There are four main methods for paying overseas suppliers for the goods you import from them: cash-in-advance payments, letters of credit, documentary collection and open account trading. Each has their own advantages and disadvantages.
With advance payments, the supplier only ships goods once they receive your payment. Wire transfer is perhaps the simplest way of transferring funds in advance into your supplier's account. Cash-in-advance payments have a high level of traceability but, once issued, it's impossible to stop them and difficult to recover them if something goes wrong.
Letters of credit
With letters of credit, your bank guarantees to pay your supplier when they present it with relevant export documentation. This is arguably one of the safest ways to make overseas payments, as credit notes balance the risks of buyers and suppliers. However, you will spend extra time on paperwork and the bank guarantee may increase the cost of the transaction, due to interest and other expenses. See more on letters of credit.
With the documentary collection, the supplier ships the goods then sends the export documents via their bank to your bank, along with the payment instructions. The banks draw up a bill of exchange and channel all funds and documents in the transaction. This method is cheaper than letters of credit, but presents more risks to the supplier - it lacks verification process and has limited recourse if the importer doesn't pay.
Open account trading
With this type of payment, the supplier ships goods to you directly, and asks for payment within an agreed period. For suppliers, this option has the highest risk of non-payment as they bear the costs of production and shipping until you pay them.
Minimise risks associated with paying overseas suppliers
For importers, the risk decreases as you move down the list of payment options. Advance payment is the riskiest - there is a chance you'll pay but never receive the goods. Open account trading is the least risky - you only pay after receiving the goods.
For exporters, however, the risk increases as you move down the list. So while you might prefer open account trading, your overseas supplier may want advance payment.
Letters of credit and documentary collections offer some protection to both parties by involving their banks as intermediaries in the process.
Overseas sourcing and cashflow issues
Payment methods can have a major impact on your cashflow position. Most banks offer import finance packages to bridge the period between paying for your imports and receiving payment when you sell them on to your customers. See cashflow management.
To mitigate cashflow problems, you can often negotiate payment methods and terms. For example, you might offer a supplier a letter of credit in return for an extended 75-day payment period to match your cashflow requirements. See invoicing and payment terms.
Paying invoices in foreign currency
Unlike standard, domestic invoices, an international invoice could result in additional costs for your business, due to currency conversion fees, exchange rate margins and transfer fees. Find ways to mitigate foreign currency and exchange risks.