An Overview of Top International Trade Payment Methods

What is International Trade?

Essentially, international trade is the process of exchanging goods or services between different countries, including manufactured goods, commodities, and even labour. It represents purchasing goods or services between a seller and an international buyer.

However, where it gets a little more complicated is that international trade involves financial, tax, administrative, and customs issues, which can make the process more complex.

An Overview of International Payment Methods

International trade comes with significantly higher risks compared to a domestic transaction. This is because there could be language, political, and legislative differences in addition to the complications of working in different currencies.

So, it is important to understand how international payments work, as well as the specific characteristics and risks associated with each method.

Secure Payment Options for International Trade

While there are numerous options to facilitate payments in international trade, the most secure payment options include:

Documentary Credit

Documentary credit, or as it is sometimes known a Bill of Exchange, is an international payment method that offers the most balanced risk for both the seller and buyer.

Although the seller will not be paid before they send the shipment, the shipment won't be received until the buyer pays the amount due in full or makes a firm commitment to pay on a specified date.

The buyer and seller draw up a contract of sale, and the seller can then ship the goods and provide their bank with the required documents.

This should include a Bill of Lading, which documents the goods for shipment. The collecting bank then sends a payment order to the bank of the buyer, requesting payment.

Once the buyer pays in full, the seller’s bank sends the shipping documents along to the buyer’s bank. The buyer can then receive the shipment. This creates one of the most secure methods for both parties, offering a guaranteed payment.

Documentary credit works best when there is a similar level of reliability and trust between the buyer and seller. The seller and buyer can settle the financial transaction using their preferred method, including cash, a corporate card, or an electronic funds transfer from a business account.

Cash in Advance

Cash in advance offers the lowest risk for exporters, but importers assume a high-risk payment obligation. It requires importers to make full payment into the seller's bank account before the exporter issues the shipping documents and sends the goods.

This eliminates the risk of non-payment for the exporter, but as the importer pays before receiving, their risk is substantial.

The cash in advance payment method is only likely to work when the exporter has a strong reputation, particularly if they are dealing with a new buyer or one with a poor credit rating.

However, there is a risk that the exporter may negate their competitive advantage, with the risk that they will lose business to companies that offer more flexibility. Both parties need to be comfortable with the payment arrangement to continue the trading relationship.

Open Account Transaction

An open account is one of the most common methods of payment, and it’s perhaps the best payment method for the buyer, but it provides the greatest risk for the seller. Essentially, it is a credit transaction where the seller ships the goods to the buyer before they receive payment. The seller offers extended payment terms of 30, 60, or 90 days after the delivery has been confirmed or the invoice has been issued.

This payment is popular for international trade as it offers more flexible payment terms. The seller can delay payment until they have received and inspected the goods, allowing for easier expense management.

However, it is typically reserved for importers and exporters with a long-standing relationship, since the seller needs to trust that they will receive payment at the agreed time.

In simple terms, the seller is extending the buyer credit for up to 90 days, allowing foreign buyers to improve cash flow. This encourages repeat business from buyers who appreciate the flexibility.

There is a payment risk for the seller, but there is lower admin associated with an open account, making international sales easier to manage.

How to Select a Payment Method for International Trade

Every business and enterprise is different, so you need to choose a payment method that works best for your international trade transactions. There are several factors to consider:

Assess the Risks

Different payment methods allocate the risk between both the buyer and seller, so you must ensure that your chosen payment method aligns with your risk tolerance.

For example, an advance payment places the buyer at higher risk, while an open account leaves the seller at higher risk. Choose a payment method that provides an acceptable balance of power.

Consider Your Buyer-Seller Relationship

Which payment method will work best for your transaction will depend heavily on your buyer-seller relationship.

Established relationships have greater trust, so if you have a long-term partner with a strong history, an open account, or another “riskier” payment method could be worthwhile to continue the relationship.

On the other hand, if you’re dealing with a new or one-time partner, you may prefer a more secure option that presents less risk, thus protecting against fraud and non-payment.

However, you need to consider the regional and cultural practices in the other party’s country. Some countries have standard preferred payment methods.

Research Country-Specific Factors

There could be country-specific issues that influence the preferred payment method.

