CHAPTER 5: CASH APPLICATION, DEDUCTIONS, AND DISPUTE MANAGEMENT
LETTER OF CREDIT (LC) A letter of credit (LC), which is a common form of international payment, is fairly simple. The customer applies for a LC with its bank. That bank issues the LC to your company’s bank, and notifies you that the LC has been issued, thus dedicating the funds for this transaction. Your company then ships the goods to the customer. In this scenario, the issuing buyer’s bank then pays your bank, and your bank pays your company. The LC stipulates, of course, that the customer will reimburse its bank. LCs can be expensive. A bank issuing a LC will usually charge your customer a percentage of the value of the goods purchased, which normally amounts to at least a few hundred dollars. The LC should specify which party is responsible for paying any fees incurred. Although LCs can be expensive, they are ideal for payments from customers with whom you do not have an established and trusted relationship. It is important to note, however, that the LC does not obligate your company to ship the goods—that obligation should be contained in the underlying purchase order or contract, which is separate from the LC. OPEN ACCOUNT Open account is also a fairly common form of international payment. Under open account terms, the company simply ships the goods with an invoice. This method can only be agreed upon if you fully trust your customer (i.e., it has a strong credit rating and/or payment history with the supplier). Open account is in fact the ideal way for a trusted customer to pay you. In order to establish such relationships, careful attention must be given by both organizations. Payment is typically EFT. PAYMENT IN ADVANCE Payment in advance is a good method from an AR perspective, as it eliminates credit risk and accelerates cash flow. Your company might also require it, at least for certain customers. However, it is not a method that many customers like, and they will agree to it only if they are desperate and cannot find an alternative source of supply. For the customer, it is an inefficient process, and they must be absolutely certain of your integrity. An alternative might be to consider accepting half up front and half upon delivery. Once the customer has purchased from you a few times, they will likely want to negotiate different terms. DOCUMENTS FOR COLLECTION Like open account or payment in advance, the documents for collection process is used the buyer and seller have established a high level of trust. However, the scenario works more like a LC. The seller’s bank will send the shipping documents (bills of exchange) to the buyer’s bank. The buyer’s bank will hand the bills of exchange to the buyer when they either pay for them, or when it accepts bills of exchange payable at some date in the future, as agreed between the two parties. The buyer’s bank does not make any promise of payment but simply agrees to hand the shipping documents to the buyer under the terms stipulated by the seller.
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THE ACCOUNTS RECEIVABLE SPECIALIST CERTIFICATION PROGRAM E-TEXTBOOK
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