Mastering International Trade Payments - A Guide to T/T, L/C, D/P, D/A, and O/A Methods

When engaging in international trade, one of the critical aspects to consider is the payment process. It sets the foundation for successful transactions and ensures that both parties involved are protected.

Throughout this article, we will delve into the intricacies of various common payment methods, including T/T (Telegraphic Transfer), L/C (Letter of Credit), D/P (Documents against Payment), D/A (Documents against Acceptance), and O/A (Open Account). By exploring these methods in detail, we aim to provide you with a comprehensive understanding of their features, benefits, and potential challenges that may arise during international trade transactions.

T/T (Telegraphic Transfer)

T/T, also known as Telegraphic Transfer, is a widely used method of remittance. In this process, the remitter sends a message via telex or telefax to a branch or correspondent bank located in another country (known as the remitting bank), instructing them to transfer a specific amount to the recipient.

T/T transactions are settled in foreign currency. Your customer will remit the payment to your company’s designated foreign exchange bank account. T/T falls under the category of commercial credit. Once the goods are ready, if the customer intends to make full payment, you can directly send the documents to the customer without involving the bank.

There are two types of T/T wire transfers. The first type requires the consignor to receive 100% of the purchase price before shipping the goods. This method is considered the most secure for sellers in international trade, as they bear no risk. Shipment is only made once the payment is received. This payment method can also be flexible, with options ranging from a 20% to 40% deposit, followed by the remaining 80% to 60% before shipment. The specific proportion varies based on different circumstances and flexibility requirements.

The second type involves shipping the goods first and then having the buyer pay the balance. The balance payment is typically made upon presentation of the copy of the Bill of Lading (B/L). This payment method offers more flexibility, with the common practice being a 30% deposit from the customer and the remaining 70% paid after reviewing the B/L. Some variations include a 40% deposit with the remaining 60% paid upon seeing the B/L.

Common challenges associated with T/T payments

1. Incorrect recipient information leading to pending accounts: Many customers tend to be careless when providing recipient information. Errors such as misspelled names or exceeding the remittance space restrictions can hinder the release of funds. Typically, it takes around 15 days (or as per the bank’s policy) to resolve such issues. If no solution is found within the given timeframe, the money will be returned to the original source. To address this, it is crucial to inform customers to make amendments to their information and emphasize that without the correct details, the funds cannot be collected, and the order cannot be executed. In cases where the company name is too long, it is advisable to communicate with the customer and suggest writing the abbreviated portion of the name in the address field to ensure a smooth transaction.

2. Customer defaulting on final payment: Some customers may delay the final payment, causing inconvenience. To prevent this, it is essential to clearly specify the final payment deadline in the contract. For instance, including terms such as “payment to be made within 3-5 working days upon receipt of the B/L copy” can help avoid delays in receiving the final payment. Additionally, conducting thorough customer analysis and risk assessment beforehand can contribute to proactive risk mitigation strategies.

By understanding the intricacies of T/T payments and being aware of potential challenges, you can navigate international trade transactions more effectively and ensure smoother financial processes.

L/C (Letter of Credit)

To begin with, it’s important to note that a letter of credit operates independently from the underlying contract of sale and purchase. The bank places great emphasis on the written form of authentication of the letter of credit, separate from the actual trade transaction, when reviewing the documents.

Secondly, a letter of credit is primarily a documentary transaction, meaning that payment is based solely on the compliance of the presented documents. The focus is not on the physical goods themselves. As long as the documents meet the agreed-upon criteria, the issuing bank is obligated to make payment unconditionally.

Furthermore, a letter of credit serves as a form of bank credit and functions as a guarantee document. The issuing bank assumes the primary responsibility for payment, ensuring that the beneficiary receives the agreed-upon funds.

Understanding the Different Classifications of Letters of Credit

Letters of credit (LC) play a crucial role in international trade, providing a secure payment method for exporters and importers. They can be classified in various ways, depending on the documents involved or the specific requirements outlined in the LC itself. Let’s explore some common classifications:

Classification Based on Document Requirements:

1. Confirmed Letter of Credit: In a confirmed LC, the issuing bank engages a confirming bank to add its guarantee to the payment. This provides an additional layer of security for the beneficiary, as the confirming bank becomes liable for payment if the issuing bank fails to fulfill its obligations.

2. Unconfirmed Letter of Credit: An unconfirmed LC is solely backed by the issuing bank, without the involvement of a confirming bank. The payment guarantee relies solely on the issuing bank’s creditworthiness.

Classification Based on Time of Payment:

1. Sight Letter of Credit: A sight LC requires the issuing bank or the paying bank to fulfill the payment obligation immediately upon receiving the compliant shipping documents or draft. This means that the beneficiary will receive payment promptly upon submission of the required documents.