For example, a foreign country may impose limits on foreign currency transfers or require certain documentation for payments.

There could also be political or economic stability issues, where unstable regions carry a higher risk of non-payment, necessitating a more secure payment method. Additionally, if the country has a weaker banking system, you may need to opt for a safer method.

Review the Trade Terms

Trade finance terms will define the responsibilities and risks, including detailing the payment timing. Everything must be compatible with your chosen payment method. It should be clear when the payment should be released and what documentation is required.

Evaluate the Payment Speed

While every business owner wants to receive payments as quickly as possible, if you have some flexibility, you can evaluate the payment speed of different methods to find one that works for you.

If you have an urgency of cash flow and need immediate funds, you may prefer an advanced payment. If there is less urgency, you could opt for a payment method with a slower clearing time. Credit card payments tend to be quick, but you may prefer to offset this for other payment methods where there is a more balanced risk profile.

However, it is important to appreciate that there could be bank delays. Some payment methods may be delayed due to collection procedures or document checking.

Assess the Costs

Each payment method has its own associated costs, and these can vary significantly. Methods where banks ensure payment tend to involve significant fees, as the banks involved impose issuance, confirmation, and other charges.

Some payment methods may also require more time and paperwork, which increases the internal handling costs. Always consider conversion fees that may impact your profit margin.

Can You Mitigate the Risk?

Finally, is there anything you can do to mitigate the risk of your preferred payment method? Bank guarantees and credit insurance can protect against buyer default, and there are third-party services that may be more appropriate for a high-risk trading partner.

Document everything—including the payment terms—with clearly defined conditions for release and payment due dates, along with any penalties for non or late payment. This will provide you with protection should an issue occur.

Streamline your Global Payment Process with Aspire

Engaging in international trade transactions exposes your business to foreign exchange (FX) risks. Often, international payments come with high transfer fees and unfavourable FX rates—costs that can add up quickly. This is where Aspire can help.

With an Aspire Business Account, you can streamline your international payment processes. Enjoy same-day transfers in over 15 currencies with no hidden fees and full transparency in cost breakdowns. You can also send money in more than 30 currencies to over 130 countries.

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Frequently Asked Questions

What is the Most Common Payment Method For International Trade?

Traditional bank transfers or wire transfers remain the most common methods of payment for international trade, but you must consider the payment vehicle for the transaction. You can use a bank transfer to set up a documentary credit, arrange payment in advance, or fund an open account.

Can You Pay Internationally Without Fees?

There are some methods that can minimise or eliminate transaction fees, such as using a wire transfer. However, the cost of the transfer is only one consideration.

Sending a bank transfer for goods or services from an international trade partner leaves you at a higher risk of fraud or non-receipt. In this scenario, you may prefer a more secure payment arrangement.

What are the Payment Terms in International Trade?

The payment terms are the conditions agreed upon to complete the transaction by both parties. The payment terms are used to finalise the trade deal and should be documented in the sales contract.

What are the Negatives of Documentary Credit?

The negative of using documentary credit is that there are bank fees to arrange the transaction. It also requires significant admin, which can make it more complicated to arrange, particularly if you are dealing with higher transaction volumes. However, the foreign distributor can ensure payment from the correspondent bank for smooth transactions.

What Happens if Documentary Credit is Not Paid?

If the buyer fails to make payment for the purchase, the seller can act against the buyer’s bank. The bank has an obligation to pay regardless of disputes between the buyer and seller and the bank must honour the demands for payment in compliance with the terms of the contract.

Conclusion

Financial transactions for goods and services between countries need not be complicated or expensive. There are a number of international trade payment methods, each with its own characteristics for cost, speed, compliance, and security.

With a little research, you can find appropriate payment methods that align with the needs of your business or enterprise.

Traditional methods, such as bank transfers on a cash in advance arrangement, are straightforward. They can provide more risk for the buyer, but the seller may prefer this method with a new or high-risk customer.

For well-established relationships, sellers may extend open account arrangements to facilitate the ease of the transaction and flexibility for the buyer.

Assess your requirements, preferences, and risk tolerance to determine the best international payment methods to scale your business globally.