Many companies that I speak to – both in the SME sector and at the big end of town – face challenges with getting paid on time (or at all) when they sell to customers overseas.
In the worst-case scenario, payment problems may force a company out of business in a particular country. This was the case with Australian construction company CIMIC Group Limited (formerly Leightons). It left the UAE market in early 2021 after failing to recover $1.8 billion that it had been owed for more than a decade.
Although most companies will not face a situation this serious as they work or sell abroad, not getting paid is still one of the biggest risks of doing business internationally.
In this chapter, I want to look at the steps you can take to ensure that you get paid – on time, and in full.
Background work and research
One way to set yourself up for success as you start selling internationally is to understand the systems, protocols and customs of getting paid in your target market. You should also understand the consequences of not getting paid. Companies doing business overseas are often surprised and unprepared for the very different legislative framework of chasing debt that they encounter there.
As a starting point, research the company you are about to do business with. Look through its portfolio of clients, compare their services and prices, read referrals and testimonials. Do as much research as you can to check the credit worthiness of that company, including running a credit check if one is available in that country.
Also, check the insolvency framework in your target market. Bankruptcy rules are unclear in some jurisdictions, making it relatively easy for a company owner to fold a company to avoid paying a debt.
If you have any doubts about the company simply do not do business with it or at least be prepared to write off the debt if it refuses to pay your invoice later down the line.
Getting paid – what are my options?
To be frank, to succeed in today’s global marketplace and win sales against foreign competitors, you will need to offer your clients attractive sales terms supported by appropriate payment methods.
Because getting paid in full and on time is the ultimate goal for each international sale, it is critical that you choose an appropriate payment method that minimises the payment risk while accommodating the client’s needs. For you (the exporter), any sale is a gift until you receive payment. For your client (the importer), any payment is a donation until the goods are received. In short, you want to receive payment as soon as possible, preferably as soon as an order is placed or before the goods are sent to the importer. Importers want to receive the goods as soon as possible but to delay payment as long as possible, preferably until after the goods are resold to generate enough income to pay you.
Broadly speaking, there are five primary methods of payment for international transactions. You and your client will need to agree which one works best for both parties.
1. Upfront payment
Upfront payment means just what it says: you are paid for your products before delivering your goods to the customer.
Upfront payments enable the seller to avoid credit risk because payment is received before the ownership of the goods is transferred. For international sales, wire transfers and credit cards are the most common upfront payment methods and online escrow services are becoming another upfront option for small international transactions.
However, requiring payment in advance is the least attractive option for the buyer, because it creates unfavourable cash flow. International buyers are also concerned that the goods may not be sent if payment is made in advance. If you insist on upfront payment, you may lose to competitors who offer more attractive payment terms.
Pros
- Least risky form of payment for the seller – you get your money at the time of the sale.
- Upfront payment provides the working capital you need to process the order so there is no strain on your cash flow.
- Simple and clear to transact for the seller.
Cons
- Upfront payment is the least attractive and competitive from the buyer’s point of view, as it is the riskiest way for them to do business – they part with their money upfront but have no guarantee you will deliver the goods.
- This method can also tie up a buyer’s cash while they are waiting for delivery.
- If the buyer must borrow all or some of the amount, this adds another step to their process and, with interest payments, could increase their total cost to buy your product.
- As a result, few international customers will agree to cash-in-advance purchases, unless the transaction is a small one.
2. Letters of Credit
A Letter of Credit is an important payment method in international trade. It is particularly useful where the buyer and seller do not know each other personally and are separated by distance, differing laws in each country, and different trading customs.
The buyer establishes a credit with his or her bank and pays the bank to render this service. When the seller presents the documents – which are specified in the contract for sale – to the bank, he or she receives payment for the goods from the bank. The seller relies on the credit risk of the bank, rather than the buyer, to receive payment, and if the buyer cannot pay for the purchase, the seller may demand payment from the bank. The bank will examine the seller’s demand and if it complies with the terms of the Letter of Credit, will honour the demand.
A Letter of Credit also protects the buyer since no payment obligation arises until the goods have been shipped.
Pros
The main advantage of using a Letter of Credit is that it can give security to both the seller and the buyer.
- The seller is reassured that, providing they present documents in-order and within an agreed timeframe, they will receive their money in full and on time.
- A Letter of Credit is one of the most secure methods of payment for exporters as long as they meet all the terms and conditions.
- The risk of non-payment is transferred from the seller to the bank (or banks).
- When a buyer uses a Letter of Credit they get a guarantee that the seller will honour their side of the deal and provide documentary proof of this.
