In international trade, documentary collections are important because they act as an independent third party that basically provides cash on delivery type services. Documentary collections services don’t provide the same security as letters of credit, but the total cost tends to be lower. A documentary collection is basically a process in which a seller will forward documents related to the export of goods to a buyer’s bank. The buyer will only receive these documents once payment has been made.
Documentary collections are important because they can simplify a sometimes difficult process. It uses the bank as a channel for the documents but it usually does not require any type of costly insurance coverage like with letters of credit. Typically, documentary collections work best when there is a long lasting relationship between buyer and seller. The seller may not want to provide services on an open account basis but they can save themselves and the buyer time and money by choosing documentary collections over letters of credit.
The seller should use documentary collections if they have no doubts about the buyer’s ability to meet the financial requirements of the transaction. This process does not require the buyer to make an advance payment so they may even sell the goods first and then make payment to the seller. This type of collection of payments allows for flexibility for both buyer and seller. Some other benefits include:
- Importer doesn’t require a line of credit with the bank
- Exporter has control over the documents until the buyer has either made payment or accepted a later payment date
As an exporter or seller, documentary collection offers you much more security than an open account, but not as much as a letter of credit. To make up for the lack of security though, the involved costs for both parties are often times much lower. Though, there is no protection for credit, political or transfer risk so it’s important that you know exactly who you’re dealing with. Exporters often expose themselves to too much risk by producing/shipping goods before payment so it’s important that documentary collections are used in the right situation. They can be very beneficial as long as their is an established relationship between importer/exporter and there’s no doubt about the buyer’s ability to pay.