GGBBEE –– WWEEEEKK 1111 6-3. Payment Payment Instruments of GBT As we have learned earlier, financial documents, also called instruments, are widely used in international trade and payment. They clearly record currency to certain extent, circulating among participants, facilitating the transfer of credits, acting as payment and credit tools in mechanise exchange. In GBT, the main instruments of payment are the currency and bills, i.e. bill of exchange (draft), promissory note, and cheque. (i) Bill of Exchange The bill of exchange or draft has played a vital part in the world’s commercial and financial life for some countries. Also, it is widely used for settlement in international trade. A bill of exchange or draft is an unconditional order in writing prepared by one party (drawer) and addressed to another (drawee) directing the drawee to pay a specialised sum of money to the order of a third person (the payee), or to the bearer, on demand or at a fixed and determinable future time. In conjunction with the definition, Figure 18 Specimen: Bill of Lading may be dissected as follows: ① An unconditional order in writing; ② Addressed by one person/party (the drawer); ③ To another (the drawee); ④ Signed by the person (the drawer) giving it; ⑤ Requiring the person to whom it is addressed (the drawee or payor) to pay; ⑥ On demand, or at fixed or determinable future time; ⑦ A sum certain in money; ⑧ To, or to the order of, a specified person, or to bearer (the payee). [Figure 18] Specimen: Bill of Exchange 2 / 27 (ii) Promissory Notes A promissory note is an unconditional promise in writing made by one person (the maker) to another (the payee or the holder) signed by the maker engaging to pay on demand or at a fixed or determinable future time a sum certain in money to or to the order of a specified person or bearer. From definition of promissory note, it is easy to find that there is no accepter, only the maker and the other parties are payee, endorser, bearer and holder. The maker has prime liability while the other parties have second liability. Should the promissory note be made by two persons, then they are jointly and severally liable to the note according to its tenor. Bill of treasuries, bank notes, etc., are daily used examples of promissory note. Main contents are stated as follows (please refer to Figure 19): ① The words “Promissory Note” clearly indicated; ② An unconditional promise to pay; ③ Name of the payee or his/her order; ④ Maker’s signature; ⑤ Place and date of issuing; ⑥ Tenor of payment; ⑦ A certain amount of money. [Figure 19] Specimen: Promissory Note (iii) Cheques A cheque is defined as an unconditional order in writing drawn on a bank signed by the drawer, requiring a bank to pay on demand a sum certain in money to the order of a named person or to the bearer. The meaning of the different parts of the definition is: 3 / 27 ① Unconditional: Payment cannot hinge on certain conditions being met, e.g. “Pay Mr Patrick USD200 provided my salary cheque has been paid into my account”. ② Writing: It must be in writing, pen, ballpoint pen, print, even pencil can be used although the latter is not recommended because details can easily be altered. ③ Signed: A cheque must be signed by the drawer, who is the person paying the money. ④ On Demand: It is expected that the cheque will be paid as soon as it is presented to the other bank. ⑤ Certain Amount: The amount of the cheque must be definitive, both in words and figures. ⑥ Named Person or Bearer: The cheque must be payable to someone by name or payable to “the bearer”. Basically, there are five essential elements in a cheque. They are mentioned as follows: ① Indicating the word “cheque” or “check”; ② Detailed name of the drawee, i.e. the paying bank; ③ Name and signature of the drawer; ④ Date and place of issuance; ⑤ Currency and a certain amount. [Figure 20] Specimen: Cheques (I) 4 / 27 [Figure 21] Specimen: Cheques (II) Methods of Payment Nowadays, how to choose a certain payment method among them is the result through analysis and comparison and a contest for both buyer and seller. The main methods of payment introduced in this section are as follows: cash in advance, T/T payment in advance, open account, D/P, D/A, documentary letters of credit and documentary drafts, documentary collection (draft), documentary drafts, letters of credit (L/C). [Figure 22] Flowchart of Exemplary International Payment Procedure (in China) 5 / 27 1. Cash in Advance Receiving payment by cash in advance of the shipment might seem ideal. In this situation, the exporter is relieved of collection problems and has immediate use of the money. A wire transfer is commonly used and has the advantage of being almost immediate. Payment by cheque may result in a