BANK’S DOCUMENTARY COLLECTION
Under this payment terms, the seller gets paid and the buyer and the seller exchange
the documents representative of the goods and the payment via the intermediation of a
remitting and a collecting bank).
This type of payment works in this way:
1. The seller ships the goods to the buyer
2. The submits the shipping documents and a “collection order” to its bank
(“Remitting bank”) at the time of shipping. The draft includes instructions to
release the documents to the buyer upon receipt of a buyer’s payment or
buyer’s acceptance of the draft (which can be at sight, demanding payment on
presentation, or deferred at a future date)
3. The Remitting bank sends the documents, the draft, and the collection
instructions to the “Collecting or presenting bank” (the bank of the importer)
4. The collecting bank carries out the seller’s collection order and, upon receipt
of payment from the buyer, remits payment to the seller’s bank and to the
seller,
ultimately
CASH AGAINST DOCUMENTS (“CAD” or “DP”)
Cash Against Documents (“CAD” or “D/P”) are widely used payment terms in
international trading operations.
CAD is a payment term in which an exporter instructs his bank to hand over the
shipping documents to the importer when the importer fully pays the accompanying
bill of exchange or draft.
Under a CAD agreement, the seller receives the payment of the goods if the buyer
pays the due amount and withdraws the pre-agreed documents (generally through its
own bank).
The shipping document set includes, generally, the commercial invoice, packing list,
test certificates, inspection documents, bill of lading, insurance certificate, mill test
reports, and allows the importer to take possession of the goods.
The advantages of CAD are:
Lower complexity and cost than a letter of credit (easier both for seller and
buyer)
Buyer’s credit lines are not impacted
Faster process for buyer and seller, as bank intervention is minimal
This payment term is represented in the illustration below:
Risks of Cash Against Document Payment:
The main risk of CAD payment term is that buyers may not collect the goods and
the shipping documents after the shipment has taken place.
Hence, DAP is a very different arrangement than the payment by letter of credit,
where the seller basically no payment risk in case compliant documents are sent to the
issuing bank within the validity of the credit.
Due to this fact, sellers shall be very careful with DAP payment terms as they
generate unpaid invoices and excess stock.
LETTER OF CREDIT
A Letter of Credit, simply defined, is a written instrument issued by a bank at the
request of its customer, the Importer (Buyer), whereby the bank promises to pay the
Exporter (Beneficiary) for goods or services, provided that the Exporter presents all
documents called for, exactly as stipulated in the Letter of Credit, and meet all other
terms and conditions set out in the letter of Credit.
A Letter of Credit is also commonly referred to as a Documentary Credit.
Letters of credit are used between trade partners that do not know themselves well,
are located in remote locations and do not accept the payment risks of other payment
terms as open account, bank transfer, and, cash against documents.
The terms “Letters of Credit” /or L/C) and “Documentary Credit” (D/C) have the
same exact meaning. The first is more common in USA and Asia, whereas the latter is
common terminology in Europe.
HOW TO ISSUE AN LC
Before issuing an LC, the importer shall have approved credit limits sanctioned by the
issuing bank.
Moreover, imports and exports transactions that involve foreign currencies are subject
to foreign exchange regulations and other International rules like UCPDC 600, URR
etc.
Generally, the issuing bank requires the importer to submit an LC Application form to
issue a Letter of Credit.
After receiving the application, the bank issues a draft LC that the importer and
exporter can review and, in case, amend. As the LC is agreed between the parties, the
issuing bank submits the LC to the exporter advising bank, who in turn informs the
seller. As an LC is received, the seller can start the manufacturing or delivery
operations with strong payment security.
TYPES OF LETTERS OF CREDIT
There are a few types of letter of credit, the most common are:
1. At Sight LC
2. Time/Usance LC
3. Differed/Mixed Payment LC
4. Revolving LC
5. Confirmed LC
6. Transferable LC
7. Back to Back LC
8. Advance Payment LC
9. Discounting LC
10. Standby LC
STANDBY LETTER OF CREDIT
A standby letter of credit is a guarantee of payment by a bank on behalf of a client. It
is a loan of last resort in which the bank fulfills payment obligations at the end of a
contract in case of failed payment by the bank’s client.
