Export payment methods and the letter of credit (L/C)

In exporting, collecting payment securely matters as much as selling the product. A poorly chosen payment method can turn a profitable sale into a loss. In this article we cover the main export payment methods and how a letter of credit (L/C) works.

Why is the payment method so critical?

In international trade, buyer and seller are usually in different countries, under different legal systems, and often never meet. The payment method is therefore a trust mechanism that balances both the seller’s collection risk and the buyer’s risk of not receiving goods.

1. Cash in Advance

Payment is received before the goods are shipped. It is the safest method for the seller and the riskiest for the buyer. It is preferred with new customers where no trust relationship exists, but it may deter buyers in competitive markets.

2. Open Account

The goods are sent to the buyer and payment is made later. It is the most comfortable method for the buyer and the riskiest for the seller. It is usually used in long-term, trust-based relationships.

3. Documentary Collection

Through a bank, documents are released to the buyer only against payment or acceptance. It is cheaper than a letter of credit and safer than open account; however, the bank does not guarantee payment.

4. Letter of Credit (L/C)

A letter of credit is the buyer’s bank undertaking to pay the seller provided the specified documents are presented in full. It is the most common secured method in international trade, protecting both buyer and seller.

How does a letter of credit work?

The buyer applies to its bank and opens a letter of credit in favour of the seller. The seller ships the goods and presents the required documents (invoice, bill of lading, certificate of origin, etc.) to the bank. If the documents comply with the terms, the bank pays. The critical point is this: under a letter of credit, payment is based on documents, not on the goods. Even the smallest discrepancy in documents can delay payment.

Choosing the right method

The right payment method varies with your level of trust with the customer, country risk, transaction size and competitive conditions. As part of export consultancy, Tuvti Trade designs payment and documentation processes for you. For details, reach out to us.