CHAPTER SIX

THE BUSINESS OF FOREIGN

TRADE
• Facilitating international trade is one of the most important activities
of a bank’s international department.

• In this chapter we are going to see the various alternatives to

financing international trade and then examine the documents of
international trade.
1- THE CONTRACT

• Trade transactions begin with negotiations between a buyer and seller.

Before concluding the negotiations, the buyer and the seller have to
agree on mutually acceptable means of payment.

The payment options are:

-Prepayment by the buyer

-Open account shipment by the seller

-Collection

-Letter of Credit
Prepayment (cash in advance)
•The buyers pay for the merchandise in advance of the shipment. This
is made when there is a heavy demand for seller’s merchandise, or
the buyer has a poor credit reputation. In this transaction the buyer is
at risk. He is running the risk of paying the goods but not receiving
them, if the seller does not ship them. The bank assists transactions
by transferring funds on the order of the buyer to the seller through a
foreign draft.
•Method : Prepayments
The goods will not be shipped until the buyer has paid the seller.
Time of payment : Before shipment
Goods available to buyers : After payment
Risk to exporter : None
Risk to importer : Relies completely on exporter to ship goods as
ordered
 Open Account:

• In this transaction, the seller ships the goods, and the buyer pays
them after the merchandise is received and found to be
satisfactory.
• This is made when the buyer is large and has a good reputation.
The risk here is with the seller.
• A variation of this type of sales basis is a “consignment” sale. In a
consignment sale the merchandise is shipped to the foreign buyer,
who does not have to pay until he has sold the product.

• Method : Open Accounts

• The exporter ships the merchandise and expects the buyer to remit
payment according to the agreed-upon terms.
• Time of payment : As agreed upon
• Goods available to buyers : Before payment
• Risk to exporter : Relies completely on buyer to pay account as
agreed upon
• Risk to importer : None
Method : Consignments
The exporter retains actual title to the goods that are shipped to the
importer.
Time of payment : At time of sale to third party
Goods available to buyers : Before payment
Risk to exporter : Allows importer to sell inventory before paying
exporter
Risk to importer : None
Draft (Bills of exchange)
Although not a document directly related to the movement or
protection of merchandise, it is an important document in L/C and
collections. The draft is the document by which the seller
demands payment from the buyer, the buyer’s bank or some
other bank.
A draft drawn “at sight” is payable when presented to the drawee.

Method: Drafts (Bills of Exchange)

These are unconditional promises drawn by the exporter
instructing the buyer to pay the face amount of the drafts.
Banks on both ends usually act as intermediaries in the
processing of shipping documents and the collection of
payment. In banking terminology, the transactions are known
as documentary collections.
Method : Drafts (Bills of Exchange)
Sight drafts (documents against payment) :
When the shipment has been made, the draft is presented to the
buyer for payment.
Time of payment : On presentation of draft
Goods available to buyers : After payment
Risk to exporter : Disposal of unpaid goods
Risk to importer : Relies on exporter to ship goods as described in
documents
Method : Drafts (Bills of Exchange)
Time drafts (documents against acceptance) :
When the shipment has been made, the buyer accepts (signs) the
presented draft.
Time of payment : On maturity of draft
Goods available to buyers : Before payment
Risk to exporter : Relies on buyer to pay
Risk to importer : Relies on exporter to ship goods as described in
documents
Method: Letters of credit (L/C)
These are issued by a bank on behalf of the importer
promising to pay the exporter upon presentation of the
shipping documents.
Time of payment : When shipment is made
Goods available to buyers : After payment
Risk to exporter : Very little or none
Risk to importer : Relies on exporter to ship goods as
described in documents
International Trade – means of payment:
Comparison of Payment Methods for International Trade
Documentary Collection

• A documentary collection is a process by which an exporter's bank collects

funds from the importer's bank in exchange for documents detailing shipped
merchandise.
• With a documentary collection, exporters allow their bank to act as a
collection agent for payment of shipped goods to the buyer.
• Documents against payment (D/P) requires the importer to pay the face
amount of the draft at sight. Documents against acceptance (D/A) requires
the importer to pay on a specified future date.
Exporter trusts his bank to forward the documents of title to a bank in the
Buyer’s country.
The Exporter and the Exporter’s bank hope that the foreign bank doesn’t
make a mistake and collects the money for the shipment before turning
over the documents of title to the Buyer.

OR:
The Exporter forgets the banks and sends the documents to his own
trusted agent in the Buyer’s country with the same instructions to collect
the money.
If Exporter gets paid within a few days of doing this, he has just financed
his customer for those number of days at -0- interest and full loss
potential.
2. DOCUMENTS
Banks deal only in documents.
The required documents typically include a draft (sight or time), a
commercial invoice, and a bill of lading (receipt for shipment).

Sometimes, the exporter may request that a local bank confirm

(guarantee) the L/C.

2.1 Transport Documents (Bills of Lading)

Bill of lading is one of the most important documents in international

trade, which is issued by the transportation company when moving
the goods from the seller to the buyer.
 -Bills of Lading
-Ocean bill of lading (vessel)
-Rail bill of lading (rail)
-Truck bill of lading (truck)
-Air way bill (air)
-Certificate of posting (mail)
-Inter modal bill of lading (combined transportation)

• The bill of lading is prepared by a shipping agent and signed by the

shipping company and given to the exporter.

