Question

what are the advantages and disadvantages of these payment terms: documentary collections, open-account sales, revocable letters of credit?

Answer 1

(1): Documentary collection – In this type of payment terms the exporter gives the task of collecting the payments with regards to the export to the bank of the exporter.

Advantages – This payment term gives considerable payment warranty to the exporter and the method is less complicated than other alternatives like letters of credit. For the importer this method offers the advantage of a ‘deferred payment’ option.

Disadvantages – In terms of disadvantages this method does not reduce the risks faced by exporter. For instance in case of a counter party failure the exporter will face the risk of non-payment after delivery. Counterparty credit risk also remains tangible.

(2): Open-account sales – In this method goods are shipped and delivered before the payment is due.

Advantages – This method allows optimization of cash flows and costs for the importer. Also the importer does not require a bank credit.

Disadvantages – For the exporter the primary disadvantage is that it is a high risk method or option. Another disadvantage of this method is that it may increase the price of goods quoted by the exporter as the exporter will have to weigh in the additional risks.

(3): Revocable letters of credit – This letter of credit can be changed or cancelled by the bank that has issued it at any time and for any reason.

Advantages – In some cases revocable letter of credit is secured by the applicant’s assets and so there is some mortgage security or personal guarantee involved. Besides it enables the trade partners to expand their businesses in a relatively safe manner across the world.

Disadvantages – The main disadvantage with this payment term is the level of uncertainty associated with it. On the other hand this method has a high degree of risk in the form of possibility of misuse.