One of the subjects of international business that I have a particular interest in concerns the different payment tools that Account An open account is one of the most inexpensive, time-saving, and simplest forms of payment for an international product exchange. As the name implies there is a previous agreement between the purchaser and seller of goods as to the terms of the transaction and the behavior of the parties involved. An open account works like this: The exporter sends the product overseas to the importer.
The exporter sends a weekly/monthly/yearly bill to the importer. The importer pays the exporter. That is all! An open account is a very risky form of international transaction for the exporter because of the idea that the importer, upon receiving the goods, will not pay the exporter. Small companies usually do not participate in open account transaction because they usually have infrequent suppliers/consumers, or simply can not accept the risk of a major account defaulting with non-payment. Given mutual confidence between the buyer and the seller there is little need for a letter of credit or documentary draft for collection when making an international business transaction.
For this reason, an open account is the most common form of payment for an international business transaction (Weiss, p.177). This is because the greatest majority of international trade is between affiliated companies, or between huge firms that know and trust each other without fooling with complex trade payment procedures (Weiss, p.177). This type of account is basically an extension of the domestic type accounts that are common in the business world of today. With an open account, an importer calls an exporter for an order, the order is shipped, and the importer bills the exporter on a monthly basis exactly like a normal, domestic account. The terms of an international account are usually similar (example: 1/20 net 40) and the importer usually pays all of the costs that are involved in getting the goods sent to the importer.
Payment in Advance
A payment in advance is the opposite of an open account. Advance payment shifts the risk of the transaction to the importer. With an advance payment: An importer places an order with an exporter for the delivery of a product The importer sends the exporter a check in advance for the product. The exporter then ships the product to the importer at a specified time. A bundle of samples, an international gift, or a small, one-time purchase is usually the ideal candidate for a payment in the advance transaction.
The importer will look through a catalog, or on the Internet, purchase the item with cash/check/credit card, and rely on the exporter to send the goods as expected. This type of transaction does not occur very much in the business world, and usually only occurs in small, final consumer/international retailer transactions. If a proper business relationship is going to be formed where a mutual trust between the importer and the exporter is expected, an open account, and not a payment in advance, is usually created. Payment in advance does work, and if you are the exporter, it is the cheapest and most secure to get paid for an overseas transaction. Barter As a result of the historically recent decrease in the number of nations practicing communism, the world is becoming more capitalistic. Capitalism requires money, and the transfer of goods with money, to work effectively.
Bartering, by definition, is the exchange of goods without the use of money. One would think, with the recent surge in international trade via capitalism, that barter exchanges are becoming less common. This is not true. Bartering today is common practice for businesses that wish to get rid of excess inventory, take advantage of emerging Internet technology, or to broaden their product reach past domestic markets.
Bartering by corporations has been practiced for the past century or so to get rid of, as mentioned before, excess inventory without having to liquidate the product. Companies do this because of manufacturing overruns, to rid themselves of discounted models, or to clear warehouse space for other goods (Emigh, p.56). More often than not the products in question are of top quality with no prior usage, and liquidation would be inefficient because the corporation will take a loss in profit. Here is how a modern barter works: A corporation decides that rather than liquidation, they want to barter.
The corporation contacts a barter company. The barter company sends a representative to evaluate the goods offered, or the goods are shipped to the barter company’s warehouse. An assessment of the value of the goods is made. The barter company issues an amount of trade credit that can be exchanged for any other goods in the barter company’s possession. The corporation decides to exchange the trade credits for a different desirable good that was bartered by another company minus a minimal fee from the barter company.
The different goods are delivered to the corporation and the transaction is complete. Bartering can be classified as an international transaction because more often than not, the bartered items eventually end up in overseas markets. Companies are more likely, with a barter, to trade for products without losing as much profit margin as they would with a straight liquidation (Campbell, p.41). For example..Levi-Strauss manufactures a line of clothing that includes bell-bottom jeans, and drastically overproduces the jeans. There is no use for the jeans in the United States anymore, so liquidation would not be desired. Levi-Strauss can barter with a foreign company that might have a suitable market to sell the jeans in exchange for some raw manufacturing materials..such as denim.
