Advance payment, letter of credit, documentary collection and open account: four ways to pay across borders, and who carries the risk in each.
Have you ever bought something from a Facebook page? You face a choice. Pay first, and hope the parcel comes. Or choose cash on delivery, and the seller hopes you won't refuse the parcel at the door.
Every trade deal faces the same question: who takes the risk? If the buyer pays first, the buyer worries. If the seller ships first, the seller worries. Traders and banks use four main ways to share that worry. Think of them as a ladder, from safest for the seller to safest for the buyer.
The buyer pays before the goods are shipped.
It is common for small orders, samples, or when the buyer badly wants the goods. Countries usually set rules on advance payments, because money leaves before any goods arrive; Bangladesh's import rules set limits and safeguards for this.
Booking a tailor for Eid with full payment upfront: great for the tailor, nerve-racking for you until the clothes are ready.
The buyer's bank promises to pay the seller, as long as the seller presents the documents the LC asks for, on time.
Most LCs follow an ICC rule book called UCP.
It is a bit like the "escrow" some online shops use: a trusted middle party makes sure the seller is paid once proof is shown. With an LC, though, the bank makes the promise itself, and the "proof" is the documents, not the goods. If the papers are right, the bank pays, even if the goods later disappoint.
The seller ships the goods and gives the documents to her bank. That bank sends them to the buyer's bank, which hands them to the buyer only when the buyer:
Banks handle the documents but don't promise to pay. If the buyer refuses, the seller's goods sit at a foreign port. It is cheaper than an LC and works when buyer and seller trust each other a little. The ICC rule book here is URC.
This is cash on delivery with a twist. The courier won't hand over the parcel until you pay (or sign a firm promise to pay). But if you simply refuse, the seller has a parcel stuck far away.
The seller ships the goods and sends the documents straight to the buyer, then waits to be paid on the agreed date, say 60 or 90 days later.
Big global buyers often insist on open account. Sellers protect themselves with credit insurance, factoring, or a long, good relationship. Bangladesh's export rules have a separate part on open account terms, with conditions, because the money still has to come home on time. Check with your AD bank before agreeing to them.
It is like a shop that gives a trusted neighbour groceries "on the khata" (credit book) and collects at the end of the month. It works beautifully until the neighbour moves away without paying.
No rung is always best. The choice depends on:
Many exporters start with LCs and move down the ladder as trust grows.
A new tenant pays an advance and a deposit. After five good years, the landlord may happily accept rent at the end of the month. Trust moves you down the ladder.
So far: four ways to get paid, on a ladder of risk. Advance payment (safest for the seller), letter of credit (a bank's promise against documents), documentary collection (banks carry the documents but don't promise), and open account (safest for the buyer). Trust, country risk, bargaining power, cost and the rules decide which one fits.
Next: whichever rung you choose, the money has to cross a border. How does a dollar actually travel from Hamburg to Dhaka?
Four quick questions. Nobody sees your answers but you.
With advance payment the seller has the money before shipping anything.
Under an LC the issuing bank commits to pay against complying documents. In a collection, banks pass documents but give no payment promise.
Under DA, the buyer gets the documents now by accepting a bill (a promise to pay later).
Open account carries the most risk for the seller, so it is usually accepted with trusted buyers or with extra protection such as credit insurance.
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