Open Account Trading
Open account trading is one of many methods of receiving payment from a customer of a business. It is most commonly used in transactions between businesses in the same country but can also be used for import/export relationships.
In an open account relationship, the goods are shipped and the title documents are sent independent of payment to the buyer in order that he can clear customs in his country. Receipt of goods is not dependent upon payment in this relationship and settled at a later date.
Payment is generally made by the buyer on a monthly basis when each individual shipment/invoice is totalled and funds are sent to the supplier having no reference to when goods were shipped or arrived at the buyers premises.
Open account trade is the least secure method of payment since it means that the shipper loses control of the goods before he receives payment. Therefore, this method of payment should only be used between two firms with a well-established relationship and when the buyer is domiciled in a politically stable country.
Payment terms involved
An open account transaction often includes payment terms. That is to say, the seller allows the buyer an extended period of credit, say, thirty sixty or ninety days but allows the buyer access to the goods immediately.
This clearly requires a degree of trust between the seller and buyer. Even a transaction where the payment is due on receipt of goods or upon arrival of the vessel, there is a degree of trust. However, in a sight transaction (a trade where title to the goods and the payment move simultaneously) trust is necessary since the shipper has several expenses prior to having any certainty of payment.
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Insurance also becomes a major consideration for the shipper since you will generally have to insure the goods to ensure at least a degree of security, unless the relationship is long and very well established.
Letters of credit are by far the most secure method of shipment since they allow a degree of security to both the seller and buyer. The seller can ensure that he has a bank guarantee of payment no matter the financial condition of the buyer when the goods arrive. The buyer also has security because he can insist on a certificate being presented as part of the documentation required that assures the quality, origin and quantity of the goods.
There is a great deal of online trading accounts through the likes of eBay, Amazon and Alibaba that provide a guarantor of payment and quality. Importers often buy goods advertised on Alibaba or eBay for that very reason while Amazon provided a similar service to the retail market.
Open account trade finance
Open account trade finance offers several alternatives to simple “payment against goods” or what is known as an acceptance. An acceptance is a piece of paper signed by the buyer of the goods (obligor) that acknowledges that he has the liability to pay the seller (creditor) at a certain fixed date in the future.
An open account relationship between a buyer and a seller is created by a degree of trust on both sides. The buyer trusts that he will receive the goods he has ordered while the buyer, without any additional security, trusts that he will receive payment in accordance with terms agreed in advance.
Cash against documents or cash against acceptance can be guaranteed by a bank.
Banks have seen their traditional dominance of the trade finance market gradually eroded by several businesses that have come into being driven by both a technological revolution and a move away from “traditional” banking products.
Fees for letters of credit have increased as banks try to regain a share of revenue for non-lending products.
For a cash against documents transaction, the documents can be presented through the buyers bank with instructions only to release them against payment. The bank will happily accept this task (for a fee) since they act as little more than a post office.
In a goods against acceptance transaction, the bank can act in two ways:
- It can hold onto the accepted document (draft) with instructions from the obligor to debit his account and pay the creditor upon the payment date. They will treat this draft like a cheque and only pay if funds are available.
- The bank will (subject to credit) add its own acceptance to the draft and return it to the supplier. If this is the case, you can either ask your bank to discount the draft providing you with funds immediately or you can present it at maturity for payment although the bank will take a fee for taking on the risk of its customer.
A supplier will only open a trading account for a customer if he is happy with every aspect of the relationship and has taken suitable trade references from the market.Again, a bank can help with this as they can often obtain an in-depth trading reference through the banking community.
Open account trading adds to the commercial risk of any trade particularly given the unpredictability of certain markets, but once a relationship has been established, it is a cost-efficient method of trading and allows a great degree of trust to build up over many years.
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About Alan Hill
Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”
