5-2. Documentary Collection and Latter of Credit (D/P, D/A, and L/C)
Overview
Learning Points
- Review of the Payment Methods
- Documentary Collection (D/A and D/P)
- Lettr of Credit (L/C)
- Pros and Cons
Review of the Payment Methos
In the previous lesson, we explained that payment methods can be broadly categorized into two main types in Trade
・Documentary collections (D/A, D/P) and Letter of Credit (L/C)
These are the financial instruments to make transactions more secure by using documentary bills or a letter of credit!
What is a Documentary Collection?
Documentary collection is a method in international trade where banks help exchange shipping documents and payment between a buyer and a seller.
There are two types:
- D/A: where the buyer receives documents with an agreement to pay later
- D/P: where the buyer gets documents upon payment
Shipping Documents Used in a Documentary Collection
The buyer can obtain shipping documents from their bank upon payment or acceptance of the bill of exchange (draft). Shipping documents include the following:
- Bill of Exchange
- Bill of Lading (B/L)
- Invoice
- Packing List
- Certificate of Origin
- Insurance Documents
D/A
In a Documents against Acceptance (D/A) transaction, the importer accepts the Bill of Exchange (draft) and commits to make a payment by the specified maturity date.
In return, the importer receives the shipping documents upon accepting the draft. The payment is made when the draft matures by the importer.
D/A Payment Terms
There are two types of payment terms in D/A:
- Payable at Sight
The term “D/A at xx days after sight” is specified, with the exporter setting xx days. The importer must make the payment xx days after accepting the draft.
- Payable at a Fixed Date
The term “D/A at xx days after yy date” with yy often indicates a fixed date, such as the B/L date or Invoice date. The importer must make the payment xx days after the specified yy date.
This type of draft is also called a “usance bill” as it grants the importer a specific period by the due date indicated in the draft.
Pros
Before settling the payment, the importer can obtain the shipping documents and pick up the goods.
Cons
As soon as the importer accepts the draft, the ownership of the goods is transferred to the importer. This exposes the exporter to the risk of non-payment.
D/P
In a Documents against Payment (D/P) transaction, the importer can only obtain these documents, including the B/L, after paying for the goods.
It is also referred to as D/P at sight.
Pros
As the documents are not released until the importer settles the payment, the exporter can avoid the risk of fund collection.
Cons
The importer must pay before receiving the goods, which can impact cash flow.
It’s good for the exporter, though!
Letter of Credit
Combining a documentary bill with a Letter of Credit (L/C) is considered a method with the lowest risk of fund collection in international trade transactions.
It enables addressing the mentioned risks and reduces the burden on the exporter and importer.
What is a Letter of Credit?
A Letter of Credit (L/C) is a document issued by a bank. It serves as a payment guarantee in international trade transactions.
Under the condition that the exporter presents the documents specified in the L/C to the bank, the bank guarantees to make the payment on behalf of the importer.
Pros
- The exporter is guaranteed the payment
- The exporter can receive the money immediately by submitting the necessary documents to the bank in the export location
Cons
- Commission fees are incurred due to the bank’s intervening
- In case of document discrepancies, settlement may be delayed
How to Choose the Payment Method
There are various payment methods, and it is important to consider the advantages and disadvantages of each one before selecting the most suitable option for each case.
When using the D/A and D/P methods, the exporter cannot collect payment immediately, even if they submit the draft to the bank, unlike with L/C settlement.
It would be wise for exporters to use an L/C if there is not enough trust in the importer.
Summary
Secure payment methods can be broadly categorized into two types.
- Documentary Collection (D/A, D/P)
- Letter of Credit
Understand the respective advantages and disadvantages, and choose the one that suits your transaction best.
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Test Yourself
Reinforce your understanding of this topic by working through the exercises. Attempting the exercises without referring to the material as much as possible is advisable.
