MECHANISM OF ITERNATIONAL TRADE TRANSACTIONS
Means of Payments in IB
(1) Open Account
(2) Cash in Advance
(3)Letter of Credit
(1) Cash in advance
Cash in advance affords the exporter the greatest protection because payment is received either before shipment or upon arrival of the goods.
(2) Letter Of Credit
Letter of credit is a letter addressed to the seller, written and signed by a bank acting on behalf of the buyer. In the letter, the bank promises that it will honour drafts drawn on itself if the seller confirms to the specific conditions set forth in the letter of credit In exchange for the bank's agreement to honour the draft
for payment that results from the transaction, the importer promises to pay the bank the amount of transaction and an agreed fee. The letter of credit obviously becomes a fmancial contract between the issuing bank and a designated beneficiary that is separate from the commercial transaction.
Advantages to the exporter.
1. The letter of credit eliminates credit risk if the bank that opens it is of undoubted standing. Obviously, the exporter needs to check only on the reputation of the bank.
2 A letter of credit also reduces the danger that payment will be delayed or with held due' to exchange control or other political risks. Countries generally permit local banks to honor their letter of credit. Failure to honor them could severely damage the country's credit standing and credibility.
3. A letter of credit reduces uncertainty. The exporter knows all the requirements for payment because they are stipulated on the letter of credit.
4. The letter of credit can also guard against preshipment risks. The exporter who manufactures, under a contract, a specialised piece of equipment runs the risk of contract cancellation before shipment. Opening a letter of credit will provide protection during the manufacturing phase.
5. Letter of credit facilitates financing because it ensures the exporter a ready buyer for its product. It also becomes easy to create a banker's acceptance-a draft accepted by a bank.
Advantages to the importer:
1. The letter of credit ensures that the exporter delivers goods and produces certain documents which are carefully examined by the bank. If the exporter fails to deliver the goods, it will be much simpler for the importer to withdraw deposit from the bank. I
2 Because a letter of credit is as good as cash, the importer can usually command better credit terms and /or prices.
3. Letter of credit financing may be cheaper than the alternatives. There is no tie-up of cash if the letter of credit substitutes for cash in advance.
The letter of credit operations are quite simple.
To illustrate how it operates, consider the case of USA Importers Inc, of Los Angeles. The company is buying spare auto parts worth $38,000 from Japan Exporter Inc, of Tokyo, Japan. USA Importers applies for, and receives, letter of credit for $38,000 from its bank, Wells Fargo. The actual process is shown in Fig.
(3) The Drafts
The draft, also called the bill of exchange, is written by an exporter on the importer directing the latter to pay a certain sum on a specified date for having goods shipped to the importer. The exporter submits the bill to its banker who collects the stated amount from the importer's bank and remits the proceeds to the seller or to the bearer.
The draft has three parties:
(a) The exporter-is the party who draws the bill and hence called the drawer,
(b) The importer on whom the bill is drawn and hence called the drawee, and
(c) the party who is entitled to receive payment is called the payee. Normally, the drawer and the payee are the same persons in which case thereare only two parties to a draft.
The draft serves three important functions and hence is widely used in foreign trade:
1. It provides written evidence of obligations in a comprehensive form.
2 It enables both parties to potentially reduce their costs of financing.
3. It is a negotiable and unconditional instrument.
To serve the three purposes, the draft needs to fulfill the following conditions:
• It must be in writing
• Signed by the drawer (exporter)
• An unconditional order to pay
• A certain sum of money
• Payable on demand or on a specified future date
• Payable to order of bearer
Under the consignment the exporter sends goods, on consignment, to the importer who arranges for the sale of goods and makes payment to the exporter, after deducting a specified commission.
Goods on consignment are duly shipped to the importer, but they are not sold. The exporter (consignor) retains title to the goods until the importer (consignee) has sold them to a third party. This agreement is normally made only with a related company because of the high risks involved. There is little evidence of the buyer's obligation to pay, and should the buyer default, it becomes difficult to collect.
(5) OPEN ACCOUNT
Open account selling is shipping goods first and billing the importer later. The credit terms are arranged between the buyer and the seller but the seller has little evidence of the importer's obligation to pay a certain sum at a certain date.
Sales on open account, therefore, are made only to a foreign affiliate or to a customer with which the exporter has a long history of favorable business dealings.
The benefits include greater flexibility (no specific payment dates are set) and involve lower costs, including fewer bank charges than with other modes of payment. As with shipping on consignment, the possibility of currency controls is an important factor because of the low priority in allocating foreign exchange normally accorded to this type of transaction.
DOCUMENTS OF IINTERNATIONAL TRADE
(b) Bill of lading,
(c) commercial invoice,
(d) insurance certificate, and
(e) consular invoice
(A) Bill of lading
The most important document used in financing of foreign trade is the bill of lading (B/L). A B/L is a shipping document issued to the exporter or its bank by a common carrier that ships the goods. It serves three important functions:
1. It is a receipt acknowledging that the goods have been received by the carrier.
2. It is a contract binding the carrier to deliver the goods to the importer.
3. The negotiable B/L, its most common form, is a document that establishes control over the goods.
(B) commercial invoice
A commercial invoice contains an authoritative description of the merchandise shipped, including full details on quality, grades, price per unit, and total value.
It also contains the names and addresses of the exporter and the importer, the number of packages, any distinguishing external marks, the payment terms, other expenses such as transportation and insurance charge, any fees collectible from the importer, the nanle of the vessel, the ports of departure and destination and any required export or import permit numbers.
(C) insurance certificate
All cargoes going abroad are insured. Most of the insurance contracts used today are under an open, or floating policy. This policy automatically covers all shipments made by the exporter, thereby elinlinating the need for arranging individual insurance for each shipment. To evidence insurance for a shipment under an open policy, the exporter makes out an insurance certificate on forms supplied by the insurance company.
This certificate contains information on the goods shipped. All entries must conform exactly with the information on the BIL, on the commercial invoice and where required, on the consular invoice.
(D) CONSUMER INVOICE
Exports to many countries require a special consular invoice. This invoice, which varies in its details and information requirements from nation to nation, is presented to the local consul in exchange for a visa. The form needs to be filled carefully, for even trivial inaccuracies can lead to substantial fines and delays in
customs clearance. The consular invoice does not convey any title to the goods being shipped and is not
FINANCING TECHNIQES IN FORIGN TRADE
Besides direct bank financing, there are several other techniques available for trade financing:
• Bankers' acceptances,
• Factoring: Many firms resort to factoring in which the factoring company buys the exporter's foreign accounts receivable at a discount.
• Forfeiting: When the trade involves very large capital items like commercial aircraft and ships, forfaiting Is a technique of financing. Forfaiting is the discounting of medium-term export receivables denominared in fully convertible currencies