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The frequency of a business's importing and exporting activities directly determines how it pays international business partners through foreign transactions. For growing enterprises, long-term business with an overseas vendor or supplier could be grounds for a switch from letters of credit.
Adopting a new international payment method requires analyzing the relationship between a buyer and seller. Here are a few considerations for business owners to keep in mind before changing.
Letters of credit can help both importers and exporters create an initial relationship with their trading partner, says Neil Jacobs, international corporate attorney and founder of N.I. Jacobs & Associates, a law firm based in New York City.
— Neil Jacobs, international corporate attorney and founder of N.I. Jacobs & Associates
"If I'm importing coffee from Brazil and I want to make sure that the beans are fair trade, part of my contract with the seller will include a certificate of inspection by the local chamber of commerce," Jacobs adds. "The certificate of inspection will not be included in the letter of credit, but delivery of such a certificate might be a condition to payment in the letter of credit."
While letters of credit can be helpful early on, the process of issuing and sending them continually can be costly. According to Jacobs, the charges for procuring a letter of credit "can range anywhere from $1,000 to $2,000." And a business owner might have to wait several weeks for his or her partner to collect all of the necessary documents, which can be even more detrimental to the profit margin. "There could be exchange rate fluctuations in the waiting period, and letters of credit don't provide adjustments for that type of thing," Jacobs says.
The lack of transparency associated with letters of credit, plus exchange rate fluctuations can be problematic. A company such as Western Union Business Solutions is an expert in payments, says Tiffany Burk, senior European market analyst at Western Union Business Solutions. "Following currency market developments is part of that process," she says. "This enables a company or person to make a knowledgeable decision on currency purchases, which can potentially be more cost effective." Individuals can better monitor the currency markets by signing up for email market-rate alerts from an online foreign exchange provider, which alerts them to preferred exchange rates for foreign transactions.
To save time and cut costs, businesses may also choose to handle international payments through an online foreign exchange service. But the decision to use this method over letters of credit should be based on the level of trust an international business has with its foreign partner. "Everybody wants to get to the point where they can sell on open terms," Jacobs says. "It's a matter of developing trust over a period of time. It's possible that within just six months, you could do over 25 transactions with somebody and feel confident."
Before transitioning, business owners should evaluate the dependability and timeliness of payments, as well as the quality of the goods being received. If a business owner is still hesitant about handling international payments on open terms, he or she should review a partner's previous payment history via a credit report from an international reporting agency like TransUnion or Graydon, Jacobs recommends.
With a trusted foreign exchange provider business owners can gain better control over their payments and greater visibility on both sides of the foreign transaction. "When people are in the import and export business, the less confusion, delay and uncertainty they have, the better," Jacobs says.
Example: 1USD = xx INR
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