Methods of payment in trade

The four main methods and how they differ

When you are trading internationally, the method of payment you choose shapes exactly how and when the money moves. You need to know what protection exists for both buyer and seller if the deal goes wrong or there is a dispute. The four main payment methods, cash in advance, letters of credit, documentary collections and open account, aren't just different in process. Each one shifts the risk in a different way between you and your counterparty, from full protection for the seller at one end to a position that's safest for the buyer at the other.

You won't always be able to avoid risk entirely, but you control some of it by selecting the right approach and by deciding who handles the transaction. Banks usually get involved, especially when the parties don't know each other well. The choice will also affect how fast funds are settled, what you pay in bank or finance charges, and how much documentation you'll need to prepare.

Risk for the buyer and seller at each method

• Cash in advance: The buyer pays up front, before the seller ships. That's little risk for the seller, but the buyer carries all the uncertainty and has to trust the goods will get dispatched in full.
• Letter of credit: Here, a bank promises payment to the seller if all documents match the agreed terms. This shares the risk more evenly between buyer and seller. Costs are higher and you will need to deal with more steps, see how a letter of credit works for details.
• Documentary collection: Banks send the key documents, and the buyer either pays or commits in writing before the bank releases them. Payment itself is not guaranteed by banks, if the buyer refuses to pay, the seller might get the goods back or face further costs.
• Open account: In this scenario, the seller sends the goods and invoices the buyer for payment at an agreed time later. It's generally lower risk for the buyer but leaves the seller exposed until payment actually arrives.

Choosing a method in practice

The way you select a payment method in real transactions hinges on several factors: trust between the parties, the size and value of the shipment, the relevant countries' commercial practices, and whether you can afford to have funds tied up (for example, in a letter of credit margin). Often, new partnerships start with something secured such as a letter of credit, then may shift to open account as a payment history develops and reliability grows.

You'll want to check your payment terms line up with both your sales contract and the Incoterms in use (these clarify when the risk transfers from seller to buyer). If a seller ships on open account to a buyer who then delays payment, that can leave the seller exposed, so sometimes it makes sense to use a more secured method until payment behavior is clear. Where unsure, consult a bank or trade finance advisor before you sign the deal.

Frequently asked questions