American exporters under some circumstances require cash in advance of shipment.
This requirement may be met by the foreign importer in several ways.
1. He may send a dollar draft with his order.
2. He may send a dollar draft to the exporter when the goods are ready for shipment.
3. He may provide the exporter with a letter of credit.
A letter of credit, as has been explained, enables the exporter to draw on a bank rather than on an importer and thus permits him to ignore the credit standing of the importer. Particularly is this so if the letter of credit is irrevocable and is confirmed by the American bank.
The letter of credit may provide for the drawing of sight drafts. If so, the exporter draws such a draft (in dollars or foreign currency according to the terms of the credit) on the bank specified in the credit, attaches the required documents, and obtains immediate payment. This sort of letter of credit--providing for "cash against documents"--is extremely favorable to the exporter. It provides him with cash at the time of shipment just as surely as if the importer had forwarded a dollar draft and it throws the entire problem of financing onto the importer and his bank.
Letters of credit may also require the exporter to draw time drafts. In this case, after the drawee bank has detached the documents and accepted the draft, the latter becomes a bank acceptance. It may be discounted by the exporter at a rate lower than that accorded to commercial acceptances by the money market.
Had the letter of credit been expressed in a foreign currency the drafts would be drawn on a foreign bank. In this case confirmation of the credit by an American bank obligates it to honor (or purchase) the drafts on a foreign-currency basis or the equivalent in dollars at the current rate; that is, the confirming bank does not assume the risk of exchange. If the American bank merely transmits the letter without confirming it, it is required only to cooperate with the drawer in forwarding the drafts to the foreign drawee bank. It should be observed that all sight or time drafts drawn under a letter of credit must be presented to the drawee bank for payment or acceptance before the expiration date set forth in the credit.
So satisfactory does the letter of credit appear to be as a sales arrangement that we may well ask why exporters do not always require their foreign buyers to supply letters of credit. In other words, to what extent and under what circumstances do American exporters sell on time drafts under letter of credit or--even more advantageously to themselves--on sight drafts under letter of credit or other cash terms?
Excepting a few staple commodities, and as long as credit risks are good and exchange is free of restrictions, letter-of-credit and cash-in-advance terms are used by American exporters less frequently than any of the other sales terms subsequently discussed, except consignment. Rather than being surprised that these export arrangements are so infrequently used, we may wonder why good risks are ever required to supply letters of credit--or, even more severe, cash in advance--when exchange conditions are normal. Here we again turn to custom for a partial answer. Importers in many parts of the world are accustomed to the use of letters of credit more or less regardless of their credit standing. The nature of the product is also relevant. If the product is perishable or is made to order, the exporter is less likely to extend credit and more likely to demand cash or a letter of credit. Finally, if the exporter has been selling to an importer for only a short time he may desire a letter of credit or cash with order even though he has no reason to rate the credit risk as other than first grade.
When exchange restrictions are prevalent, or when credit risks are doubtful, exporters become very much more likely to sell for cash in advance or before shipment, or under letter of credit, usually in dollars. This tendency may be illustrated by the following quotation from a letter written by the export manager of a manufacturer of heavy equipment.
To firms of known responsibility in foreign markets with whom we have direct dealings we allow terms of sight draft with ocean bill of lading and other documents attached, the amount of the draft covering shipping expenses. . . . It may be well to point out here that on account of the special nature of our products we sell only on a strictly cash basis. On most export orders, unless financed by reliable exporters in this country (e.g., export agents), our terms are part payment (at least 25 per cent) in advance with the order and the balance covered by sight draft with ocean shipping documents attached. For shipments to countries having exchange restrictions or where an "order" bill of lading is not permissible, we insist on guaranteed payment in New York, either by means of a documentary confirmed irrevocable letter of credit or through a reliable export house.
Only a small percentage of the exporters questioned were receiving cash in advance from importers of good credit rating in markets free of exchange restrictions, but when exchange restrictions are prevalent the percentage increases substantially. If, in addition, the credit rating of importers is doubtful, cash in advance or sight draft in dollars under letter of credit become the terms favored by exporters.
Such terms are a very sure method of circumventing exchange restrictions and of avoiding the abnormal delays which those restrictions sometimes impose on payments. However, all too often exporters discover that in the foreign markets where exchange restrictions are severe and exchange control is vigilant, banks are either not permitted to issue letters of credit or may do so only for the most essential imports. Importers in such markets usually find it extremely difficult or even impossible (except through devious and extralegal channels) to obtain dollar exchange in other forms for payment in advance.
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