Standby letters of credit are issued not to be used, normally. Standby letters of credit
help prove a business’ creditworthiness and pay back ability.
Types of Standby Letters of Credit
Performance Standby letter of credit
o Performance standby letters of credit ensure the nonfinancial
contractual obligations (quality of work, amount of work, time, cost,
etc.) are performed in a timely and satisfactory manner. If these
obligations are not met, the bank will pay the third party in full.
The financial Standby letter of credit
o Financial standby letters of credit ensure financial contractual
obligations are fulfilled. Most SLOCs are financial.
o Financial SLOCs are often required when performing an international
trade or other large purchase contracts under which other forms of
payment protections (such as litigation in the event of non-payment)
can be difficult to obtain.
TRANSFERABLE LETTER OF CREDIT
A transferable letter of credit is a special transferable form of a documentary letter of
credit opened for the benefit of the intermediate seller (the first beneficiary).
The transferable form allows the intermediate seller to apply to the nominated bank
with a request of transferring the letter of credit in whole or in part to the supplier (the
second beneficiary).
In case the intermediate seller purchases products from multiple suppliers, it has the
right to instruct the nominated bank to transfer the letter of credit by parts to each of
the suppliers.
CONFIRMED LETTER OF CREDIT
A confirmed LC is a letter of credit with higher payment security than unconfirmed
letters of credit: indeed, such type of letter of credits are guaranteed both by the
issuing and the confirming bank. Confirmed LCs are frequently used when selling to
countries subject to political risks, that may generate default of the local issuing
banks.
The beneficiary of an LC may request his bank to confirm the credit (“add
confirmation”), paying a cost, if the issuing bank has accepted such a possibility
under the terms of the credit.
By adding a confirmation, the confirming bank (the seller’s bank, generally) commits
to honoring the letter of credit in case the beneficiary submits a compliant set of
documents within the validity of the credit.
Such undertaking from the confirming bank is separate from, and in addition to, the
undertaking of the issuing bank.
BENEFITS OF CONFIRMED LC
The exporter may be interested in adding confirmation to the letter of credit in the
following cases:
when the creditworthiness of the issuing bank is uncertain
when selling to politically unstable countries
to prevent the risk of default of the issuing bank
to execute the LC faster
Banks confirm LCs at a cost that is expressed as an interest rate or a fixed fee (or a
combination of both). Generally, the cost is an interest rate ratio (example Libor) plus
a spread (confirmation fee). The higher the risk for the confirming bank, the higher
the cost.
BACK TO BACK LETTER OF CREDIT
Back to back LC’s are interesting instruments used by skilled
traders/intermediaries to finance buy and sell transactions without using own
capital or collaterals.
Under this schema, the trader who is the beneficiary of the letter of credit from an end
user may leverage the “main LC” (export LC) and obtain a “secondary” LC (import
LC) from his bank in favor of its supplier(s), without using own capital for the
transaction.
A back to back transaction involves two different (but connected) letter of credits:
main LC/ export LC: the LC issued by the end user to the trader
secondary LC/ import LC: the LC issued by the trader to its seller
(manufacturer, stockholder, distributor of the goods to be delivered to the end
buyer)
Under this schema, the intermediary uses the export LC as collateral to get an
import LC issued by his bank, without financing such LC with own funds.
The back-to-back LC schema is represented here:
CONDITIONS FOR A BACK TO BACK LC
The key conditions to put in a place a back to back schema are:
the trader has a successful trading history with his bank
the trader is the first beneficiary of the “export LC” (the LC issued by the end
user)
the export LC has been issued by a prime bank, and it can be confirmed by the
advising bank of the trader (first beneficiary)
trader’s supplier(s) shall accept payment by letter of credit
import and export LC’s show same terms and conditions, except for the price
of the goods (nature of goods, delivery place, and terms, pay location,
documents, etc)
Not all banks accept a back to back schema, as it involves some degree of risk for the
bank itself. However, when banks can ensure a consequential cash in and cash out,
and know the terms of the transaction well, a back to back LC may be arranged.