A barter exchange will occur, the value of the swap is advantageous to both parties, and there may be a relationship formed for future business. Bartering also has different, sometimes more advantageous tax implications than a straight liquidation (Meyer, p.48). Bartering has recently come into the limelight through advances in information technology (Emigh, p.56). The Internet is a major contributor. The Internet has been a very important tool in the development, and upsurge of barter exchanges. Though B-2-B (business to business) organizations, a real-time, immense product database greatly facilitates the progression of a barter transfer (Meyer, p.47).
Dot-com companies such as Ariba.com, Fastparts.com, Freemarkets.com, and Barterexchange.com all use “trade credits,” offer real-time solutions to overproduction through bartering, and have huge databases and company relationships that result in rapid product turnover. Despite the impending maturity, and shakeout of the Internet industry, this type of B-2-B practice is flourishing. Barter exchanges in the United States are growing at a rate of 8% annually, over half of the Fortune 500 companies use corporate barters (Campbell, p.41), and B-2-B barter transactions are expected to reach an equivalent of $1.3 trillion in value by the year 2003 (Meyer, p.49).
Insurance and Payment pitfalls
Regardless of how thorough and careful an importer or exporter may be, there will come a time when payment default or conflict will occur concerning an international transaction.
In addition to selecting the proper type of international transaction, a company may choose to further minimize the risk of loss by carrying various forms of insurance. In addition, certain pitfalls may be avoided if a company educates itself about potential problems that may occur when participating in a foreign transaction. There are basically two types of insurance that a company needs to address when shipping products overseas. Companies need to know the benefits of accidental loss insurance and credit insurance.
Insurance can be acquired to cover a company’s loss due to theft, property damage, liability, and a host of other problems. Shipping materials overseas places unusual stresses on products due to extremes of transportation, shipping and handling. Things sometimes get broken. Shipyards, international ports, and warehouses are havens for criminal activity.
Things are sometimes stolen. Insurance is designed to reduce the risk of all of these potential problems and should be a “no-brainer” for any company. Most companies will not hesitate to insure against theft, property damage, liability, or a host of other unpredictable, high-exposure events (Robertson, p.76). When it comes to their accounts receivable, exporters for some reason, bear the entire risk of non-payment themselves (Robertson, p.76). Credit insurance is a good idea for any company that runs the risk of non-payment or theft with an international transaction.
This translates to basically anyone who does business as an importer or exporter with an unfamiliar client. There are many organizations that offer credit insurance. Credit insurance typically has low premiums and unusually high deductibles (Robertson, p.77). Of course, the deductible is usually lower than the loss that would be incurred if the company did not have an insurance policy for the goods in the first place. There will always be a way to beat the system, and regardless of the rules set into place, there will always be a time that an entity will become a victim.
Regardless of countering the threat with an insurance policy, the pitfalls of non-payment still hurt a company through lost time, damaged rapport, and lost efforts spent on the replacement of lost goods. The best way for a company to come out ahead in the trade game is to simply learn the game. Banks, the Small Business Association, the International Chamber of Commerce, and the EXIM Bank of America are all sources of information for the rules and regulations of international trade (World Trade Staff, p.51). The importance of proper documentation can not be stressed enough and can be an important defense against payment default. Word-of-mouth information is also very important, and keeping in touch with a forwarder, counterpart company, or attending a trade show can bring forth insight on how to efficiently perform an international transaction.
Conflicts often occur using a letter of credit regarding discrepancies of a letter of credit must be carried out word-for-word. Punctuation and grammar on the actual document is important as well. If somehow the name of a company is not spelled properly during the issuance of a letter of credit, that company can not acquire the profit from the transfer unless the conflict is resolved. The accurate documentation of a letter of credit can not be stressed enough (Mehta, p.13).
