LC or collection? Choosing wisely

Leave aside advance payment, the top rung from How trade works, where the seller is paid before she ships. Here are the other common ways, from safest to riskiest for the seller:

• Letter of credit (LC): the issuing bank promises to pay against complying documents. The seller's risk moves from the buyer to the bank and its country. Highest cost and heaviest paperwork.
• Documents against payment (D/P, also called CAD): the banks pass the documents, and the buyer pays to get them. No bank promises anything. If the buyer refuses, the seller still controls the goods through the papers, but the goods sit at a foreign port. Cheaper and simpler than an LC.
• Documents against acceptance (D/A): the buyer signs (accepts) a bill of exchange, promising to pay on a later date, and takes the documents now. The goods are gone; the seller holds only the buyer's signed promise.
• Open account: the seller ships and sends the documents straight to the buyer, then waits for the money. Cheapest and simplest, and the riskiest for the seller.

See the pattern? As cost and paperwork go down, the seller's risk goes up and the buyer's comfort goes up.

One warning about D/P: the seller's control works best with a negotiable sea bill of lading made out to order. An air waybill is not a document of title, so with air cargo her control is much weaker.

Safety has a price: bank charges. Rates differ from bank to bank and deal to deal, so here we name the kinds of charges, not the amounts:

• LC opening (issuance) commission: charged to the buyer, usually by amount and how long the LC stays open.
• Advising fee: the advising bank's charge, usually paid by the seller.
• Confirmation fee: the price of a second bank's promise. The riskier the issuing bank or its country, the higher it tends to be.
• Amendment fee: charged for each change to the LC.
• Discrepancy fee: charged when documents don't comply, often taken out of the seller's money. Bangladeshi exporters know it well.
• Acceptance commission: for a usance LC, when a bank accepts a bill and promises to pay later.
• Collection charges: the remitting and collecting banks charge for handling D/P or D/A documents, usually much less than LC costs.

Add courier and SWIFT costs. Who pays which charge is part of the deal, so write it into the LC or collection instruction.

The buyer also needs room in his credit limit, because his bank counts every LC it opens against it. It may also ask for margin, tying up his cash. A collection carries no bank promise, so it doesn't use an LC limit the same way.

Before Evelyn says yes to D/P, she runs through a few questions. Any seller can use them:

• The buyer's track record: new, or tested? Has he paid on time before? Does he often raise discount claims?
• The buyer's country: is it stable? Can it get the dollars or euros to pay? A country short of foreign exchange may delay payments even when the buyer is willing. That is country risk.
• The issuing bank: if it is an LC, is the bank strong and well known? If Evelyn is unsure, she can ask for a confirmed LC.
• The goods: perishable goods (frozen fish, vegetables) can't wait at a foreign port while a refusal is argued over. Custom-made goods, like shirts with the buyer's own label, are hard to sell to anyone else. Both point towards an LC.
• The size of the deal: a small repeat order can live with less protection. An order worth half of Evelyn's year needs the strongest one.
• Her own paperwork: an LC protects her only if her documents comply. A careless team can turn a safe LC into a pile of discrepancies.

A simple rule of thumb: the more question marks, the higher up the ladder she should stay.

Now sit in Kamal's chair. The importer worries about different things:

• Getting what he paid for: under an LC, the bank pays against documents, not goods. So Kamal writes what he needs into the LC, for example an inspection certificate from a named company. Under D/P, he sees the documents before paying, but not the goods. Under open account, he gets the goods first.
• Timing: an LC lets him set a latest shipment date and an expiry date. With a collection, the documents may reach his bank after the ship arrives, and port charges can pile up while he waits.
• Cost of finance: LC fees and margin cost money. Under a sight LC or D/P, he pays when the documents arrive, often before he has sold anything.
• Usance: a usance LC or D/A gives him time to pay, so the machine can start earning first. Sellers often price that credit in.
• UPAS ("usance payable at sight"): the seller is paid at sight, while the importer pays later. A bank funds the gap, and the importer normally bears the interest cost. In Bangladesh, UPAS LCs are arranged through AD branches under the foreign exchange rules.
• Exchange rate: for a payment months away, the Taka may move. A forward contract can fix the rate.

Payment terms are not a life sentence. A common path looks like this:

• First orders: an LC, perhaps confirmed.
• After several clean shipments: D/P. Both sides save fees, and the buyer still pays before he gets the documents.
• Later: D/A, giving the buyer time to pay.
• A long, healthy relationship: open account, often with credit insurance or factoring as a safety net for the seller.

Trust can also move back up the ladder. If a buyer starts paying late, or his country runs short of dollars, a wise seller returns to an LC. That is not an insult; it is good housekeeping.

Every step must also fit the foreign exchange rules of both countries. In Bangladesh, exports and imports are handled through AD branches. The export rules set conditions for collection and open account terms, and expect the money to come home within the allowed time. The import rules say which payment methods may be used, and how. The buyer's country may have its own rules too. So before changing terms, Evelyn and Kamal each talk to their AD branch.

And Evelyn's answer to Hamburg? Three shipments paid in full, a stable country, a buyer who pays on time: D/P looks reasonable for the next order, with the LC kept ready if things change.