Cons
- Letters of Credit can be expensive. Banks charge for providing them, so it is sensible to weigh up the costs against the security benefits.
- As a seller, you should be aware that you will only receive payment if you keep to the strict terms of the Letter of Credit. You will need to give documentary proof that you have supplied exactly what you contracted to supply.
- Using a Letter of Credit can sometimes cause delays and other administrative problems.
3. Documentary Collections
There are two basic types of Documentary Collections: ‘documents against payment’ and ‘documents against acceptance’. For documents against payment, your bank sends a set of shipping documents to a correspondent bank in your customer’s market. When your goods arrive at the port of entry, the correspondent bank presents the documents to your customer. The customer pays the bank, receives the shipping documents in exchange, and uses them to release the goods from customs. The correspondent bank then sends the payment to you via your bank.
The process is almost identical for documents against acceptance, except you allow your customer to pay the correspondent bank on some specified future date. At that time, and on the customer’s payment, the correspondent bank releases the documents to the customer. You are then paid through your bank.
Documentary Collections do not provide the same level of security as Letters of Credit, but they are less expensive. Unlike the Letters of Credit, for a Documentary Collection, the bank acts as a channel for the documents but does not guarantee payment. The bank that has received a Documentary Collection may debit the buyer’s account and make payment only if authorised by the buyer.
Pros
- Because the transactions are carried out through banks, with your bank acting as your agent, Documentary Collections carry less risk for you than an Open Account.
- They are also less expensive than Letters of Credit, so they may be a more competitive option if your customer balks at paying for a Letter of Credit.
Cons
- Unlike Letters of Credit, your bank does not assume liability to pay if your customer will not, or cannot, pay once the goods arrive. It is more secure than an Open Account, but riskier than a Letter of Credit.
- Documentary Collections should therefore be used with extra caution if the market is politically risky or there if there is otherwise a risk the buyer will not pay.
4. Open Account
Open Account terms mean that you agree to ship your goods to your customer before you get paid. The customer promises to pay within a certain time after receiving the goods, typically within 30 to 180 days.
Pros- Open Account is a very low-risk option for your customer, as they receive the goods before paying for them.
- Using an Open Account can help you land a sale, but you should be sure that the buyer’s credit is good before you agree to it.
- In most markets, offering Open Account terms will make you more competitive, which can increase repeat business and help you build both market share and customer loyalty.
- The biggest risk with an Open Account is getting paid late, or not getting paid at all.
- If the customer does not pay, you may also incur costs trying to collect on the debt in addition to the loss from unpaid debt itself.
Simply offering longer payment terms will not necessarily make you the most competitive. It is best to find out what payment terms are most common for your industry in the target market, and remain within them.
5. Consignment
Consignment is a variation of Open Account terms. The seller only receives payment after the goods have been sold by the foreign distributor to the end customer. An international consignment transaction is based on a contractual arrangement in which the foreign distributor receives, manages, and sells the goods for the exporter who retains title to the goods until they are sold.
Exporting on consignment is very risky. The exporter is not guaranteed any payment and its goods are in a foreign country, in the hands of an independent distributor or agent. Selling on consignment can help you become more competitive on the basis of better availability and faster delivery of goods. It can also help to reduce the direct costs of storing and managing inventory. The key to success in exporting on consignment is to partner with a reputable and trustworthy foreign distributor or a third-party logistics provider. You will need to put in place insurance to cover consigned goods in transit or in possession of a foreign distributor as well as to mitigate the risk of non-payment.
Pros
- Consignment helps you introduce proven products into new sales channels and new or unproven products within current sales channels.
- It potentially ensures long-term business with the buyer.
- Consignment allows you to judge what levels of inventory are turned over in different time periods and can reduce inventory holding costs.
Cons
- Consignment requires you to invest a large amount of money, including shipping costs into a large amount of new inventory.
- If it does not sell, you risk a loss because you are still the owner of the goods.
- With no monetary risk, the customer may not be motivated to aggressively sell your product.
To sum up…
- How much can you trust your buyer?
- Have you established a strong relationship with the client or is this the first transaction with the company?
- How much risk are you prepared to take?
- How much risk is your buyer prepared to take?
- How large is the transaction?
- Can you bargain for more favourable terms with this buyer?
Answering these questions can help you to arrive at the best payment option for your international business, and for the specific transaction that you are dealing with.
Your bank or financial institution can also provide more comprehensive advice about payment options and the relative advantages of each, based on your situation.