This is where most of the payment problems occur on an otherwise riskless payment form. Documentary drafts for collection offer more security than an open account of payment in advance. Most of the problems that arise from a documentary draft for collection are from a lack of importer credit and a fraudulent lack of importer payment. With a documentary draft for collection, the transaction may start without the banks approval of importer funding.
This problem can usually be prevented by having an underlying sales contract to fall back on when reporting the loss to an international governing agency (Hickman, p.94). Pitfalls experienced using an open account or payment in advance, as mentioned before, can be avoided if a mutually strong relationship is created between the importer and the exporter. Another problem that firms face when using open accounts or payments in advance is a form of strategic theft. An exporter commonly starts an account with a foreign importer.
The importer pays promptly every month and frequently increases the amount of the requested product. Once huge payments are required for large amounts of a product, the importer stops payments, “disappears,” and leaves the exporter with a huge loss (Weiss, p.96). Payments from such activity are rarely recovered. The only defense of the exporter is to file complaints to the US commerce department, SBA, and hope that government threats to the importer will produce the funds. Reasons That We Need All of These Payment Types In the perfect situation, an importer would send a check to the exporter, and a week later the goods would arrive without risk of either party losing money, time, or rapport. Unfortunately, companies are misunderstood, cheated, or ripped off at great expense to the importer or exporter.
The reason all of these payment types exist is to balance risk between importers, exporters, and banks. Open accounts and payments in advance are tools that do not require much bank involvement or investigation of the parties involved. Because of this, open accounts and payments in advance are the riskiest form of payment type, and should not be transacted unless there s a mutual partnership between the importer and the exporter. Open accounts and payments in advance, however, are the least expensive form of international payment.
Letters of credit and documentary drafts for collection are tools that use banks as an intermediary to reduce the risk for both the importer and the exporter. Stipulations can be made to further ensure that prompt, predictable, and reliable payment is made. Letters of credit and documentary drafts for collection have the potential to be virtually riskless forms of international transaction because of the banks’ role in the transaction process. Bank involvement, however, comes at a price. Also, letters of credit and documentary drafts for collection can be quite complicated and time-consuming.
These types of complicated payment types are not needed if there is a strong relationship between the importer and the exporter. Letters of credit and documentary drafts for collection are frequently used by small businesses that do not tolerate the risk of default payment. Barters are unique in that there is virtually no risk involved between the importer and the exporter. The risk with barter is carried by the barter company in the form of dead inventory. Barter companies, to eliminate dead inventory, usually have close relationships with liquidation firms, factor firms, and wholesale firms. Barter companies usually charge a fee for the services that they provide in order to minimize their risk.
Barters are not always an option for a company because of a lack of demand of a particular item that an importer may possess or desire. Closing Statements I have learned, as a result of this paper, that an international transaction is not as simple as running a credit card through a machine and signing the receipt. A letter of credit and a documentary draft for collection are actually quite complicated, and I really had a hard time understanding them until I plotted the transactions out on a flow chart. Payments in advance and open accounts are basically just extensions of their domestic counterparts.
Barters were hard for me to include in my research because most of the time the companies that use bartering are not really concerned if the products being bartered end up overseas. Most barters, however, do end up in a foreign market, and for this reason I believe that barters qualify as an international transactions. Also, the emerging trend of Internet B-2-B transactions have brought bartering into the limelight. I have spent entirely too much time on this term paper, am truly glad to be finished, and have learned immeasurably.
Bibliography
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- Emigh, Jacqueline. “Corporate Barter.” Framingham: Computer World, October 25, 1999, pg.56. Hickman, Thomas K. and William M Hickman Jr.
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- “The Original Meaning of Trade Meets the Future in Barter.” Irvine, CA: World Trade, January 2000, pg.46-50. Robertson, Aaron. “Covering Non-Payment Loss.” Irvine, CA: World Trade, October 1999, pg. 76-78. Sowinski, Laura. “Letters of Credit.” Irvine, CA: World Trade, November 1999, pg.
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- World Trade Staff. “Getting Paid for Whats Transacted for.” Irvine, CA: World Trade, September 1999, pg. 42-52.
