Indian enterprises need to be involved in international trading to maintain their place in the global economy. Choosing the right payment method for international trade is thus an important aspect of successful cross-border deals.

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This article elaborates on the main payment methods in international trade, along with their practical usage, risks, and benefits. It can help Indian businesses make the right decision when trading.

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Importance of Understanding Payment Methods in International Trade

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Global trade affords many opportunities, but it's not without its complexities, especially in securing payments. Indian enterprises venturing into international trade must be aware of these subtle nuances in order to minimize risks and in return secure deals favorably so that payments are timely. Knowing the proper payment methods helps businesses to be prepared against the possibility of not getting paid or delayed payment.

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A business should investigate the status of the buyer's credit before entering into a transaction. Chambers of commerce and credit reporting services can provide significant information on the creditworthiness of the buyer. Those sources, along with references from other buyers, form the basis of the due diligence process important for the lowering of risks before payment agreements are finalized.

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Major Payment Methods Useds in International Trade

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Different payment methods provide different degrees of risk for the buyer and the seller. The best possible method would be determined by the seller's risk of non-payment and the buyer's creditworthiness. The following is the elaboration of these common forms of payment techniques:

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1. Cash in Advance

Cash in advance is the safest method for sellers since the cash will always be paid before shipping the goods. It usually entails wire transfers or checks.

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Advantages

• No risks on payment for the sellers.
• Timely payments are received through a safe and expedient system of transferring by wire.

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Disadvantages

• Buyers are at risk of non-delivery.
• Wire transfer includes substantial costs and adverse currency exchange rates.

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2. Letters of Credit (LC)

LC is a method that uses a bank as an intermediary between the buyer and the seller. The bank ensures its payment to the seller if and only if certain conditions have been met; thus, both party's interests are protected.

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Advantages:

• Balances the risk both to the buyer and the seller.
• Guarantees payment in case the terms of the LC are satisfied.
• Especially useful for initial intercontinental relations

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Disadvantages:

• It is complex and expensive to create.
• It strictly has to abide by LC terms in order to not delay a payment.

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Note: Letters of Credit can be of different types, namely Revolving LCs, Negotiable LCs, and Standby LCs. The most flexible and the most popular kind is the Standby LC as a commitment for long-term projects rather than a tool of payment directly.

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3. Documentary Collections

Documentary collection also works by using the banks as intermediaries except that it does not guarantee payment to the seller.  The buyer’s bank will release shipping documents only after receiving payment or a promise to pay.

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Advantages:

• It is less expensive than Letters of Credit.
• It gives control over goods until payment for the seller.

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Disadvantages:

• No guarantee of receiving payment from the bank.
• There is a risk of a nonpaying customer, and the seller has no recourse other than to wait for another buyer.

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4. Open Account

In an open account arrangement, the buyer agrees to pay for goods at a future date after receiving the shipment. It is one of the most common payment methods in international trade, especially with large corporations.

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Advantages:

• Buyers prefer the method because they will receive goods before they pay for them.
• This reduces the immediate cash outflow for buyers.

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Disadvantages:

• Its risk is higher for sellers, especially when the buyer is new or unverified.
• Difficult to enforce payment, especially in foreign countries with differing legal systems.

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5. Hybrid Payment Methods

In real practice, many international transactions use a mix of payment methods. For example, a seller may require that a buyer pay 50% cash upfront and the balance by documentary collection.

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Advantages:

• Flexible depending on the mutual trust and risk assessment among trading partners.
• Reduces the risks posed by each individual payment method.

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6. Consignment

Consignment involves the seller shipping goods but receiving payment only after the buyer sells the goods. This method is common in industries such as fresh produce.

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Advantages

• The buyer is free to inspect them and sell them to receive payment.

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Disadvantages

• It is very risky for the seller since they can do little if anything, should their goods not be sold or damaged while being transported.

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7. Credit Cards

Some banks also give credit lines to international buyers. Thus, such buyers can even purchase goods with their credit cards. However, this option is not widely used for international trade due to major differences in country rules.

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Advantages:

• Both the buyer and the seller save time
• No complicated paperwork involved

Disadvantages:

• Expensive for both buyers and sellers.
• Credit card laws vary considerably from country to country

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8. Countertrade and Barter

Countertrade is an exchange method whereby instead of converting money, goods and services are traded off instead. This is predominantly practiced once the hard currency exchange becomes problematic. Barter is a process of international trade by way of exchanging commodities between two parties.

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Advantages

• Very helpful in situations where currency exchange is a problem.
• A flexible way of meeting the needs of both parties involved.

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Disadvantages

• It's hard to value the goods or services being exchanged.
• It tends to complicate accounting and regulatory processes.

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Role of Currency and Hedging in International Trade

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Currency exchange rates play a very strategic role in payment methods for international trade. Sellers generally want to get paid in their home currency to reduce any exchange rate volatility. For larger deals, say above $50,000, businesses hedge the currency risk associated with currency through options and forward contracts. This manner helps businesses freeze attractive rates as well as protect them from a sudden currency swing.

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Conclusion

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From cash in advance and letters of credit to documentary collections and open accounts, choices abound. Each one has its strengths and weaknesses. Indian businesses entering international markets need to be clear about the nature of buyer relations, tolerance for risk, and specific transaction requirements. In case of uncertainty, it is often advisable to consult a reliable international banker or financial advisor for more clarity and security.

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Karbon can help you get started with your international trade payment needs, we specialize in cross-border payments for Indian businesses. You can always speak to an expert at Karbon to learn more!

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FAQs

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What are the most secure payment methods for international trade?

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The most secure payment methods for both buyers and sellers in international trade balance the risk and ensure protection for both parties:

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Letter of Credit (LC): Secure for both, as the buyer's bank guarantees payment to the seller upon meeting the agreed terms, while the buyer ensures goods are shipped as specified.

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Escrow Services: Protects both parties by holding the buyer's payment until goods are received and verified by the buyer, ensuring compliance.

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Documentary Collection with Aval: Provides security for sellers with the buyer’s bank guaranteeing payment (avalisation makes the bank a co-obligator), while the buyer has the assurance that documents are checked.

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Open Account with Trade Credit Insurance: Beneficial for buyers with deferred payments, but sellers are protected through insurance in case of non-payment.

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Why is an open account risky for sellers?

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With an open account, the buyer takes delivery of goods before making payment, thus exposing sellers to the risk of non-payment in particularly in relation to new buyers.

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How can businesses protect themselves against currency fluctuations in international trade?

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Forward and option are two hedging strategies pertaining to currency, where businesses lock in favorable exchange rates, thereby reducing currency risk.

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