Methods of payment
Exporting generally involves four main payment methods. Understanding which is the right payment option for your business will help reduce the risk of non-payment.
When choosing a method of payment you will need to take into account:
- the size of the transaction
- how much you trust your customer
- how much bargaining power you have
- the risk you are prepared to take on
- the risk your customer is prepared take on.
Methods of payment include:
Upfront payment
Getting paid upfront, or cash in advance, before shipping the goods is the safest way for you to get paid. However you will find that few foreign customers will accept such payment terms. It may be possible to negotiate a partial payment upfront with the remainder paid via another method. If you are exporting a service you may be able to get paid in instalments once key milestones are met. If possible, try to arrange some payment in advance when dealing with new customers.
Documentary letters of credit
Documentary letters of credit offer a high degree of security, especially when you and your customers have not yet built a strong relationship.
If your customer can produce a letter of credit they are likely to be a good trade prospect. This is because a letter of credit is a guarantee from their bank that it will pay you on your customer’s behalf (as long as you have complied with the agreed terms and your side of the export contract).
Documentary letters of credit offer three important benefits:
- You reduce your risks because you’re guaranteed payment by your customer’s bank. You don’t have to rely on your customer’s ability or willingness to pay.
- They are internationally recognised so you can often set up discounting or loan arrangements to cover you for the shipment period or a customer’s request for extended terms. This will help the strain on cashflow.
- You can request “confirmation” of a letter of credit. Confirmations are ideal if you have concerns over the overseas bank’s creditworthiness in the country you are exporting to. Your bank can guarantee payment should problems arise with the buyer’s bank or the overseas country which prevent payment being made to you.
If you are considering a letter of credit, read it carefully so that you understand all the terms and conditions. Talk it over with your bank and make sure that:
- you can meet all the requirements it specifies before you go ahead with shipment
- all your documents (including any accompanying request for payment, acceptance or negotiation) align with every detail in the letter of credit’s terms.
Letters of credit can be issued on a ‘sight’ or ‘term’ basis.
- Sight means that drafts are drawn for immediate payment.
- Term means payment is made only after a specified term (eg, 30 days from bill of lading).
Documentary collection
With a documentary exchange your customer agrees to pay you an exact amount at a time specified in your contract. This may be on sighting the bill, or a set number of days after the shipping date or a future fixed date. This is a common payment method although with future-dated payments there is a risk that your customer may be unable or unwilling to pay your bill on the due date, but will already have the goods.
You can get even more financial security and protection from bills of exchange when you combine them with negotiable documents (such as invoices, bills of lading and air way bills) and sending them through the banking system. This is because your bank handles these “documentary collections” and controls the release of the documents on your behalf when:
- For sight collections, it receives payment from your customer.
- For future payments, your customer has signed and accepted the bill, promising to pay on the due date.
Normal credit terms
Trading on “open account” is the most commonly used method for intra-company trading or where you and your customer know and trust each other and want to eliminate the costs and administration of bills of exchange or letters of credit.
It is the “do it yourself” approach. You ship the goods to your customer and then bill the customers for those goods. Customer payment is usually made via bank drafts or telegraphic transfer to your New Zealand bank account or an offshore account you control. Some companies still post out cheques made out in a foreign currency.
Open account is the most inexpensive payment method, however it exposes you to the risk of the customer not paying. Also, payment terms may mean you will not get paid for 30, 60, 90 days or even longer, so your cashflow may be affected. You may also need to take currency fluctuations into account.
Discuss the various forms of payment and their costs and conditions with your bank.
Payment for services
If there is no physical product it can be difficult for you and your customer to put a value on your services. The payment options are endless; for example you can charge customers a flat rate for your services, an hourly rate, work on a commission basis or a project-based payment.
Fees are often the biggest complaint a customer has about service providers. It's best practice to tell them what you expect the work to cost before you start work. And stick to your estimate. It is also a good idea to give your customer a written copy of your terms of engagement, including information about the following matters:
- the basis on which fees will be charged (for example on an hourly rate
- who will be responsible for travel, accommodation and office expenses
- whether your fees include GST or other taxes
- how often accounts will be issued
- when payment is due
- the consequences of non-payment, including the rate of interest that may be charged
- acceptable methods of payment, for example direct credit or cheque.
Update your customer regularly about your progress against your estimate.
Invoicing your customers
When invoicing a customer, use a commercial invoice detailing:
- The buyers name and address
- The transport used and the date of despatch
- The shipment / airfreight port and destination
- Product quantities, weights and measures
- The value of the goods and the basis of the quotation, eg CIF
- The description of the goods and any shipping marks
- Your export customs declaration / export entry number
- Any requirements of the country of import, such as customs requirements
- The buyers order number
- The buyers import licence if needed
- The insurance company involved in the transaction
You may also have to meet country or customer requirements such as:
- Certification by a Chamber of Commerce
- Certification by the Consul of the destination country, sometimes called the consular invoices
- Certification of health, quality and analysis
- Certification of origin
- A pro forma invoice
Note: if you are using a documentary letter of credit, your invoice must comply exactly with its terms.
Minimising the financial risks
The risk of not being paid may be minimised through the following:
Credit checks
When you receive your first export order, conduct the same credit checks you would with any new customer in New Zealand. As part of your credit application process ask for credit references, preferably from New Zealand suppliers, and follow these up. Once you are satisfied with a customer’s creditworthiness, establish clear payment terms in advance of the deal.
Government agencies, legal and accounting firms, and credit agencies can assist you in confirming the bona fides of inquirers and potential partners/customers.
Export credit guarantees
The best way to eliminate the risk of not getting paid is to secure payment up front (for example, if you sell online, you probably require the customer to pay by credit card before you process the order). In reality however, most business clients will be looking for at least 60 to 90 days credit terms.
Along with price, quality and expertise, the ability to offer customers credit has become an increasingly competitive factor in international trade. If you can offer attractive credit terms you may stand a better chance of securing the deal.
Private credit insurance companies can provide short-term trade credit insurance for many markets and credit-worthy clients worldwide. However, if you are exporting to riskier countries, or your buyer is seeking finance terms beyond 12 months, then consider contacting the New Zealand Export Credit Office.
Damage or loss of goods
Consider marine insurance for loss or damage caused to goods during transport. Marine insurance policies will cover land, sea and air transport.
An internet search for ‘export insurance’ will help you find a specialist broker. Alternatively talk to your bank when discussing payment options and credit guarantees. They may be able to offer insurance or recommend a suitable company. Also talk to your freight forwarder.
Exchange rates
The global environment is extremely volatile, with exchange rates and commodity prices changing rapidly. The volatility in currency exchange rates can erode your projected profitability on an export order.
Exchange rate risks include:
- Transaction risk. The exchange rate will change between the date the price is agreed and the date when payment is made.
- Translation risk. When your balance sheet assets and liabilities are denominated in a foreign currency.
- Economic risk. Where long term currency movements can affect the viability of your export activity.
Consult your bank or accountant about the best way to manage these currency risks. Options include:
- Managing the risk by borrowing and selling in the same foreign currency.
- Maintaining foreign-currency accounts.
- Offsetting component import costs with export receipts in the same foreign currency.
- Forward contracts.
