International Documentary Collections vs Letter of Credit
International Documentary Collections vs. Letter of Credit by Thomas H. Ward
Reading this article will make you a semi expert on the subject. For more information you can see my book Letters of Credit and Documentary Collections which can be found on line. Also see my other articles on Letters of Credit on Associated Content. This information is based on my 30 years of experience in international business operations. Go to:
Another very simple and safe way you can do an international sale for export is to use D/P (documents against payment). This is a very powerful tool. To use this system, you give instructions to your bank that the documents attached to a sight draft for collection are deliverable to the buyer only against payment. This means the buyer cannot obtain the goods until he pays the bank. Upon payment, he gets to obtain the goods when the bank releases the documents such as bill of lading and invoice.
Using this method is the best way if both parties have a trusting relationship, as it has the advantages of reducing banking cost and paperwork. In addition, it reduces the time required for you to get paid, and it does not tie up money for your customer as do letters of credit. The risk is mainly taken on your side as the seller. If you ship the goods and the customer does not make payment, then you have materials stuck in a foreign country that you will need to have shipped back to you at your expense.
So to use the D/P system, you really need to know your customer very well. The good point is you are usually paid before the goods even arrive at the country if the shipment is done by ocean freight. Normally you can receive payment within twenty days. For air freight shipments, payment can be even faster.
A sight draft is payable when presented by your bank to the customer’s bank. It is payable at sight or when the completed documents are presented to the bank. All letters of credit and D/P use a sight draft or a bank draft as it shows the exact dollar amount to be paid. The Sight Draft is covered in another article.
Another international collection method is D/A or documents against acceptance. This works the same way that D/P does, but a time draft is used. This means you are giving your customer some extra time to pay, such as thirty days or sixty days after receiving the goods instead of paying right away. This adds some more risk to the transaction.
How the D/P system works: 1. Exporter fills out sight draft and documents and sends to your freight forwarder or shipper. 2. Freight forwarder ships goods and obtains bill of lading signed by the actual carrier doing the shipment. 3. Freight forwarder sends documents back to you, and you can forward these documents to your bank. 4. Your bank sends the documents to mporter’s bank. 5. Importer accepts the documents and approves payment. The importer is given the documents by his bank, and this is proof the goods belong to him so the carrier will release the goods. 6. Importer’s bank wire transfers money to exporter’s bank. Your bank puts the payment into your account. 7. The transaction is complete.
You will be sent a notice of payment. You will need a good freight forwarder that is certified and can handle your shipments. The freight agent needs to send the bills of lading back to you quickly so you can get paid. If the freight forwarder does not provide fast return service of the bill of lading, then your payment will be delayed, sometimes by as much as one month. To keep your company cash flow in good shape, fast payment is very necessary. So in conclusion, your selection of the bank and the freight forwarder is very important to be successful in international business. It is important that you pay the freight and select the freight agent as this allows you to control the shipping and thereby the Bill of Lading which is proof of shipment. Most companies want the customer to pay the freight charges but this can cause you many problems.
I used the D/P method for years with a Korean Company who would purchase $150,000 worth of material from us every month. We had a distributor agreement with our supplier here in the United States who gave us up to ninety days to pay. Using the documents against payment method, the Korean company paid us within twenty days of the ship date. We would send the documents to the bank right away and sometimes we were paid in ten days. This gave us a very positive cash flow, allowing us to use the customer’s money for up to seventy days.
Documents that are used for D/P and D/A are: Application of documentary collection, bank cover letter, draft, Invoice, packing list, certificate of origin, bill of lading, certificate of analysis, declaration of nonconiferous wood packing material is required for China shipments, copy of customer purchase order or contract, advice letter from your bank that the customer accepted the documents and will make payment.
After the documents are submitted, you will receive a letter advising the customer has accepted them. This letter usually comes from your bank within two weeks. Receipt of this letter means your company will be paid within a few days of the date on the letter.
In conclusion, the reader should now have a good knowledge of the way that documentary collection works. The documents required are basically the same as for a letter of credit. The big advantage is you have no letter of credit to read and conform too.
So the use of documents against payment or D/P and documents against acceptance or D/A is a much easier method to use for an international collection. The bank only acts as an in-between, handling the documents and payment between you and your customer. Another nice advantage is that the D/A and D/P method will cost you far less money than a letter of credit payment by your customer. Your customer may like to use D/A or D/P as it means they do not have to have the funds on deposit for a letter of credit. So both customer and supplier benefit from the use of these payment methods.
The only drawback is as the supplier, you really need to know your customer is a reliable trading partner and will pay you on time if using the D/A method. If D/P method, you have less worry as they are required to pay before the release of documents in most countries. This brings up an important point about international trade, and that is to try to find out what are the banking rules in the country you are trading with. This can be found out by contacting your banker.
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