China payment terms 101

What people are saying about Mulberry Fields
I have already learned a great deal about China and your business through your website and blog posts. Very impressive.”  – a company in Toronto.

I had an email from someone the other day who was trying to negotiate payment terms with his supplier in China.  This person wanted to buy product out of China on LC ( Letter of Credit) terms. But of course the vendor preferred TT ( Telegraph Transfer). The difference between the two has to do with who assumes risk.

In a TT order vendors are paid when the goods are delivered to the port and they can furnish the importer with the necessary documents, bill of lading, inspection certificates ( if applicable), certificate of origin, commercial invoice etc etc.  that shows they have made and delivered the order as promised to the designated vessel.  When the importer receives these documents they pay the vendor even though the product may still be in transit. There is substantial risk here if you are not sure who you are dealing with and do not inspect your order before it leaves China. The only risk to the vendor is if they invest a lot of money in your order and then you cancel the order ( which does happen more often then you would believe) . For this reason vendors usually require a 30% deposit, which is a standard deposit on all orders in China. If your vendor asks for more than 30%, you should look for another vendor.

With an LC, both vendor and buyer designate a bank to hold the money for an order. Just as with a TT, when the vendor delivers the order to the port and furnishes the buyer/bank with documentation then the bank releases the funds to the vendor. The caveat however is the extensive documentation and the involvement of a third-party, the bank.  The risk here is to the vendor because if there is anything remiss with the shipment or the documentation then the buyer’s bank may not release the funds. Of course if the buyer really wants the product, LCs can be amended – if the buyer and seller agree on the terms – and everyone can go home happy.  But let’s say demand for a product has waned since Buyer X placed an order with China Vendor Y and Buyer X no longer wants all the product he ordered.  All he has to do is find one mistake in the LC documentation and he can request that the designated bank not release the funds.  Needless to say, it is easy to see why vendors do not want to do orders on LOC terms. There is just too much documentation and too much risk.   In fact the only time a vendor might agree to an LOC would be if it was a substantial order and they had a deposit to work with (maybe with a Red Clause LC which advances money to the vendor to make the order).

In short, if you vendor tells you that their terms are TT with a 30% deposit you should not raise your eyebrows and suggest an LC.  If you suggest an LC to a new China vendor and you do not have the QTYs to justify it you are doing two things:  1.) telling your vendor that you don’t trust them;  2.) telling them that you do not have experience in China sourcing.  Both are to be avoided at all costs ( no pun intended).

www.theeastasiaco.com

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