Payment terms: TT, LC and open account

Three families of payment

Most international purchases settle through one of three structures. A telegraphic transfer, usually called TT, is a bank payment against an agreed trigger. A letter of credit, or LC, is a bank undertaking to pay against compliant documents. Open account means the goods ship and the buyer pays later, with no bank undertaking in between.

The difference is not only timing. Each structure allocates the risk of non payment, the risk of non delivery and the burden of administration. A term that protects the seller can starve the buyer's cash flow. A term that protects the buyer can leave the seller financing the order.

The practical choice is usually a sequence rather than a single answer. A new supplier may start on a deposit with TT and move to open account after a track record. A large one-off order may justify an LC even with a known supplier.

Telegraphic transfer

TT is a bank transfer. The term covers many arrangements, so the trigger has to be stated. Payment in advance protects the seller and exposes the buyer to non delivery. Payment after shipment protects the buyer and leaves the seller waiting. Payment against a copy of the transport document sits in between.

A common structure is a deposit with the balance before shipment or against documents. The deposit funds the material and shows commitment. The balance keeps some hold until the goods are ready. The percentages and the trigger should be in the purchase order, not left to the invoice.

TT is cheap and fast compared with an LC, but the bank transfer itself does not verify the goods or the documents. The buyer is relying on the supplier and on its own inspection. For a first order, a pre shipment inspection is often more valuable than a more elaborate payment instrument.

The letter of credit

An LC is a bank's undertaking to pay the beneficiary against documents that comply with the credit. The buyer's bank issues it, and a bank in the seller's country may advise or confirm it. The documents usually include the invoice, the packing list, the transport document and, where relevant, a certificate of origin or an inspection certificate.

The strength of an LC is that payment depends on documents, not on the buyer's instruction at the time of shipment. The weakness is that documents must comply exactly. A spelling difference, a late shipment, a missing endorsement or an inconsistent quantity can lead to a discrepancy and a delay.

Costs include the issuing fee, the advising fee, confirmation, amendment fees and the bank's charges for presentation. A confirmed LC shifts the issuing bank risk to the confirming bank, at a price. The buyer should compare the total cost with the value of the protection, not just the headline fee.

An LC also consumes credit lines and staff time. The applicant may need cash margin or security. The beneficiary may wait for payment if the credit is payable at a later date. Both effects belong in the landed cost and the cash flow plan.

Open account

Open account means the seller ships and invoices, and the buyer pays after an agreed period. It is the normal term in mature domestic supply chains and increasingly common in international trade with known counterparties.

For the buyer it is the cheapest and most flexible option. There is no bank instrument to arrange and no document set to perfect. For the seller it is an unsecured credit sale. The seller carries the risk of non payment, currency movement and delay.

Sellers can reduce that risk with credit insurance, a parent company guarantee, a standby letter of credit or a bill of exchange. Each adds a cost or a process. The buyer may be asked to accept a shorter period or a security instrument in return for the term.

Open account also changes the working capital position. The buyer holds the goods and pays later, which improves cash flow. The seller funds the gap, and that funding cost is usually reflected in the price. A lower price on TT and a higher price on open account can describe the same economics.

The credit period should be long enough to cover the transit, the customs clearance and the buyer's own payment cycle, but not so long that the seller prices in a large financing cost. A period that ends before the goods arrive creates a payment without a sale, which is a common source of disputes.

The documents that make a term work

Every payment term depends on a document set. Under an LC the set is defined by the credit and must be complete before shipment. Under TT the set may be simpler, but the buyer still needs the invoice, the packing list and the transport document to clear the goods and to check the order.

The transport document is often the weak point. A bill of lading must be clean, properly endorsed and consistent with the credit. An air waybill is not a document of title, so it does not give the same control. A sea waybill is convenient but also weaker as security.

The invoice, the packing list and the certificate of origin should agree on the parties, the quantity, the description and the terms. A discrepancy between documents is a customs risk even when it is not a payment risk. Build one document set and use it for both purposes.

Under an LC, the document set is checked against the credit, not against the contract. A credit that calls for a certificate of origin, an inspection certificate or a specific transport document changes the work at the supplier's end. Review the draft credit before it is issued, not after the goods are ready.

Comparing the three

The table gives the practical shape of each term. The ratings are qualitative, because the cost and risk depend on the banks, the countries and the relationship.

Choosing and negotiating

Start with the value and the relationship. A small sample order does not justify an LC. A large first order with a new supplier may need one. A repeat programme with a stable supplier can move to open account once the quality record and the financial checks support it.

Then check the cash position on both sides. A term that the supplier cannot finance will come back as a higher price or a delay. A term that the buyer cannot administer will produce discrepancies and late payment. The workable term is the one both parties can actually run.

Put the trigger, the documents, the currency, the bank charges and the late payment consequence in the purchase order. Review the term when the order value, the country risk or the relationship changes. A payment term is a commercial decision, and it should be recorded like one.

A term that looks expensive at the bank counter can be cheaper than the price of a failed shipment. A term that looks cheap can hide the cost of financing in the unit price. Compare the total cash cost and the risk, and keep the reasoning with the order file so the next buyer does not start from zero.

• State the payment trigger, not just the percentage.
• Name the documents required for each payment.
• Agree who pays bank charges and amendment fees.
• Check the credit period against the cash cycle.
• Review the term when the order value or country risk changes.