Terms and Conditions of Purchase or Sale/Terms of Sale – the Advantages and Disadvantages

Unit 5.1-Terms and Conditions of Purchase or Sale

Introduction | Modes of Entry | Terms of Sale | Applying Your Knowledge | Commercial Agreements | Summary | Resources | Activities | Assessment Go to Unit 5.1 | Unit 5.2 Return to Trade Finance Module 5: Selecting Payment Methods

Terms of Sale – the Advantages and Disadvantages

After completing the country and customer analysis, the mode of entry decision will be made. This process is then followed by a decision regarding the terms of sale which include the method of payment. (As methods of payment are discussed in detail in Task 4 we will only provide a brief list and description of each method of payment. For further detail and definitions including risks and the advantages and disadvantages, please refer to 4.1).

Whether the credit-decision maker is dealing directly with the customer as the seller, agent, or distributor, credit evaluations to determine appropriate terms of sale and methods of payment must take place. The terms of sale available for international transactions include countertrade, barter, counterpurchase, advance purchase, buy backs bilateral arrangements, offsets, consignment or direct transaction. When selecting a direct transaction the appropriate methods of payment must also be chosen based on the risk involved in the transaction. The available methods of payment include: open account, documentary collection, letter of credit, or cash in advance.

Countertrade and Consignment

When traditional forms of financing are not available alternative types of financing such as countertrade, offsets and consignment are used. These alternative forms allow commerce to continue despite additional steps and obstacles presented. These alternative forms can allow the penetration of the market and the capture of a greater market share. Barter, counterpurchase, advance purchase, buy backs and bilateral arrangements are the most common commercial mechanisms for reciprocal trade under the umbrella of countertrade. This form substitutes the exchange of merchandise without the exchange of cash. Consignment is the placement of goods with an importer without giving title to the goods. When the goods are sold the exporter is paid

Countertrade

Countertrade is an arrangement whereby the importer and exporter contract to exchange goods or services as payment in kind without the use of cash. This exchange of goods and services to finance purchases represents 10-15% of world trade. Countertrade is often utilized in underdeveloped countries especially when there is a shortage of foreign exchange capabilities.

The governments of these developing countries can require trade deals to include countertrade because it can give them the following advantages.

• Protection of foreign exchange reserves: Reserves can be limited or depleted, countertrade allows them to trade internationally regardless of their hard currency reserves.
• Create new export products or markets: The exporting country through the buyer can get access to new contacts, distribution channels and market strength which can provide additional export sales further benefiting the exporting country.
• Provide a balance of trade for political reasons: Balancing exports with imports ensures the balance of trade does not swing too far out of line as to put pressure on the national currency.
• Acquire new technology: Technology takes time and resources to fully develop especially in the case of defense purchases. Countertrade allows the importing country to gain the benefit of the technology and share in the employment benefits of the purchase.

These advantages are almost exclusively for the importing country. The importing country has considerable loss of flexibility and the additional following experience risks.

• Sales: The importer may not have sales experience in the countertrade product and experience substantial problems in the disposition of the foreign goods.
• Negotiations: The negotiation process is more difficult to accommodate related costs and adequate legal protection to protect financial interests.
• Standards: The establishment of quality standards can be difficult.
• Contract: Contract terms are more difficult for non-cash transactions.
• Profitability: Countertrade imposes added costs which can include trading house brokerage fees, storage and marketing fees, and customs fees and import duties.

Developed countries generally do not use countertrade because of the associated costs and the availability of a tradable currency which allows them to trade more freely.

This may not be the most desirable way to do business but it does provide additional opportunities. It is often used to penetrate new markets, secure long term supplies and allows trade where conventional financing would be impossible.

Barter

Bartering is the most widely known form of countertrade but it represents only a small part of all countertrade transactions. Barter involves an even exchange of goods or services for goods or services. This exchange can involve more than two parties. One example could be a computer manufacturer had some older inventory that would not sell in the local market. They found a buyer in South America that had nuts to exchange for computers. The computer manufacturer sold the nuts to a local grocery store chain in exchange for some cross marketing opportunities. Trading houses that specialize in this form of trade are often involved in these complex barter arrangements.

Counterpurchase

Counterpurchase also known as parallel bartering is considered the classic or most commonly used form of countertrade. This is defined as an arrangement where one company agrees to sell products to a foreign purchaser for cash, but also simultaneously agrees to purchase products or services from the foreign partner. The purchase amount can vary and can contain penalties for non-fulfillment dependent upon the underlying contract.

In a counterpurchase deal a car manufacturer agrees to sell the government of China $15 million worth of vehicles in exchange the car manufacturer agree to purchase $6 million worth of component parts for one of its divisions. The transaction does not have to be balanced but must be acceptable to both parties and is contractually binding. The complete transaction may occur over time and consists of two independent contracts.

