Lesson 5: Open Account and Advance Payment
Welcome to the fifth lesson of Module 3. In this lesson, we'll explore two contrasting payment methods in international trade: Open Account and Advance Payment.
Open Account
An Open Account transaction in international trade is a sale where the goods are shipped and delivered before payment is due, usually in 30, 60 or 90 days. This is one of the most common payment methods in international trade, especially for established trading relationships.
Characteristics of Open Account:
- Highest risk for the exporter
- Most secure and cost-effective for the importer
- Typically used in stable export markets and for established trading relationships
- Can improve competitiveness in the global market
- Often supported by export credit insurance or factoring
Open Account Example
A German machine parts manufacturer ships €50,000 worth of parts to a long-standing customer in France. The invoice states payment is due in 60 days. The French company receives and can use or sell the parts before making payment.
Advance Payment
Advance Payment, also known as prepayment, is when the importer pays the exporter before the goods are shipped. This method is the most secure for the exporter but the riskiest for the importer.
Characteristics of Advance Payment:
- Lowest risk for the exporter
- Highest risk for the importer
- Often used for small export transactions or when goods are custom-made
- May be required when the importer is not creditworthy or the country risk is high
- Can create cash flow issues for the importer
Advance Payment Example
A start-up in the USA orders custom-designed packaging from a supplier in China. The Chinese supplier requires full payment of $10,000 before starting production. The US company transfers the funds, and only then does the Chinese company begin manufacturing the packaging.
Comparison of Risk Levels
Open Account (Exporter's perspective):
Advance Payment (Importer's perspective):
Comparison: Open Account vs. Advance Payment
| Feature | Open Account | Advance Payment |
|---|---|---|
| Risk for Exporter | High | Low |
| Risk for Importer | Low | High |
| Cash Flow Impact on Importer | Positive | Negative |
| Typical Use Case | Established relationships | New relationships, custom orders |
| Competitiveness | Can enhance exporter's offer | Can limit importer's options |
Key Points to Remember:
- Open Account offers competitive advantage but high risk for exporters
- Advance Payment provides security for exporters but may deter potential importers
- The choice between methods depends on various factors including trust, market conditions, and product type
- Risk management tools like credit insurance can help mitigate risks in Open Account transactions
Test Your Knowledge: Payment Methods
Ready to check your understanding of Open Account and Advance Payment methods? Take this quick quiz!