Relationships Between Buyer and Seller Discussion
HOT TIP: Relationships between buyer and seller make the difference by reducing mistrust. Make an effort to meet and get to know your trading partner.
Consignment. In a consignment arrangement, the consignor (seller) retains title to the goods during shipment and storage of the product in the warehouse or retail store. The consignee acts as an agent, selling the goods and remitting the net proceeds to the consignor. Like open-account sales, consignment sales can be risky and lend themselves only to certain kinds of merchandise. Great care should be taken in working out this contractual arrangement. Be sure it is covered with adequate risk insurance.
Bank Drafts. Payment for many sales is arranged using one of many time-tested banking methods. Bank drafts (bills of exchange) are written orders that activate payment either at sight or at “tenor,” a future time or date. Each is useful under certain circumstances.
A bank draft is a check, drawn by a bank on another bank, used primarily when it is necessary for the customer to provide funds payable at a bank in some distant location. The exporter who undertakes this payment method can offer a range of payment options to the overseas customer.
Time (Date) Draft. The time draft is an acceptance order drawn by the exporter on the importer (customer), payable a certain number of days after “sight” (presentation) or days from date to the holder. Think of it as nothing more than an IOU, or promise to pay in the future.
Documents such as negotiable bills of lading, insurance certificates, and commercial invoices accompany the draft and are submitted through the exporter’s bank for collection. When the draft is presented to the importer’s bank, the importer acknowledges that the documents are acceptable and commits to pay by writing “accepted” on the draft and signing it. The importer normally has 30 to 180 days, depending on the draft’s term, to make payments to the bank for transmittal.
Sight Draft. The sight draft is similar to the time draft except that the importer’s bank holds the documents until the importer releases the funds. Sight drafts are the most common method employed by exporters throughout the world. They are nothing more than written orders in standardized bank format requesting money from the overseas buyer. Although this method costs less than the letter of credit (defined below), it has greater risk because the importer can refuse to honor the draft.
Bill of lading: A document that provides the terms of the contract between the shipper and the transportation company to move freight between stated points at a specified charge. Commercial or customs invoice: A bill for the goods from the seller to the buyer. It is one method used by governments to determine the value of the goods for customs valuation purposes. At sight: A term indicating that a negotiable instrument is to be paid upon presentation or demand.
Authority to Purchase. Authority to purchase is occasionally used in the Far East. It specifies a bank where the exporter can draw a documentary draft on the importer’s bank. The problem with this method is that if the importer fails to pay the draft, the bank has “recourse” to the exporter for settlement. Therefore, before consenting to an authority to
purchase, the exporter may wish to specify “without recourse” and so state on drafts.
The major risk with the time, sight, and authority to purchase methods is that the buyer can refuse to pay or to pick up the goods. The method of avoidance is to require cash or a sight draft against documents. Unfortunately, banks are slow in transferring funds because they want to use the time float (short-term investment of bank money) to earn interest. Using a wire transfer can get around the delay.
Letter of Credit (L/C). Ideally an exporter deals only in cash, but in reality few businesses are initially able or willing to operate under those terms. Because of the risk of nonpayment due to insolvency, bankruptcy, or other severe deterioration, procedures and documents have been developed to help ensure that foreign buyers honor their agreements.
The most common form of collection is payment against a letter of credit (L/C). The L/C is the time-tested method whereby an importer’s bank guarantees payment to the exporter if all documents are presented in exact conformity with the terms of the L/C. The procedure is not difficult to understand, and most cities have bank personnel familiar with the mechanics of L/Cs.
This method is well understood by traders around the world, is simple, and is as good as your bank. Internationally the term documentary credit is synonymous with letter of credit. L/Cs involve thousands of transactions and billions of dollars every day in every part of the world. They are almost always operated in accordance with the Uniform Customs and Practice for Documentary Credits of the International Chamber of Commerce, a code of practice that is recognized by banking communities in 156 countries. A Guide to Documentary Operations, which includes all the standard forms, is available from: ICC Publishing Corporation, Inc., 156 Fifth Avenue, Suite 302, New York, NY 10010; phone: (212) 206-1150; fax (212) 633-6025; Web: www.iccbooks.com.
An L/C is a document issued by a bank at the importer’s or buyer’s request in favor of the seller. It promises to pay a specified amount of money upon receipt by the bank of certain documents within a specified time or at intervals corresponding with shipments of goods. It is a universally used method of achieving a commercially acceptable compromise. Think of a letter of credit as a loan against collateral wherein the funds are placed in an escrow account. The amount in the account depends on the relationship between the buyer and the buyer’s bank.
Standby LICs. Sometimes when dealing in an open account, the exporter requires a standby L C. This means just what the name implies-the LC is executed only if payment is not made within the specified period, usually 30 to 60 days. Bank handling charges for standby letters of credit are usually higher than for commercial (import) L/Cs.
Typically, if you don’t already have an account, the bank will require 100 percent collateral. With an account, the bank will establish a line of credit against that account.
Commercial letter of credit charges is competitive, so you should shop around. Typical charges are shown in Table 5-2.