Lessons · Lesson 3 of 6
The ladder, sorted by whose willingness you depend on
Re-sort the payment methods by the one question that decides how much risk you carry, and state the honest limit of each one.
Lesson 3 of 6 · 17 min
The wrong axis, and the right one
Payment methods are usually taught as a line from safe to risky: advance payment at one end, open account at the other, credits and collections somewhere in between. That order is not wrong. But it is a conclusion dressed up as a definition, and it does not tell you why one rung sits above another.
One question produces the order, and it is worth more than the list itself:
When the day comes, whose willingness do I depend on to be paid?
Sort the methods by the answer and they fall into four bands. Inside a band, the differences are paperwork. Between bands, the differences are structural. A move between bands is the only kind of move worth arguing about.
| Band | Method | Whose willingness you need | What you are holding if it is refused |
|---|---|---|---|
| 1 | Advance payment | nobody's — you already have the money | the money |
| 2 | Documentary credit, sight or usance | a bank's, and only if your documents comply | a bank's undertaking, if you presented cleanly |
| 3 | Documents against payment | the buyer's, but you still hold title | a container at Antwerp |
| 4 | Documents against acceptance | the buyer's, and they have the goods | an accepted bill of exchange |
| 4 | Open account | the buyer's, and they have the goods | an invoice |
Two things about that table before the detail.
First, documents against payment and documents against acceptance are not neighbours. They are one word apart in writing and a whole band apart in substance. Under one, the collecting bank hands over the bill of lading only when the buyer pays. Under the other, it hands it over when the buyer signs. The difference between paying and signing is the whole security of the deal.
Second, the two collections and the credit are often lumped together as bank methods. They are not the same kind of thing at all, and it is worth being blunt: in a collection, no bank promises you anything. The banks are handling documents on your instructions. A collection has its own international rulebook, quite separate from the one that governs credits, and that rulebook says so in its own text.
Band 2 in detail, because people misread it
A documentary credit is the only instrument on the list where a party much larger than your buyer takes on an obligation to you directly. That is genuinely powerful, and it is why credits exist. It also has two limits, and both are routinely forgotten.
The first limit: the promise depends on you. Scheldt Bank has promised to pay against a complying presentation. If the documents do not comply, the promise is not engaged. Your risk has not been removed. It has been converted from will the buyer pay into will my documents survive a check three thousand kilometres away. That second risk is one you can actually control, which is exactly why the trade is usually a good one. It is not a free one. Over its last twenty-four presentations, Nabaruh had nine sets sent back with at least one discrepancy. Lesson 4 puts a price on that.
The second limit: the promise is only as good as the bank that gave it, in the country it sits in. A credit issued by a bank you have never heard of, in a market with exchange controls, is a promise you cannot easily enforce and may not be able to convert into your own currency. The remedy is a confirmation: a second bank, usually in your own country, adds its own promise to the first. It costs money, and it is sometimes the cheapest money you will spend all season.
Course 13.2 is the whole of the check and the discrepancy. What matters here is the shape. The credit moves you from band 4 to band 2, and it does that by putting a bank's promise where a company's used to be.
Band 3, and what owning the goods is really worth
Documents against payment feels strong. You keep title until the buyer pays. If they will not pay, you still have the jackets.
Price that. Thurlemont declines the documents on 10 November. The container is at Antwerp.
| Line | USD |
|---|---|
| Quay rent and detention, 24 days at 118.00 a day | 2,832.00 |
| Return freight and handling, Antwerp to Damietta | 4,150.00 |
| Egyptian formalities on the factory's own returning goods | 1,900.00 |
| The jackets: made at 16.25, sold to a clearer at 6.50 | 179,400.00 |
| Total | 188,282.00 |
USD 188,282.00. That is 5.2 times the order's entire margin, from a security everybody calls strong. And the largest line is not the freight or the quay. It is the garments: 18,400 chore jackets in Thurlemont's three colours, with Thurlemont's labels sewn into the necks. To anybody else they are worth roughly what the cloth is worth.
That is the honest limit of band 3. Title is a real thing, and it is not the same as being paid. It protects you from the worst outcome, where the buyer has both the goods and the money. It does nothing at all for your margin.
Band 1, and why it is not the answer
Advance payment is the only rung where nobody has to be willing. The money is in your account before the fabric is cut.
Every factory wants it and very few get it. The usual explanation is that buyers refuse because they have the power. That is only half the reason. The other half is that an advance is not free to you either. The buyer is funding your production, they know it, and a competent buyer puts a price on it. Lesson 5 does that arithmetic from both sides of the table, and the result is smaller than most people expect.
Check yourselfA buyer will not open a credit but offers documents against acceptance at 60 days instead of open account at 75. Is that a real improvement?Show the answer
Barely. Both are band 4. In each case the buyer has the jackets and your payment depends on their willingness. What you gain is fifteen days of funding and an accepted bill, which you can enforce in its own right and can sometimes sell on. What you have not gained is any change in who decides whether you get paid. Treat it as a small gain in cash and no gain in credit risk, and price it that way rather than reporting it as a move to a bank method.
What you should be able to do now
- Ask the band question first on any payment term you are offered: whose willingness do I depend on? Everything else is detail.
- Never treat documents against payment and documents against acceptance as versions of one thing. One word, one band, the whole security of the deal.
- State the limit of a credit out loud when you recommend one: it turns a commercial risk into a paperwork risk, and it is only as good as the issuing bank.
- Price what you would be holding, not what you would have lost. Goods in a foreign port are an asset at clearance value, not at FOB.