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LU 9: Methods of payment - Coggle Diagram
LU 9: Methods of payment
analyse procedures in documentary credits, bank collections and open account transactions
Letter of credit(documentary credit);
basically the the importer's bank promises the exporter that if the importer doesn't pay them they will.
- the credit worthiness of the bank is switched for the importer this how the exporter stays protected.
- with this LOC's are not paid until the exporter provides the necessary set of documents, which was agreed to in advance. protecting the importer.
- Importer and exporter agree to conduct business on a LOC basis, exporter sends a pro forma invoice to the importer( basically a pre-receipt)
- the importer calls his local bank(issuing bank), to provide them a LOC, naming the exporters as the beneficiary.
- The Importers bank bank sends the LOC to the exporters bank(advising bank)
- the exporters bank(AB) reviews the LOC, ensuring that it is what the exporter originally agreed on.
- the exporter ships goods to importer, by doing so it collects some documents from the carrier(based on incoterm) and sends all these doucments(invoices, etc) to the AB
- the AB checks the documents against the LOC and the notifies the importer bank(IB) that everything is in order. then the exporter bank then sends the document to the IB
Discrepancies (incase its not in order), when the AB checks against the LOC and notices there is a differences(Discrepancy) between the documents submitted by the exporter and the documents requested by the LOC, it asks the IB to amend the LOC
- only after the LOC is amend(with mutual consensus) the AB forwards the documents to the IB
- the IB send the documents to the importer
- After receiving the documents, the import pays the the IB
- The importer's bank transfers the funds the AB
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Types of LOC's
(Advising banks) AB, on occasion the exporter doesn't or cant advise a LOC issued by a bank with which the AB's are not familiar with.
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Correspondent bank, a bank in the importers country which the exporters bank has a relationship.
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Stand-by LOC,
similar to a ordinary(basic) LOC, but its valid for multi shipments and allows for bills of lading to be issued on multi dates. With such a system, exporter will make shipments on an open account and will call(bring it out) on the LOC only if the importers is not meeting its obligation.
SBLOC;
the bank is obligated to pay if the exporter presents the docs required by the LOC and the importer has not paid
Transferable LOC,
LOC that the beneficiary uses to secure its own payment to others, i.e. a TLOC is used when the exporter needs to buy more raw mats before it can produce what is sold to the importer.
Back to back LOC,
a LOC issued by the exporter, naming its suppliers as the beneficiary, and that LOC is issued to the Importer's bank as evidence of credit worthiness
Red-clause LOC,
when the exporter doesn't have enough to working capital to finance manufacturing the product they need to sell to the importer. possible to ask the importer to issue a red-clause LOC, where the importer gives the exporter with a cash down payment, prior to shipment, to afford the production of the goods.
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Advantages and disadvantages of various methods of payments with suppliers, customers, banks an financial managers of importers and exporters
1. Cash in advance;
highly secure for seller but requires trust and financial strength, the exporter requests that the customer provides payment in advance before the shipment occurs. This is entirely risk free to the exporter, no collections, exchange fluctuation exposure, no cash-flow problem, exchange fluctuation exposure.
Only recommended in few countries where i fraud is rampant, where there is political instability, where currency is non-convertible or where there is the possibility of foreign exchange.
- not the best for developed countries.
2. Open account,
a method where goods are shipped before payment, favouring the buyer, this method is similar to conducting business domestically, where the exporter gives an invoice and expects to paid promptly(or with a certain time frame.)
- LOCS, covered on the right
4. Documentary collection,
basically the importers store the documents in the importer banks, and once exporters fufill quota, the recieve what the instructions, payment or information is
- a middle-ground option where banks assist in exchanging documents and payments but do not guarantee payment
5. Trade credit insurance:
tool mitigates risk by covering potential losses if the buyer defaults
- its possible to make international payments on an open account with little risk, provided the non-payment risk is transferred to an insurance company
- insurance companies sell credit insurance, a policy that covers non-payment by the importer