To select the best payment method, it can be helpful to think about it in terms of the above risk ladder. The nature of the relationship with your buyer may also determine the settlement method used.
Payment Method 1: Open account
This is probably the least secure payment method for you as the exporter. Your buyer receives the goods and then pays for them, usually with a credit period attached (30, 60 or 90 days).
This payment method extends the period before which your business receives cash –and your working capital position will be impacted further if a period of credit applies.
You might consider offering this option under the following circumstances:
- You have an established relationship with the buyer
- The buyer is a multinational business with strong buying power and strong buyer credit rating
- Smaller value exports.
Payment method 2: Bank collection
This is a more secure option than an open account, whereby, as the name suggests, your bank collects the money on your behalf. It is also known as a documentary collection.
An instruction document is forwarded by your bank to your buyer’s bank for release against either Payment (Documents against Payment) or Acceptance – of a Bill of Exchange (Documents against Acceptance).
This can be a good way of “meeting in the middle” with your buyer, wherein the risk is reduced (but not eliminated) for you both.
It is also not as time consuming or costly as a letter of credit, and doesn’t take up any credit facilities.
Payment method 3: Letter of credit
A letter of credit is essentially a bank’s promise to another bank that you they know you and (hold your overdraft facility) will act as a guarantor for your transaction. You need both banks’ party to the transaction to agree to act in this way.
Once it is agreed, in the event that your buyer is unable to make payment, the bank will cover and pay the outstanding amount, provided that certain delivery conditions have been met.
One of the important things to note from a payment method perspective is that, if ever you receive a letter of credit, ensure you give it your immediate attention and check it in detail.
Remember, it is a document that should lead to your business being paid on time. Lack of attention to detail could delay payment and cost you money.
Payment method 4: Advance payment
This is the most advantageous method for you as the exporter as, where the buyer has to pay for the goods before they receive them. Consumers essentially do this every day when purchasing online, being charged either at the time of order or when the goods dispatch.
This method is advisable in the following circumstances:
- You have a new relationship with the buyer, where there is a ‘lack of trust’ between buyer and seller
- The buyer does not have a strong credit rating
- You sell a unique/rare product of high value.
So, once you have selected the appropriate method of payment, allow sufficient time to get everything in place and make sure you ask questions – of your buyer, if need be, and especially of your bank, who are there to help.
Time Rate System
Under this system, the amount of remuneration or the total wages outstanding to the workers depends on the time for which he is employed. This is a simple and common method of wage payment. In this method, the workman is paid an hourly, daily, monthly or yearly rate of wages.
Thus, the worker is paid on the basis of time but not on his/her performance or unit of output. A number of wages payable to a workman under this method is to be calculated as follows:
Total wages = Actual time took x time rate
or, Total wages = Total hours worked x Wages rate per hour.
Advantages of Time Rate System
The following are the advantages of time rate system,
- Simplicity: It is really easy to understand and simple to calculate the earnings of workers under this method.
- Guarantee of minimum wages: It guarantees minimum wages to the workers.
- Quality production: Since, a number of wages rate is not linked to the quantity of output, this method ensures production of better quality due to the careful attention of the workers.
- Unity among workers: Under this system, all workers falling under a particular category are paid at an equal rate without any calculation of their quantity of output. It encourages a feeling of equality among workers on account of which this method is also favored by trade unions.
- Economical: It involves less critical work and detailed records are not necessary. Since, the output is not the criteria for identification of wages, tool and materials are handled carefully and wastages are also minimized.
Disadvantages of Time Rate System
This method has the following disadvantages:
- No incentive to the efficient workers: It lacks incentive to efficient workers since all workers are paid equally and no distinction is made between efficient and inefficient workers. So, effort and rewards are not correlated.
- Go-slow policy: The worker in order to earn more wages may try to perform the work slowly which leads to increase in labor cost per unit.
- Dissatisfaction among the efficient workers: The efficient workers are paid wages at the rate equal to those payable to inefficient workers, which creates dissatisfaction among the efficient workers.
- Payment for idle time: Under this method, the idle time of the workers is also paid that increases the cost of production.
- The high cost of supervision: Since, there is no direct link between the quantity of output and wages, wastage of time on the part of the workers is common and the negligence of which requires considerable supervision leading to increased costs.
Piece Rate System
In this method, wages are paid to the employees after completion of work. Under it, a worker is paid on the basis of output not the time taken by him. This is one of the simplest and most commonly used systems of wage payment. In this system, the wage rate is expressed in terms of per unit of output, per job or per work-order. A number of wages payable to a workman under this method is to be calculated as follows:
Total wages = Total output x Rate per Unit of Output.
Advantages of Piece rate system
The advantages of piece rate system are given below:
- Simplicity: Just like time rate system, the piece rate system is also simple to calculate and easy to understand. It does not involve tedious calculations.
- The incentive to workers: This system provides an incentive to the workers to work hard as the wages are paid on the basis of the quantity of output, not on the basis of time. So, efforts and rewards are correlated.
- Ascertainment of accurate labor cost: Piece rate system wages are paid on the basis of output, the exact cost of labor per unit of output or job can be ascertained.
- No payment for idle time: Under this rating system, no payment were made to the worker for the idle time as a result of which the cost of supervision is not considerable.
- Proper care and use of machines and tools: The workers take proper care of their machines and tools since the breakdown of machines and tools means a decrease in output resulting in less remuneration to them.
Disadvantages of Piece Rate System
- Less attention to quality: As the payment of wages is made on the basis of output, the workers would try to produce more quantity of products and not focus on the quality of products which results in production of less quality products.
- Inefficient use of machines and materials: Since, the wages are paid on the basis of the quantity of output, an excessive wastage of materials and frequent breakdown of machinery may be caused by the workers due to their efforts to obtain maximum output.
- No guarantee of minimum wages: Since, there is a direct relationship between quality of output and wages, the workers suffer if they fail to work efficiently. There is no guarantee of minimum daily wages to workers.
- Dissatisfaction among inefficient workers: The inefficient workers, who work slowly, become dissatisfied by reason of lower wages as compared to the wages paid to their efficient counterparts.
- Adverse effect on worker’s health: The workers may try to work abnormally to earn more which has an adverse effect on their health and efficiency. So, this method is not accepted by a trade union.