Open Account Terms. Combining secure payment terms with risk mitigation strategies ensures smooth, profitable export transactions and builds long-term trust with international buyers.