Bill of lading indicates that:

• The shipping company received the goods
• The shipping company will deliver the goods to the foreign buyer or
others
• The shipping company’s terms and conditions
• The weight and dimensions of cargo
• The charges for shipment and
• The shipping marks on the crates
• Ocean bills of lading fall into 2 categories, received for shipment and
on board bills of lading. The latter means not only the cargo has been
received but also that the goods are actually loaded on board of the
vessel.
• The bill of lading specifies who is to receive the goods at the port of
destination.
• Straight bill of lading: Shipper directs the shipping company to
deliver the shipment directly to the buyer.
• Order or negotiable bill of lading: Anyone in possession of an order
bill of lading can obtain the merchandise.
• ‘Consigned to the order of shipper’ means the shipper should
endorse it.
• ‘Multiple Original’ means more than one original.
• ‘Clean bills of lading’ means that the merchandise was received by
the shipping company in apparent good order (no damage).
• ‘Foul bill of lading’ means goods received not in good order
(damaged)
• ‘Liner Vessel’ means the vessel is operating on a regular route.
• ‘Charter party bills of lading are specialized bills of lading that
operate within the framework of a charter party agreement.
 2.2 Insurance
• All merchandise should be covered by
insurance. This is good for exporters, importers
and bankers.
• Marine insurance covers merchandise transported on a
vessel.
• “General Average” the captain of the vessel can throw some
of the cargo to the sea if the vessel is in danger of sinking.
When the vessel arrives safely in port, those shippers whose
cargo got through safely must reimburse those whose cargo
was sacrificed to save the common venture.
• “All risks” coverage gives a good protection to the
merchandise owner.

2.3 Invoice
A statement prepared by the seller for buyer describing the
goods sold, price and other details (date, ref no, shipping
date, etc).
• Consularized commercial invoice
 2.4 OTHERS

• A certificated of origin: It shows where the goods are grown or

manufactured.
• A weight list (gross weight, net weight)
• A packing list
• An inspection certificate
 3. Trade Terms
• C.I.F (cost, Insurance and Freight)

• F.O.B (Free on Board)

• F.A.S (Free Along Side)

• C&F (Cost and Freight)

 Collection

• The seller agrees to make a shipment before demanding payment

and the buyer agrees to pay before getting possession of the
merchandise. Here the seller is at risk.

COLLECTION TYPES
There are two types of collections:

1 Clean Collections (financial document alone)

• Checks, traveler’s checks, money orders drawn on banks are
received by individuals and/or companies (home or abroad) then
these checks are taken to the bank in order to credit their account.
2 Documentary Collections
• It includes commercial documents either with a financial document
or alone. The commercial documents are; invoices, bills of lading,
weight list etc. The bank pays the exporter after receiving these
documents and the buyer possesses the merchandise. The
important point here is that, the buyer can get hold of documents
after giving payment instruction to his bank to pay the seller
(exporter). This procedure is called documents against payment
(D/P).
3. SIGHT DRAFT
• A sight draft becomes payable when it is first presented to the importer
by the collecting bank in the importer’s area. In some countries the
importer is permitted to wait until the vessel arrives before paying.

• Direct Collection: To speed up the transactions many banks furnish

exporter with bank drafts and collection instruction letters. This enables
the exporter to mail it directly to the foreign bank. This is called direct
collection.

• Protest is the formal legal process of demanding payment of a draft

from the drawee who has refused to pay.

• The exporters usually determine the collecting bank.

• The expenses and commissions of the bank are paid by either the
exporter or the importer depending on the agreement.
4. TRADE ACCEPTANCE

• In some cases, the exporter in order to make sales may agree to be paid
after the importer gets and sells the merchandise. In agreeing to release
the merchandise before receiving a payment, the seller wants to have a
written promise from the buyer that the payment will be made at a future
specific date. In this case the exporter draws the draft, not at sight but at
a future date say “90 days after sight”.
• This is sometimes called documents against acceptance.
• The importer accepts the draft, collects the document and agrees to pay
the exporter on a specific day. This is trade acceptance.

5. IMPORT COLLECTIONS

• Collections for import are the reverse of those covering exports. The
collections are usually received from a foreign bank, which conveys all
instructions from the seller. Any deviations from the foreign bank’s
instructions are at the risk of the collecting bank.
6. FOREIGN CURRENCY COLLECTIONS
• The documents accompanying the draft are presented to the importer. To
pay the draft, the importer will need to purchase the foreign exchange.

7. OTHER COLLECTIONS
• Some exporters sell on “cash against documents” term (same as a draft
sale)
• Eligible products: Payments are made after the shipment passes
inspection by health authorities
• Consignment Method: Payments are made after goods are sold. All
expenses belong to the exporter
• Delivery order: The shipping agent informs the buyer that goods ordered
are ready to be delivered.

FINANCING
• If the exporter wishes to obtain financing, the bank finances the exporter
while the collection is being forwarded to the importer. If importer does not
pay then the exporter -together with the interest- pay back this loan.
ADVANTAGES AND DISADVANTAGES
• A collection provides more protection to the seller than selling on open
account and more protection to the buyer than prepaying the shipment.
The cost of collection is low compare to L/C or other method.
• And the seller is exposed to non-payment by the buyer either from the
buyer’s death, bankruptcy or refusal to pay (the collection is the property
of the exporter and the intermediary banks are the exporter’s agent).
• For the bank, collections develop business and relationship.
• The risk for the bank is that, in case of protest of nonpayment, the name
of the bank can be deteriorated although it is merely passing on its
customers instructions.
• If the exporter bankrupts then some charges such as storage cannot be
recovered.
• Accounting: Outstanding collections do not appear in a bank’s financial
statement as the bank is an agent and has no responsibility unless it acts
against the customer’s instruction. Fees and commissions are reflected in
the bank’s income statement.
• In short, in collections the bank acts as an agent for the seller of the
goods in presenting the demand for payment to the buyer. Once the
payment is made the bank then gives the shipping documents to the
buyer who needs them to take possession of the goods.