In international trade, the importer and exporter follow a standardized process to ship goods to and from the country. However, the process is far from perfect and very often, exporters & importers face non-payment and non-delivery risks.
One practice used to mitigate such risks is by following a trade finance method, documentary collection.
What is a Documentary Collection?
Documentary collection is a type of trade financing in which an exporter receives payment for his goods from an importer after the financial institutions of the parties involved exchange the relevant documentation. After the items arrive at the importer's location, the exporter's institution collects payments from the importer's institution for paperwork releasing a title to the transported elements.
The exporter receives cash from the importer for the shipping paperwork, known as "documentary collection." The customer will need shipping paperwork to clear the items through immigration and take possession. A commercial invoice, a certificate of origin, an insurance certificate, and a packing list are all included.
The bill of exchange or drafts, which is a legal demand for payment from the exporter to the importer, is a crucial document in a documentation collection. According to URC 522/ Article 02, documentary collection means a collection of -
- Financial documents accompanied by commercial documents
- Commercial documents not accompanied by financial documents
There are two types of documentary collection:
The importer must pay the face amount mentioned in the shipping documents when dealing with documents against payment. When the buyer receives the copy before releasing any shipping paperwork, the importer must send the deposit to the bank. Because of the lower risk to the vendor, this is the most typical method of documentary gathering.
Documents opposing acceptance impose a payment deadline on the importer. The bank releases the documents to the purchase once the buyer approves the time draft.
Who Issues a Documentary Collection?
The exporter will seek payment by providing their shipping and collecting documentation to their issuing bank with a documentary collection. The issuing bank then sends these documents to the importer's bank. The importer's bank will then pay the bank of the exporter, who will transfer the payments to the exporter.
When to Use a Documentary Collection?
There must be a long-standing partnership between the exporter and the importer.
The exporter must have faith in the political and economic stability of the receiving country.
When an open account sale is deemed too risky, and the importer refuses to take a letter of credit.
The buyer's willingness or ability to pay is undeniable.
There are no restrictive foreign exchange controls in the importer's country.
How does the Documentary Collection Process Work?
Listed below are the steps explaining the documentary collection process:
Step 1: When the sellers and buyers agree on the payment amount, shipment information, and the transfer will be a documentary collection, the sale is complete. The exporter next transports the items to the port or site from which export will take place. One can do this through a logistics company.
Step 2: The exporter's bank, also known as the remitting bank, prepares the documentation and sends them to the remitting bank. The exporter's bank subsequently forwards the paperwork to the collecting bank, which is the importer's bank.
Step 3: When received by the importer's or buyer's bank, the paperwork informs the buyer that the paperwork has been obtained. In exchange for the paperwork, the buyer's bank seeks payment from the buyer.
Step 4: The bank releases the documents to the buyer once the buyer's bank has been paid or approved the time draft. The buyer uses the paperwork to collect the goods.
Let's understand the process with an example:
A and B get into a transaction and agree on payment amounts and shipping information. A, the exporter, transports the items to B, the importer. A's bank prepares the documentation and sends it to B's bank.
On receipt of documents, B's bank informs A about the receipt and seeks payment from B. On receipt of payment, B's bank approves the time draft. B can now collect the shipped items. The documentary collection process is now complete.
Difference Between Letter of Credit and Documentary Collection
Though a letter of credit and documentary collection is a crucial element in international trade, they have significant differences:
- A letter of credit is a legally binding document that guarantees payment to a seller. A documentary collection allows a buyer to refuse a shipment if it does not match the standards of excellence.
- The importer's bank issues the letter of credit, while the exporter's bank issues a documentary collection.
- In the letter of credit facility, the bank pays the exporter if the importer cannot. The bank bears no such liability in the documents' acquisition capacity.
- The cost of issuing a letter of credit is higher, whereas documentary collection is less expensive.
- When commerce is at risk owing to location limitations, a letter of credit is favored, but the documentary collection is preferable when the merchants have deep, reliable relationships.
Documentary Collection vs. Open Account vs. Cash Against Documents
Cash against documents involves the exporter (drawer) submitting a bill and transit documents to its bank (remitting bank) for delivery to the importer's bank (collecting bank). The documents are only delivered to the importer after the collecting bank has received money from the remitting bank.
A sale with an open account is one in which the products are transported and given before payment is due. The goods are transported straight to the importer, who has paid the exporter's bill on a specific date.
Let’s understand the differences:
Advantages of Documentary Collection
- Bank's safe and dependable support in securing the export collection
- Unlike LCs, the process is straightforward, quick, and inexpensive
- Document management is simplified
- Payments received more quickly
- Until payment is received, the seller keeps ownership of the items
- Exporters covered by a payment guarantee
- Sellers can grow their businesses all around the world
- Maintaining a record of overdue collections
- Less expensive than LC
- You can carry out monetary transactions
Disadvantages of Documentary Collection
- It's possible that the risk of non-payment is higher. If the bill of exchange stipulates payment after delivery, the exporter relinquishes control of the goods but risks non-payment on the due date.
- The bank's role is restricted, and payment is not guaranteed. The banks do not check the shipping paperwork or guarantee that your buyer will pay you.
- Exporters' cash flow may be strained, especially if the bill of exchange allows for longer credit terms. From the sale contract through the moment of payment, you are exposed to FX risk.
Frequently Asked Questions
Who is the drawer in the documentary collection?
The seller (drawer) ships the items and prepares the buyer's paperwork on issuing the order for collection. The seller sends the needed documents and the collection order to his bank (remitting bank).
Who is the drawee in the documentary collection?
The person or business on whom a draft is based. The drawer directs the drawee to pay a fixed sum to the payee, the payee's order, or the bearer. The buyer is usually the drawee in a documentary collection.
How does documentary collection work as a payment method?
Both the importer and the exporter agree to do business together. Once the goods are shipped, they send the documents to the exporter's bank. The importer's bank forwards and presents the documentation. The exporter is then paid.
What is the difference between documentary collection and documentary credit?
A letter of credit is a contract in which the issuing bank (usually the buyer's or importer's bank) commits to pay the seller's bank when the products are delivered with specific paperwork, including severely precise information. In a documentary collection, if the buyer decides not to buy, the bank is not compelled to pay the seller or exporter.
What are the types of documentary collections?
There are two types of documentary collections: Documents against Payment Collection (D/P): The delivery documents are only given to the importer when payment is made. Collection of Documents Against Acceptance (D/A): Acceptance of a Bill of Exchange or a guarantee of payment is required before delivery papers are handed over.
What is the downside of a documentary collection?
There is no guaranteed payment, restricting the bank’s role. You cannot verify the paperwork.