LC vs Advance Payment
How the four common ways of getting paid for a commodity shipment share risk between seller and buyer, and what to ask the bank first.
A small West African commodity exporter negotiating with a first foreign buyer faces a key choice: ask for payment upfront, or let the buyer pay against documents or later, and carry more risk. Cash upfront is the safest choice for the seller, but many buyers resist it, so most exporters trade some protection for the chance to win the sale.
Four ways to get paid
The US International Trade Administration's Trade Finance Guide ranks the main methods from least to most risky for the exporter:
- Cash in advance: the buyer pays, usually by wire transfer, before the goods are shipped. The seller avoids credit risk; the buyer carries all of it and loses cash flow, so insisting on it can cost sales.
- Documentary letter of credit (LC): the buyer's bank gives a commitment to pay the exporter, provided the documents presented comply with the terms of the credit.
- Documentary collection: the exporter's bank sends the shipping documents to the buyer's bank, which releases them against payment (documents against payment, D/P) or against the buyer's acceptance of a bill to pay on a later date (documents against acceptance, D/A).
- Open account: the goods are shipped and delivered before payment is due, typically in 30, 60 or 90 days. It is one of the highest-risk options for the exporter unless covered by export credit insurance or trade finance.
Where the bank helps, and where it does not
In a letter of credit, the bank stands between buyer and seller. Most commercial LCs follow the ICC's Uniform Customs and Practice for Documentary Credits (UCP 600). Banks deal only with documents, not with the goods: each bank examining the documents has a maximum of five banking days after presentation to decide whether they comply. If the invoice, bill of lading, certificates or dates do not match the credit, the bank can refuse to pay, and the exporter is again exposed to the buyer. A confirmed LC adds the undertaking of a second bank, usually in the exporter's country, which protects against problems with the buyer's bank or country.
In a documentary collection, governed by the ICC's Uniform Rules for Collections (URC 522), the banks handle documents and instructions but give no guarantee of payment. The buyer cannot take the goods without the documents, but if the buyer refuses to pay, the cargo may sit at the destination port while the exporter pays for storage, a new buyer or return shipping. Collections are generally cheaper than LCs, so they can suit exporters with buyers they already know.
Open account and cash in advance carry no bank charges beyond transfer fees, while LCs carry fees for issuing, advising, confirming and checking documents. Charges vary by bank, amount and country, so compare offers from more than one bank at the time of the deal.
What a small exporter should ask the bank
- Which documents the LC or collection will require, and whether each can realistically be produced in time.
- What each step costs and who pays: the exporter, the buyer, or each party its own bank's charges.
- Whether the LC can be confirmed by a local bank, and at what cost.
- How long payment takes after documents are presented.
- Whether export credit insurance or pre-shipment finance is available.
For a new or unknown buyer, an advance payment or a confirmed letter of credit gives the most protection. As trust builds with a reliable buyer, a documentary collection or open account may become acceptable. Whatever the method, write the payment terms into the sales contract before shipping.