2. Usance Letter of Credit: In a usance LC, the issuing bank or the paying bank fulfills the payment obligation within a specified period after receiving the LC documents. This allows for deferred payment, giving the buyer more time to arrange for funds.

3. Revolving Letter of Credit: A revolving LC is designed for multiple shipments over a specific period. After each shipment, the LC, whether fully or partially utilized, is restored to its original amount and can be used again until the specified limit is reached. This type of LC is commonly used for regular and uniform batch deliveries.

Back-to-Back Letter of Credit:

A back-to-back LC, also known as a transferable LC, involves the beneficiary requesting the notifying bank or other banks to open a new LC with similar content based on the original LC. This allows the beneficiary to use the original LC as collateral to obtain financing or facilitate the purchase of goods from another supplier.

Anticipatory Credit/Packing Credit:

Anticipatory credit, also referred to as packing credit, is when the issuing bank authorizes a representative bank (notifying bank) to prepay all or part of the LC amount to the beneficiary. The issuing bank guarantees repayment and bears the interest. This arrangement enables the beneficiary to receive payment before the goods are delivered, with the paying bank deducting the interest on the advance payment when settling the remaining amount.

Standby Credit:

A standby LC, also known as a commercial paper credit, is a commitment from the issuing bank to assume a certain obligation on behalf of the applicant. It serves as a guarantee that if the applicant fails to fulfill their obligations, the beneficiary can seek reimbursement from the issuing bank by providing proof of default. This type of LC is commonly used in situations where the beneficiary requires assurance of payment if the applicant fails to meet their contractual obligations.

The Letter of Credit Process:

Understanding the process of a letter of credit is essential for both exporters and importers. Here is a step-by-step overview:

1. Application: The applicant fills out an application for the issuance of the LC, providing necessary information and paying a deposit or offering other forms of guarantees.

2. Issuance: The issuing bank reviews the application and issues the LC to the beneficiary based on the provided details. The LC is then sent to the notifying bank located at the exporter’s location.

3. Notification: The notifying bank verifies the authenticity of the LC seal and delivers the LC to the beneficiary.

4. Shipment and Documentation: The beneficiary carefully reviews the LC and contract terms, proceeds with shipping the goods, prepares the required documents, and issues a bill of exchange in accordance with the LC provisions. The beneficiary then submits these documents to the negotiating bank for payment within the LC’s validity period.

5. Negotiation: The negotiating bank reviews the submitted documents and, if compliant with the LC terms, advances payment to the beneficiary as per the LC provisions.

6. Presentation to the Issuing Bank: The negotiating bank sends the draft and shipping documents to the issuing bank or its designated paying bank for claim.

7. Verification and Payment: The issuing bank thoroughly examines the documents to ensure their accuracy and compliance with the LC terms. If everything is in order, the issuing bank makes the payment to the negotiating bank.

8. Redemption: The issuing bank notifies the applicant of the payment made for redemption.

This comprehensive understanding of the different classifications of letters of credit and the LC process is vital for businesses engaged in international trade. By utilizing letters of credit effectively, companies can mitigate risks and ensure smooth transactions in the global marketplace.

D/P (Documents against Payment)

D/P, which stands for Documents against Payment, is a settlement method in which the importer must make full payment to the collection bank before receiving the commercial (freight) documents from the exporting party.

There are two types of D/P transactions:

1. D/P Sight: In this scenario, the exporting party issues a demand draft, which is sent by the collection bank to the importing party. The importing party must pay the bill upon seeing the documents, enabling them to take possession of the goods along with the freight documents.

2. D/P after Sight or after Date: In this case, the exporting party issues a forward bill of exchange, which is sent by the collection bank to the importing party. The importing party accepts the bill of exchange and pays it either on or before the due date.

Risks Associated with D/P

When engaging in D/P transactions, it is important to be aware of the risks involved. The bank does not examine the content of the documents and does not assume any payment obligations. Instead, the bank provides services such as forwarding documents, prompting payment on behalf of the bank, and facilitating fund transfers. Exporters involved in D/P transactions should consider the following key points:

1. Credibility of the Importer: In D/P transactions, the exporter’s guarantee of receiving payment relies on the importer’s ability to pay and their business reputation. Assessing the importer’s financial capacity and reputation is crucial before proceeding with the transaction.

2. Document Control: After delivering the goods, it is essential to maintain control over the documents until the importer makes the payment. Controlling the flow of documents ensures that the goods are not released before payment is received.

3. Handover Points: Problems often arise during the handover of documents at various points, including the handover from the exporter to the bank, from the seller’s bank to the buyer’s bank, and from the buyer’s bank to the importer. It is important to have control over these handover points and ensure that the documents follow the standard flow.

4. Bill of Lading: Utilizing a bill of lading can provide additional control over the goods. By managing the bill of lading, exporters can exercise control over the shipment.

