Incoterms and International Payment Methods

Incoterms are international commercial terms that define the obligations, risks, and costs of both the buyer and seller involving the delivery of goods in an international sales contract. It’s important to have a common understanding of the delivery terms because confusion over their meaning may result in a lost sale or a loss on a sale.

The most commonly applied terms of sale are Incoterms, which were created to describe the responsibilities of the exporter and importer in international trade. Understanding and using these terms correctly are important, because any misunderstanding may prevent you from living up to your contractual obligations and make you accountable for shipping expenses that you had initially intended to avoid.

You should specify all terms of payment clearly to avoid confusion and delay. For example, “net 30 days” should be specified as “30 days from acceptance,” and the currency of payment should be specified (e.g., “US $30,000”).

A complete list of Incoterms and their definitions is provided in Incoterms 2010, a booklet issued by the International Chamber of Commerce (ICC).

Some common Incoterms include:

  • Cost and Freight (C&F): The exporter is responsible for all costs and freight expenses necessary to bring the cargo to the destination named in the shipping term. The importer would then be responsible for any unloading charges, Customs clearance fees, and inland freight expenses as the cargo moves from the pier to the importer’s warehouse. Title (risk of loss or damage) is transferred from the exporter to the importer as the goods pass the ship’s rail in the port of shipment.
  • Cost, Insurance, and Freight (CIF): CIF means that the exporter pays all costs up to the point that the goods are fully unloaded from the carrier at the port of destination.
  • Free Alongside Ship (FAS): The seller’s price quote includes the charge for delivery of the goods alongside a vessel at the named port of export. The seller handles the cost of wharfage, while the buyer is accountable for the costs of loading, ocean transportation, and insurance.
  • Free Carrier (FCA): This refers to a named place within the country of origin of the shipment. The seller is responsible for handing over the goods to a named carrier at the named shipping point. This term may be used for any mode of transport.
  • Free on Board (FOB): The buyer and seller agree on a designated FOB point. The seller assumes the cost of having goods packaged and ready for shipment from the FOB point, and the buyer assumes the costs and risks from the FOB point onward.

When negotiating a sales agreement, shipping terms should be specified. Using internationally accepted INCOTERMS, such as FOB, FAS, C&F, CIF, and so on, will ensure that both parties are on the same page.

International Payment Methods

When selling a product or service overseas, using appropriate payment methods is critical, along with pricing, providing accurate quotations, and choosing the terms of sale. The level of risk you are willing to assume in extending credit in global markets is a major consideration when deciding how you want to receive payment for products sold abroad.

Several methods of payment are common for export sales, and the best option depends on the level of trust you have in the buyer. The methods, listed from most to least secure for the exporter, are:

  • Cash in advance: This is the least risky option for the exporter, as the payment is received before shipment. Payment is typically made by wire transfer for almost immediate receipt, although checks can take up to 6 weeks to clear. From the importer’s perspective, however, cash in advance creates cash-flow problems and increased risk since they are paying before receiving the goods.
  • Letters of credit: Letters of credit are a common method of payment that protects both the buyer and seller. With a letter of credit drawn at sight, the importer’s bank guarantees payment to the exporter as long as the required documents are presented to the bank before the expiration date. A time letter of credit functions similarly, but the exporter will get the money a certain number of days after the documents have been presented and accepted. There are two main types of letters of credit:
    • Irrevocable letter of credit: These cannot be amended or canceled unless all parties agree. Exporters should always start negotiations by asking that payment be made by a confirmed and irrevocable letter of credit for maximum protection against commercial and political risks.
    • Confirmed letter of credit: The validity of this letter of credit, issued by the importer’s bank, is confirmed by a bank in the exporter’s country. This assures the exporter of payment even if the foreign buyer or bank defaults.
  • Documentary collections (drafts): Documentary collections, also known as drafts, function similarly to letters of credit by requiring payment upon presentation of documents that convey title and show what steps have been taken. Like letters of credit, drafts may be paid immediately or at a later date. There are two main types of documentary collections:
    • Sight draft: Payment is made immediately upon presentation.
    • Time draft or date draft: Payment is made at a later date, typically after the buyer receives the goods.
  • Open account: This option eliminates the bank from the transaction. The exporter sends the documents directly to the importer and trusts that the payment will be sent according to the agreed-upon terms. This method is only recommended if the importer is well-established, has a good payment history, and has been deemed creditworthy.
  • Consignment: This is the least secure method of payment for the exporter, as they ship the goods and receive payment only after the importer sells them. While great for the importer, this option can be risky for the exporter and is typically only used if there is an established relationship between the two parties.

In addition to these common payment methods, other payment options are listed in the sources, including:

  • Account-to-account (A2A) transfers: This method involves the electronic transfer of money between the customer’s and merchant’s banks. This type of transaction is popular in many countries because it occurs in real time and reduces fraud and chargebacks. However, few U.S. banks offer A2A transfer services because they are not as common in the United States.
  • Person-to-person (P2P) transfers: This method involves the electronic transfer of funds to a third party who then deposits the funds into the merchant’s account. P2P transfers offer a convenient way to make payments online and can be conducted in various currencies.
  • Escrow services: An escrow service acts as a trusted third party that collects, holds, and disburses funds according to the instructions of both the exporter and importer. This method reduces the risk of fraud, as the payment is only released once the agreed-upon terms are met.

To summarize, when selecting a payment method, exporters should consider:

  • The level of risk they are willing to assume.
  • The importer’s creditworthiness and payment history.
  • The prevailing business practices in the importer’s country.

Consulting with an international banking professional can provide valuable insights into navigating different payment methods, foreign exchange risks, and other related aspects of international trade.