Whether you are collecting payment on a business transaction from a customer across the street or a client who is 12,000 miles away, learning how to collect payment on an overseas sales transaction is the single most critical yet insanely overlooked detail for small to medium sized business owners who aspire to do business internationally.
Why? Because the excitement for sales folks typically lies in striking the deal — not in determining how you get paid.
Here we outline several methods to collect payments on export sales during turbulent times. But first, here are some things that can influence your decision about how you will be paid:
- Feedback from your international banker
- Your customer
- Your cash flow needs
- The economic conditions in the country to which you are exporting
- Interest rates and currency adjustment factors
- Type of product
- Your customer’s creditworthiness
- The terms your competitors are offering
- Your supplier’s demands
- The urgency of the transaction — are you under time constraints?
Whatever terms of payment you negotiate, you must make sure they are understood by all parties and that your customer signs a document (e.g., proforma invoice) that indicates acceptance. This prevents some unpleasant surprises later on and reduces your shipment liability exposure.
It’s essential that you agree on the terms of payment in advance, and never ever sell on open account to a brand new customer.
And now, on to the payment options:
Payment in Advance
This is obviously the best of all payment methods since you can forestall possible collection problems and you have immediate use of the money. I use the advance payment method when I know absolutely nothing about the customer, when speed of handling will make or break the sale, and when the transaction is less than $5,000. The only difficult part of this financing method is actually making it happen! When your customer agrees to this arrangement, he accepts the full risk of the transaction. If he does, ask for a wire transfer from his bank account to yours, or a certified check made payable to you in U.S. dollars, preferably sent by courier. It’s reasonable to ask for half of the total sale in advance, with the balance to be paid 30 days from the bill-of-lading date. This reduces your customer’s risk, thus helping to maintain good will. Make sure, though, that the advance amount covers your out-of-pocket costs.
Second to cash in advance is payment collected online, provided the transaction is small (processing fees can take a big bite out of your profits) and you wait to release goods or your service offering until after you clear funds in your bank account.
Two well-known options are PayPal and American Express – FX International Payments. With PayPal, you can send and receive money in 24 currencies from anyone with an e-mail address in 190 countries and regions, allowing you to accelerate the pace of online transactions across borders. With American Express FX International Payments, you get expertise and the convenience of making foreign currency payments. Either of these payment mechanisms work fine on smaller-sized exports (less than U.S. $10,000). But when you get into bigger transactions, you are better off protecting your financial interest in such a way that you are guaranteed payment and the payment processing fee does not gouge your profit margin on the sale.
Letters of Credit — Security with Flexibility
After payment in advance or payment online, securing payment with a letter of credit is the next best option. We will take a detailed look at how letters of credit work, who participates in the transaction, and what variations and modifications are available to help the parties negotiate mutually acceptable terms.
THE FOUR KEY PLAYERS IN THE LETTER OF CREDIT PROCESS
There are four participants in a letter of credit transaction — two businesspeople and two banks:
- The buyer. That’s your customer.
- The opening bank. This bank normally issues the letter of credit, so it is sometimes referred to as the “issuing bank.” They assume responsibility for the payment on behalf of the buyer.
- The paying bank. This is the bank under which the drafts or bills of exchange are drawn under the credit. A paying bank in an L/C transaction might also act as the negotiating bank, advising bank or confirming bank, depending upon what responsibilities it accepts.
- The seller. That’s you.
To summarize the process: Once you and your customer agree on payment by letter of credit, it is the customer’s responsibility to take your proforma (an invoice that reflects all estimated costs involved to move product door to door) to her bank and open the L/C (letter of credit) in your favor. Once the opening bank has all the appropriate information from the customer, it advises you, the seller, that the L/C has been opened. Oftentimes this will be done by cable or e-mail to the paying bank. Your bank then forwards that information to you. The letter of credit is final and subject to correction only for errors in transmission.
It is not unusual to find differences between the L/C and the proforma invoice, such as incorrect product descriptions or reference numbers. So always consult with your banker before attempting any informal deals like this.
Accuracy in all details of your letter of credit is critical. There are a number of different kinds of L/C, but here are two are important types:
IRREVOCABLE LETTER OF CREDIT
An irrevocable letter of credit is a commercial document issued by a bank at your customer’s request in your favor. Once issued, it cannot be modified without both parties’ consent. Here “irrevocable” means that the bank must pay you even if your customer defaults, provided the documents presented are “clean,” meaning that they are in complete compliance with the language of the L/C. It’s the most secure method of payment. You can also request that the L/C be confirmed by a U.S. bank. This arrangement provides the greatest degree of protection because the U.S. bank must pay you even if your customer’s bank defaults. If the L/C is unconfirmed, the U.S. bank must wait until it receives funds from the foreign bank before it will credit your account.
REVOCABLE LETTER OF CREDIT
A revocable letter of credit is a commercial document issued by a bank at your customer’s request in your favor, which can be modified without both parties’ consent at any point. Once this L/C has been issued, you have the following assurances as the beneficiary: the bank can assure you that, yes, your customer has arranged for them to pay you such and such an amount; and, yes, your customer is known, respected and has been banking with them for decades. Unfortunately, you cannot rely on this L/C since the bank is under no obligation to cover the L/C if your customer defaults. You may as well just run a credit check on a customer and ship open account.
A letter of credit may be modified or restricted in a variety of ways. If you get stuck on negotiating payment terms with your customer, check with your banker to see if you can find a mutually agreeable option. Be creative and cooperative in investigating payment arrangements that will accommodate your customer, but always make sure YOU end up with secure and timely payment.
If you have a few extra minutes, I suggest you read “Methods of Payment: Terms, Conditions and Alternative Financing Sources For Export Sales.” More than 53,000 small business owners have already found it useful. You might, too.
Collecting money from your overseas customers doesn’t have to be painful. If you follow the suggestions above and consult with your international banker, you can grow your business global and confidently secure payments from customers all over the world.
Editor’s Note: this article was previously published at OPENForum.com under the original title: “Managing Methods of Payments on Export Sales in Turbulent Times.” It is reprinted here with permission.
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About the Author: Global business expert Laurel Delaney is the founder of GlobeTrade.com (a Global TradeSource, Ltd. company). She also is the creator of “Borderbuster,” an e-newsletter, and The Global Small Business Blog, all highly regarded for their global small business coverage. You can reach Delaney at [email protected] or follow her on Twitter @LaurelDelaney.