Although both cases of D/P involve the importer making payment before receiving the documents, there are different risks faced in commercial practice. Specifically, the risk of prompt payment is greater when the exporter directly prompts payment from the buyer’s designated bank. According to the International Chamber of Commerce’s “Uniform Rules for Collection,” the usual practice is for the exporting company to entrust its correspondent bank (the collection bank) to handle the collection process. The collection bank may then entrust the importer’s correspondent bank or the bank named by the importer to prompt payment. However, the collecting bank is not obligated to accept the exporter’s commission and has the right to refuse handling the collection instructions. In such cases, the exporter may choose to utilize their own correspondent bank for collection, and the collection bank will arrange for the collection bank (regardless of whether it is named by the importer or the importer’s correspondent bank) to handle the prompt payment and collection on behalf of the importer.

By understanding the risks and intricacies associated with D/P transactions, exporters can navigate the process more effectively and mitigate potential challenges.

D/A (Documents Against Acceptance)

Documents against Acceptance (D/A) is a payment method in international trade where the exporter delivers the documents to the importer on the condition of accepting the bill of exchange. This means that after shipping the goods, the exporter issues a forward bill of exchange along with commercial documents through the bank to the importer. Upon acceptance of the bill of exchange, the receiving bank will release the commercial documents to the importer, who is then obligated to fulfill the payment obligations when the bill of exchange matures. The acceptance of the bill of exchange allows the importer to obtain the commercial documents and subsequently extract the goods. It is important to note that the delivery method of the promissory note is only applicable to forward bills of exchange for collection purposes.

Acceptance delivery is a widely used payment method in international trade. The exporter provides instructions to the collecting bank to issue the title and other shipping documents to the importer once the importer accepts the bill of exchange. However, it is crucial to acknowledge that the exporter assumes the risk of the importer not settling the bill as scheduled.

The term “acceptance” refers to the act of recognition of the bill of exchange by the payer (the importer) at the collection bank. The acceptance procedure involves the payer signing on the bill of exchange, endorsing the word “accept,” and indicating the date of acceptance before returning the bill of exchange to the holder. Regardless of the number of times the bill of exchange has been transferred, the payer is obligated to pay with the bill of exchange on the due date. This ensures that the payment is made in a timely manner and allows for a smooth transaction between the exporter and the importer.

D/A provides benefits for both the exporter and the importer. For the exporter, it offers the security of receiving payment through the acceptance of the bill of exchange. By holding the commercial documents until the bill of exchange is accepted, the exporter maintains control over the goods and reduces the risk of non-payment. On the other hand, the importer benefits from D/A by gaining access to the commercial documents necessary for taking possession of the goods upon accepting the bill of exchange.

However, it is important to note that D/A transactions carry certain risks. The exporter must carefully assess the creditworthiness and reputation of the importer before engaging in this payment method. There is always a possibility that the importer may default on the payment, leading to potential financial losses for the exporter. Therefore, conducting thorough due diligence and establishing a level of trust with the importer is crucial when utilizing D/A as a payment method.

In conclusion, D/A is a widely used payment method in international trade that allows for the delivery of commercial documents to the importer upon accepting the bill of exchange. This method provides a level of security for the exporter while granting the importer access to the necessary documents for taking possession of the goods. However, it is important to carefully assess the risks involved and establish a level of trust with the importer to ensure a successful transaction.

O/A (Open Account)

Open Account is a payment method in international trade where the buyer receives the goods from the exporter and pays at the end of the agreed credit period. The credit period can be a fixed duration, such as 30 days, 60 days, 90 days, or as mutually agreed upon. This payment method involves a time gap between the receipt of the purchase order and the receipt of payment, with various activities such as production and transportation taking place in between.

While the Open Account method offers flexibility and convenience for the importer, it can place a burden on the exporter’s working capital position. However, exporters may still choose this method if the importer is a strong player with the potential for a significant number of future transactions. Additionally, if there is an established relationship of trust between the parties or if the amount involved is relatively small, exporters may agree to provide goods on credit.

It is important for exporters to carefully assess the creditworthiness and financial stability of the importer before engaging in an Open Account arrangement. Conducting thorough credit checks and establishing clear credit terms can help mitigate the risk of non-payment.

To protect their interests, exporters can also consider implementing risk management strategies such as credit insurance or requesting additional security measures, such as bank guarantees or letters of credit. These measures provide an added layer of protection and help ensure timely payment.

Maintaining open communication and regular follow-ups with the importer throughout the credit period is crucial. This allows both parties to address any issues or concerns promptly and maintain a positive working relationship.

In conclusion, Open Account is a payment method in international trade that allows buyers to receive goods and make payment at a later agreed-upon date. While it offers convenience for the importer, it can pose challenges for the exporter’s working capital. Careful assessment of the importer’s creditworthiness, implementing risk management strategies, and maintaining open communication are essential to mitigate risks and ensure a successful transaction.