Methods of Payment in International Trade: Open Account

For exporters, any sale is a gift until payment is received. For importers, any payment is a donation until the goods are received. Successful exporters and importers recognize this conundrum and are able to negotiate payment terms that recognize the inherent risk and yet meet the needs of both parties.

There are five primary methods of payment in international trade that offer different levels of security. Generally, greater payment security for the exporter means greater risk for the importer and vice versa. The key is striking the right balance for both sides. This article focuses on open account.

What Is an Open Account, and What Are Its Advantages?

An open account transaction in international trade is a sale where the goods are shipped and delivered before payment is due, which is typically in 30, 60 or 90 days. The sales agreement should specify when that payment period begins—for example, the invoice date. Obviously, this option is advantageous to the importer in terms of cash flow and cost, but it is a risky option for an exporter.

Because of intense competition in export markets, foreign buyers often press exporters for open account terms. In addition, the extension of credit by the seller to the buyer is more common abroad. Therefore, exporters who are reluctant to extend credit may lose a sale to their competitors.

Though open account terms can enhance export competitiveness, exporters should thoroughly examine the political, economic and commercial risks as well as cultural influences to assess the likelihood that payment will be received in full and on time.

It is possible to substantially mitigate the risk of non-payment associated with open account trade by using trade finance techniques such as export credit insurance and factoring. Exporters may also seek export working capital financing to finance production and support cash flow while waiting for payment. Working capital financing does not, by itself, protect the exporter against buyer non-payment.

How Can Exporters Manage Open Account Risk?

Under an open account, the goods, along with all the necessary export documents, are shipped directly to the importer who has agreed to pay the exporter’s invoice at a specified date, which is usually in 30, 60 or 90 days.

The exporter should assess the importer’s creditworthiness and payment history and the importing country’s commercial and political risks before extending credit. In addition, using clearly defined Incoterms rules can help both parties avoid misunderstandings around costs, delivery responsibilities and risk transfer points. Incoterms rules do not establish the method or timing of payment; those terms should be agreed separately.

Open account terms may help win customers in competitive markets and may be used with one or more appropriate trade finance techniques. Export credit insurance, export factoring and standby letters of credit can help mitigate non-payment risk. Export working capital financing, including government-guaranteed financing, helps fund the cash cycle.

Open account terms may also be offered to importers who prefer to pay in their local currency, using an appropriate foreign exchange risk hedging technique such as a forward contract.

Export Working Capital Financing

Exporters who lack sufficient funds to extend open accounts to potential international customers need export working capital financing that covers the entire cash cycle, from the purchase of raw materials through the ultimate collection of the sales proceeds.

Export working capital facilities, which may require personal guarantees and collateral such as inventory or receivables, can be structured to support export sales in the form of a loan or a revolving line of credit. Financing may be available through commercial lenders, with government guarantee programs helping eligible exporters obtain financing that lenders might otherwise be unwilling to provide.

Government-Guaranteed Export Working Capital Programs

The U.S. Small Business Administration and the U.S. Export-Import Bank offer programs that guarantee export working capital funds granted by participating lenders to U.S. exporters. With those programs, U.S. exporters can obtain needed funds from commercial lenders when financing is otherwise not available or when their borrowing capacity needs to be increased.

Export Credit Insurance

Export credit insurance provides protection against covered commercial losses, such as default, insolvency or bankruptcy, and covered political losses, such as war, nationalization or currency inconvertibility. Coverage depends on the policy’s terms, limits and exclusions and may leave the exporter responsible for a portion of the loss. Insurance can also help exporters obtain working capital financing by making foreign receivables more acceptable to lenders.

Export Factoring

Factoring in international trade is the sale of short-term receivables. The exporter transfers title to their short-term foreign accounts receivable to a factoring house for cash at a discount from the face value. In a non-recourse arrangement, the factor assumes the buyer’s credit risk as specified in the agreement and handles collections on the receivables. Exporters should confirm which risks the factor assumes before relying on factoring as protection against non-payment.

Factoring is particularly suited to recurring exports of consumer goods, although it can also be used by exporters in other industries.

Standby Letters of Credit

A standby letter of credit is a bank’s commitment to pay the exporter if the importer fails to pay as agreed, provided the exporter presents the documents required by the standby letter of credit within its terms and validity period. Using this type of letter of credit as a condition for selling on open account can preserve the importer’s cash flow while mitigating the exporter’s risk of non-payment. The issuing bank’s creditworthiness and country risk also matter.

Forward Contract

Exporters can use a forward contract to manage currency risk when offering open account terms to foreign buyers who prefer to pay in their local currency. A forward contract enables the exporter to sell a set amount of foreign currency at a pre-agreed exchange rate with a delivery date in the future to their foreign exchange service provider.

This locks in the exchange rate for the agreed amount and settlement date. It does not protect against buyer non-payment or currency inconvertibility. If the importer pays late or fails to pay, the exporter still has obligations under the forward contract.

Summary

At first glance, selling to international customers under an open account may seem too risky to even consider. There are enough potential advantages, however, that using this payment term under the right circumstances may make sense. It can make an exporter’s products more competitive and may even allow them to charge more for their goods.

The keys to selling under an open account are a sound assessment of the buyer’s ability to pay, a good understanding of how external forces like a country’s economic situation or government actions could cause payment problems or extended delays, and the use of appropriate trade finance techniques to manage payment risk and cash flow.

If open account isn’t the right payment option for your transaction, learn more about your other options in the chart below (it includes links to an in-depth article on each payment method) or download the free Trade Finance Guide: A Quick Reference for U.S. Exporters.

Comparison of Payment Methods in International Trade

This article is taken in large part from the Trade Finance Guide: A Quick Reference for U.S. Exporters, which you can download for free by clicking the link below.