BENEFITS OF BACK TO BACK LETTER OF CREDIT
The trader may finance the transaction without impacting own funds or credit
lines
buyer may not know the identity of the seller, and the seller may not know the
identity of the end buyer
The trader may expand the business beyond its financial capacity
TRANSFERABLE VS BACK TO BACK LETTER OF CREDIT
Differently from “transferrable” LCs, which require the end user to approve the
transfer of the credit from the original beneficiary to a new beneficiary (condition that
is seldom accepted, as risky), a back to back LC does not require such approval and is
a private arrangement between the beneficiary of the “main LC” /”export LC” and its
bank.
The end user and the manufacturer of the goods may be totally unaware of the fact
that a back to back arrangement has been put in place to execute the transaction.
Your Guide To Free On Board (FOB) Shipping
Meaning, Incoterms & Pricing
International trade is complicated.
And while no two countries have exactly the same laws, when it comes to freight
there are many precepts that are standardized worldwide.
This guide cuts through the legal jargon and explains everything you need to know
about this common incoterm in plain English.
What Does FOB Shipping Mean
What is the Difference Between FOB Shipping Point and FOB Destination
FOB Shipping Point: Who Pays the Freight Costs
What is the Difference Between FOB and CIF
What Does FOB Shipping Mean?
First, let’s define what FOB (free on board) means by breaking down it down
word-by-word.
The term ‘free’ refers to the supplier’s obligation to deliver goods to a specific
location, later to be transferred to a carrier.
In other words, the supplier is “free” of responsibility. ‘On board’ simply means
that the goods are on the ship.
As such, FOB shipping means that the supplier retains ownership and
responsibility for the goods until they are loaded ‘on board’ a shipping vessel.
Once on the ship, all liability transfers to the buyer.
The further clarify, let’s track the FOB shipping process:
You purchase goods from a supplier in Thailand and agree to FOB shipping terms.
The next three steps of the process are carried out at the supplier’s expense.
Your goods are packaged and loaded onto a truck (or another form of
transportation) at the supplier’s warehouse (or another facility).
The truck brings the goods to the port.
The goods are loaded on board the shipping vessel.
Once aboard, the rest of the journey from Thailand is now both your liability and
your expense. Anything that happens from this point is on you.
The concept is illustrated below:
There are situations where you may be responsible for covering costs before your
goods are on board.
When you are shipping loose cargo (ie, not a full container), for example, your goods
must go through a Container Freight Station (CFS) to be consolidated into a
container.
Some suppliers do not cover the cost of consolidation.
FCL : Full Container Load
20' Container size
40' Container size
40'HC Container size
45'HC Container size
All sizes
What is the Difference Between FOB Shipping Point and FOB Destination
The qualifiers of FOB shipping point and destination are sometimes used to
reduce or extend the responsibility of the supplier in an FOB shipping agreement.
With FOB shipping point, ownership of goods is transferred to the buyer once
they leave the supplier’s shipping point.
From there, the title for the goods transfers from the supplier to the buyer
immediately and if anything happens to the goods at any leg of the journey to the
buyer from there, the buyer assumes all responsibility.
With FOB destination, ownership of goods is transferred to the buyer at the
buyer’s loading dock.
Upon delivery of the goods to the destination, the title for the goods transfers
from the supplier to the buyer.
If anything happens to the goods on any leg of the journey to the buyer, the
supplier assumes all responsibility.
FOB Shipping Point: Who Pays the Freight Costs
When the terms are FOB shipping point, the supplier relinquishes all of his
responsibility for the goods at his shipping point and the buyer is obligated to
cover the freight costs required for getting them to the desired location.
To further clarify, let’s assume that MEDB in the Malaysia purchases a container
of ABC from a supplier based in Thailand.
An FOB shipping point agreement is signed and the container is handed off to the
freight carrier at the shipping point.
If sending the container to the Malaysia costs $1000, MEDB is responsible for
paying that sum in full in order to get the goods.
What is the Difference Between FOB and CIF
Cost, Insurance, Freight (CIF) puts the liability of payment for – you guessed it –
cost, insurance, and freight on the supplier.
This means that your shipment is in the proverbial hands of the supplier through
the process of transporting them to a port and loading them aboard a ship. They
also cover insurance costs.
The buyer still pays additional fees like customs clearance, however.
Depending on the agreement with your supplier, your goods may be considered
delivered at any point between the port of destination and your final delivery
address.
CIF is a more expensive contract option than FOB, as is demands more effort and
expense on the part of the supplier.