Advance Purchase

Advance purchase is where the buyer pays in advance for the goods through an independent third party mainly a bank (because of their reliability) placing the funds into an escrow account of the exporter. It must be noted that banks in the United States do not offer this type of transaction

This process is very advantageous to the exporter. The exporter secures the payment in the local currency avoiding any potential exchange loss. This is especially true in countries that regulate and control the inflow and outflow of their currency. The difficulty for the exporter is that the regulators may not approve an advance payment unless the exporter agrees to utilize the proceeds locally and not to transfer the funds out of the country. This makes the transaction very similar to a counterpurchase differing only in the timing of the payments.

Buy Backs

Capital plant and equipment can be purchased by paying with the products produced from the equipment purchased or some combination of cash and product. This form of financing the purchase of capital plant and equipment is buy backs. The exporter of the equipment will then have the problem of selling the product given as payment in order to convert the product back into desired cash. This form of countertrade for plant and equipment is usually done by large organizations that can handle the payback period (the time it takes to sell the product that was accepted as payment) which is usually long term. They must also have the resources to market the “buy back” product.

For example a soda company sells bottling equipment and syrup to a foreign government in exchange for the bottled product produced from the bottling plant. The soda company will distribute the product using its own global marketing efforts to sell the bottled goods. The bottled product will convert to cash in partial settlement for the equipment and syrup that is sold.

Bilateral Arrangements

Bilateral trade is a form of barter that binds trade between two countries. Countries will use this form of trade to exchange goods at agreed to prices avoiding currency conversion by passing through a clearing account which should balance after a predetermined time.

Sources of Assistance for Countertrade

• Trading houses
• Banks and consultants
• Insurance facilities

Offsets
This is one of the more commonly used forms of countertrade. Suppliers of capital equipment agree to purchase goods or services from the country that purchased the capital equipment. This allows the repatriation of their local currency. The following forms can be considered offsets.

• Co-production - This is a government to government agreement to produce all or part of an item sharing technical information and know-how to produce the item. It includes government to government licensed production.
• Licensed Production - This is an agreement between commercial manufacturers to produce all or part of an item sharing technical information and know-how to produce the item.
• Subcontractor Production - This is an agreement between a commercial manufacturer and a subcontractor to produce component parts without the need for licensing because there is no sharing of technical information or know-how. This is usually a direct commercial contract or arrangement between two commercial producers.
• Overseas Investment - Offsets may require for the exporter to invest in a subsidiary or joint venture in the foreign country. This is also considered foreign direct investment.
• Technology Transfer - Offsets may require the transfer of technology in the form of research and development under a direct commercial arrangement with the subsidiary or joint venture.

Consignment

Consignment is the transfer of goods without the transfer of title to those goods until they are sold. The importer acting as an agent for the exporter is responsible for selling the goods and paying for them once they are sold. This is considered an effective inexpensive way to test market a product in a foreign environment.

Direct Transaction

This option is what one would commonly encounter in a buy sell relationship. Once chosen the international manager must then work with the finance department to access the credit worthiness of the customer and offer the appropriate payment terms for both parties. The payment term options include:

Open Account

When open account payment terms such as Net 90 Days – Invoice Date have been agreed to, the seller will ship the goods and all the necessary shipping and commercial documents directly to the buyer. The buyer has agreed to pay the seller’s invoice at a future date (in this case 90 days after invoice date). Therefore, the seller ships the goods to the buyer along with the commercial and shipping documents; and then the buyer remits the funds of the agreed date.

Documentary Collections

When selling under a documentary collection, the shipping documents and all other documents related to the transaction are transmitted through banking channels after the goods are shipped. The documents required to clear the shipment are released to a buyer only when a seller’s demand for payment has been honored. Therefore, the seller ships the goods, and the shipping documents and drafts demanding payment are sent through the banks which are acting on behalf of the seller. Then the bank releases the documents to the buyer when the buyer meets the payment terms, which may be documents against acceptance (D/A )or documents against payment (D/P).

Letter of Credit

After agreement to the transaction a buyer will apply to a bank for a letter of credit, which is forwarded to a seller through his bank. A seller will ship the goods per the directions of the letter of credit and forward the commercial and shipping documents to the appropriate bank. Once reviewed, the documents will be transferred to the buyer’s bank; and if the documents comply with the letter of credit, the seller will be paid and the buyer will receive the documents in order to clear customs and receive the goods. Therefore, the seller ships the goods and forwards the shipping and commercial documents through the appropriate banks. Payment is sent to the seller, and the buyer receives the documents if the exporter has complied with the directions of the letter of credit.

Cash in Advance

A seller requires payment either by credit card, wired funds, company or bank checks to be received from a buyer before manufacturing and/or shipping the goods. Therefore the seller ships the goods when payment is received. The shipping and commercial documents are then sent directly to the buyer.

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