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How to pay your Chinese supplier

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Most common methods of payment used when purchasing goods from China.

There is a number of different payment methods when you deal with Chinese suppliers, and the choice depends on:
1. Degree of trust. 
2. Need for financing of parts or of the whole value chain. 
3. Whether the supplier or the buyer has best/cheapest possibilities for financing. 

 

The most common methods of payment are T/T payment in advance, CAD, D/P and L/C. 

 

T/T payment in advance
T/T means telegraphic transfer, or wire transfer.  This is the simplest and easiest payment method to use, however the method presents great risk for the buyer if the supplier is not an honest one.

 

T/T payment usually means that the buyer should transfer 30% of the contract value when placing a Purchase Order, and 70% when the goods are ready for shipment. T/T payment in advance is usually used when the sample and small quantity shipments are transported by air. The importers/ buyers are also often asked to pay by T/T payment in advance when placing the first order with a supplier they have no relation to. 
It normally takes 3-4 days to receive the wire transfer made from anywhere in the world to China.  

 

Letter of Credit (L/C)
An irrevocable Letter of Credit is often referred to as an L/C.  This method of payment gives a lot of protection to both of the parties. 
To explain it in simple way – a letter of credit is a letter written by the importer’s bank to the exporter.  It verifies that the payment will be guaranteed by the bank that wrote the letter, when the bank is presented with the documents listed in the letter (bill of lading, invoice etc).  Once the letter has been written and issued via SWIFT system, it cannot be called back without exporter acceptance. 

 

L/C usually includes applicant (the importer), beneficiary (the exporter), opening bank, negotiating bank, specification of the goods and quantity, amount of money, loading port and destination port, shipment date, the validity date of the L/C, delivery terms (Incoterms), other terms and conditions agreed by both the importer and seller, and the list of documents required by the importer like documents showing that the goods have been delivered, commercial invoice, packing list, insurance certificate etc. 

 

The L/C procedure is usually following:

  1. The importer applies to open an L/C ,around the same time when placing Purchase Order, through importer’s local bank.
  2. The opening bank will inform supplier’s bank via SWIFT system (a secure communication system that banks use) that L/C has been issued.
  3. The supplier will check all the terms in the L/C and if those are acceptable, the supplier will arrange for shipment of goods within the time specified in the L/C.
  4. After the goods are loaded onto the ship, the captain will issue the clean bill of lading to the supplier.
  5. Supplier will submit the bill of lading together with other documents required in the L/C to their local bank in China in order to gather payment. 
  6. The Chinese bank will send the document to buyer’s bank.
  7. The buyer’s bank will inform the buyer that the documents have been received and if the documents match the list of documents the buyer has requested for in the L/C and the goods have been shipped within the time defined in the L/C, the buyer’s bank will pay the Chinese bank.  If the documents are not completed or there are discrepancies, the buyer’s bank will not pay automatically, but will ask the buyer to accept or refuse to pay.

  
L/C is usually used for larger orders (approximately USD 25.000 and higher) often shipped by sea. The typical L/C scenario takes 14-21 days.


What is special for L/C is a possibility of using it as partial security for financing.  Obtaining long or any credit terms from Chinese suppliers can be difficult to negotiate and it can be expensive.  Many Chinese suppliers when asked for deferring the payment will charge approximately 10-15% margin pro annum for that.  Asking your local bank for financing might be a cheaper and more flexible solution.  It can also give you possibility to negotiate lower price with your Chinese supplier. 


L/C can also give the supplier possibility to request their local Chinese bank for financing in production period on preferable terms. 

 

Cash Against Documents (CAD) or Document against Payment (D/P)
The supplier produces the goods and ships them as agreed in the contract with the buyer.  The supplier sends the shipping documents to the supplier’s bank for collection.  The bank then sends the shipping documents along with a collection letter to the buyer’s bank, which then sends a collection notice to the importer.  The buyer makes payment when receiving the notice, and ONLY AFTER PAYMENT does the buyer receive the original shipping documents with which allow the buyer to collect the goods.


The major advantage of using Cash against documents is the low cost, compared to cost of using Letter of Credit.  However the supplier must accept that if the buyer will reject the documents for some reason and will not pay for the goods, there is little the supplier can do.  The goods are then already on the way to the buyer at that point.  Therefore this method of payment will be accepted by your Chinese supplier only if you have a long-standing relationship with them. 


Sometimes the supplier request 50% of the payment to be made by T/T transfer and 50% by CAD. 


When using CAD the buyer is requested to pay when receiving the notice.  If the buyer has been granted a credit from the supplier (D/P), the buyer will not be asked to pay when receiving the notice.  Instead the buyer will be asked to sign a Bill of Exchange by which the buyer promises to pay xxx days later.  If the supplier does not want to wait xxx days for the payment to arrive, the supplier’s bank can ask the buyer’s bank to avail the Bill of Exchange (which means that the bank will guarantee for the payment) and discount the Bill of Exchange.

 

Feel free to comment or ask questions