An enterprise engaged in foreign trade should carefully select a method of payment best suitable for each transaction at the offer stage. Foreign trade may involve risks not present in domestic trade. The choice of payment method is a way of avoiding these risks.
The choice of payment method is affected by several factors:
- requirements of the seller and buyer
- relationships between the trading partners
- the operating environment and associated risks
- object of transaction
- market conditions
Payment methods for foreign trade include clean payment, collection and documentary credit. In direct foreign payment, the seller sends an invoice to the buyer and trusts that it will receive payment on the due date. If there is no trust and the buyer's operating environment involves economic and political risks, you should choose a documentary credit or collection item. In these methods of payment, the bank supervises the release of documents and payment.
Factors that should be taken into account in choosing a method of payment include:
Trading relationship
Mutual trust among trading partners is the foundation for trading. If the trading relationship is new and the parties do not know each other well, a collection item or documentary credit is a sensible choice. Direct foreign payment is suitable for established and trustworthy trading relationships.
Economic and political risk
The seller must estimate the buyer's credit risk. Reliable credit ratings are not always available. In these cases, it is reasonable to choose a documentary credit in which the payer is the buyer's bank.
However, the bank issuing the documentary credit and its country may involve economic or political risks. The seller can protect itself against these risks by requesting its own bank to confirm the documentary credit. Exporters do not usually accept trading in high-risk areas without confirmed documentary credit.
Geographical and cultural distance
Commercial payments between Nordic and Central European countries are usually handled as direct payments thanks to social stability and geographical closeness.
The farther away your trading partner, the more frequently collection items or documentary credits are used. The payment practices and collection of receivables in different cultures vary from Finnish practice, which is why payment should be secured in advance.
Product
The product also affects the choice of a method of payment. The amounts associated with capital goods are large, and protection against risks is sought through documentary credits. Collection items and direct payments are more suitable for trading in consumer goods. A documentary credit is a highly recommended method of payment for the deliveries of tailor-madegoods and project-type transactions.