collection delay of up to six weeks. Therefore, this method may defeat the original intention of receiving payment before shipment. Many exporters accept credit cards in payment for exports of consumer and other products, generally of a low currency value, sold directly to the end user. Domestic and international rules governing credit card transactions sometimes differ, so Korean merchants should contact their credit card processor for more specific information. International credit card transactions are typically done by telephone or fax. Due to the nature of these methods, exporters should be aware of fraud. Merchants should determine the validity of transactions and obtain the proper authorisations. For the buyer, however, advance payment tends to create cash flow problems, as well as increase risks. Furthermore, cash in advance is not as common in most of the world as it is in the United States. Buyers are often concerned that the goods may not be sent if payment is made in advance. Exporters that insist on this method of payment as their sole method of doing business may find themselves losing out to competitors who offer more flexible payment terms. 2. T/T Payment in Advance T/T means telegraphic transfer, or simply wire transfer. It's the simplest and easiest payment method to use. T/T payment in advance is usually used when the sample and small quantity shipments are transported by air. The reason why is that the documents like air waybill (AWB), commercial invoice and packing list will be sent to you along with the shipment by the same plane. As soon as the shipment arrives, you can clear the customs and pick up the goods with the documents. As it's acknowledged, T/T payment in advance presents risk to the importer if the supplier is not an honest one. It takes 3-4 days for us to received the wire transfer made from anywhere in the world. 3. Open Account In a foreign transaction, an open account can be a convenient method of payment if the buyer is well established, has a long and favourable payment record, or has been 6 / 27 thoroughly checked for creditworthiness. With an open account, the exporter simply bills the customer, who is expected to pay under agreed terms at a future date. Some of the largest firms abroad make purchases only on open account. However, there are risks to open account sales. The absence of documents and banking channels might make it difficult to pursue the legal enforcement of claims. The exporter might also have to pursue collection abroad, which can be difficult and costly. Another problem is that receivables may be harder to finance, since drafts or other evidence of indebtedness are unavailable. There are several ways to reduce credit risk, through such means as export credit insurance and factoring. Exporters contemplating a sale on open account terms should thoroughly examine the political, economic, and commercial risks. They should also consult with their bankers if financing will be needed for the transaction before issuing a pro forma invoice to a buyer. 4. D/P (Documents Against Payment) The exporter makes shipment and sends the shipping documents to the exporter's bank (e.g. the Bank of China) for collection. The Bank of China then sends the shipping documents along with a collection letter to the importer's bank, who then sends a collection notice to the importer. The importer makes payment upon receiving the notice, and only after payment does the importer receive the original shipping documents with which you take the physical possession of the goods. The major advantage of the use of cash against documents payment is the low cost, versus using a letter of credit. But, this is offset by the risk that the importer will for some reason reject the documents (or they will not be in order). Since the cargo would already be loaded (to generate the documents), we have little recourse against the importer in cases of non-payment. So, a payment against documents (D/P) arrangement involves a high level of trust between the exporter and the importer. 5. D/A (Documents Against Acceptance) The D/A transaction utilises a term or time draft. In this case, the documents required to take possession of the goods are released by the clearing bank only after the buyer accepts a time draft drawn upon him. In essence, this is a deferred payment or credit arrangement. The buyer’s assent is referred to as a trade acceptance. D/A terms are usually after sight, for instance “at 90 days sight”, or after a specific date, such as “at 150 days bill of lading (B/L) date.” 7 / 27 As with open account terms, there are some inherent risks in selling on D/A: ‐ As with a D/P, the importer can refuse to accept the goods for any reason, even if they are in good condition.