Definition
Documentary Collection is a trade transaction method in which a seller uses a bank as a channel to present financial documents and shipping documents to a buyer. Under this arrangement, the buyer needs to pay for goods or fulfill other trade obligations before obtaining the documents. It provides a level of security to both buyers and sellers in international trade without offering as much protection as a Letter of Credit.
Phonetic
The phonetics of the keyword ‘Documentary Collection’ are:Doc-u-men-ta-ry Collection: /ˌdɒkjʊˈmɛntəri kəˈlɛkʃ(ə)n/
Key Takeaways
1. Security and Convenience: Documentary Collections provides a secure and flexible method of conducting international business transactions. It ensures that the importer should only receive the documents related to the goods if they agree to the terms of the payment. It also offers a level of convenience and efficiency as it relies on banking channels for the transfer of documents and funds.
2. Reduced Costs: As compared to Letters of Credit, Documentary Collections offers a less expensive solution for both the exporters and importers. The bank charges for processing a Documentary Collection are typically lower, which helps in reducing the overall costs of the transaction.
3. Limited Protection in Case of Non-Payment: Unlike Letters of Credit, Documentary Collections offers limited protection to the exporter in case of non-payment by the importer. The bank does not guarantee the payment under a Documentary Collection and if the importer fails to make the payment, the exporter may need to pursue legal actions to recover the money.
Importance
Documentary Collection is crucial in international trade as it provides a balance between the exporter’s and importer’s interests. This practice involves a bank acting as a neutral third party to collect and process all the legal and financial documents related to the trade transaction. It ensures that the exporter only sends goods upon receipt of payment, or a guarantee of payment, from the importer’s bank. At the same time, it guarantees the importer that payment is only made once the bank has received the necessary shipping documents. This risk-reduction method helps eliminate payment and delivery risks, enhancing trust, compliance, and efficiency in international business transactions.
Explanation
Documentary Collection, in the intersection of trade and finance, serves as a method for handling transactions between importers and exporters, ensuring secure cash flow and mitigating risks associated with international trade. This mechanism is managed by the banks of both parties where the exporter’s bank forwards essential trade documents related to the shipment of goods on their client’s behalf to the importer’s bank with a request to present these documents to the importer. The primary purpose is to expedite payment; documents are handed over only in exchange for payment or acceptance of a draft, thereby giving the exporter a level of protection.
The use of Documentary Collection is most fitting in instances where there is an established relationship between the trading partners and a moderate level of trust. It minimizes the risk as it ensures the exporter has shipped the goods and the importer will only make the payment upon receiving the necessary documents like Bills of Lading or Airway Bill, Commercial Invoice, among others. Also, since it represents a less-costly alternative to letters of credit (another method of settling international transactions), it allows businesses to save on transaction costs while ensuring a smooth and secure trading process.
Examples
1. International Trade: A common example of documentary collection in the real world is a scenario in international trade. For instance, an American furniture manufacturer selling its products to a retailer based in Europe may use documentary collection to ensure both the delivery of the goods and payment. The manufacturer sends shipping documents to the bank, proving that the furniture has been shipped to the buyer in Europe. However, the buyer doesn’t receive these documents until they have made payment or accepted a bill of exchange.
2. Agriculture Export: A second example could be a Kenyan farmer exporting coffee to a Canadian buyer. The Kenyan farmer would use documentary collection by depositing the shipping documents and bill of sale with his Kenyan bank. The bank would then forward these documents to the Canadian buyer’s bank, which only releases the documents to the buyer once payment is made.
3. Electronics Industry: An electronics company in Japan selling products to a U.S. distributor can use a documentary collection process to ensure the goods are dispatched and payments are made. The Japanese company will supply all the necessary shipment documentation to their bank, which are sent while initiating a documentary collection procedure with the buyer’s bank in the U.S. The distributor only receives the documents to claim the goods at the port after completing the payment.
Frequently Asked Questions(FAQ)
What is Documentary Collection?
Documentary Collection is a process of trade finance where an exporter’s bank acts to collect funds from an importer’s bank in exchange for documents that prove the shipment of goods.
How does Documentary Collection work?
It works by utilizing the banking system where the seller’s bank sends documents to the buyer’s bank along with payment instructions. The documents are only released to the buyer after payment has been received or a promise of payment has been made.
What types of documents are involved in Documentary Collection?
The documents involved mainly include the commercial invoice, bill of lading or airway bill, insurance certificate, packing list, and other documents as required per contract.
What are the main types of Documentary Collection?
The two main types are Documents Against Payment (D/P), where the documents are released only upon receipt of payment, and Documents Against Acceptance (D/A), where the documents are released upon acceptance of a draft requiring future payment.
Is Documentary Collection a secure form of payment?
While Documentary Collection provides a level of security, it is not as secure as a Letter of Credit because banks do not guarantee payment. However, it is more secure than an open account as control is maintained over the goods until payment or a promise of payment has been received.
What are the benefits of Documentary Collection?
For the exporter, it ensures better security of payment by withholding important documents until receipt of payment or promise of payment. For the importer, it is cost-effective with fewer bank charges and it provides them with the assurance that the goods have been shipped.
What are the risks involved in Documentary Collection?
For the exporter, the main risk is non-payment by the importer, especially in D/A terms where the buyer may default on their scheduled payment. For the importer, a key risk is that without an inspection of goods before payment, there may be discrepancies in what is delivered.
When should an exporter use Documentary Collection?
Documentary Collection is typically used when the exporter and importer have a well-established relationship, there is a stable political and economic environment in the importer’s country, and the exporter is confident that the importer will accept and pay for the goods upon presentation of the necessary documents.
Related Finance Terms
- Drawer: The individual or entity that issues the documentary collection is called the drawer.
- Drawee: The party that is expected to pay the money under the drawer’s instructions in a documentary collection.
- Presenting Bank: This is the bank that presents documents to the drawee in a documentary collection transaction.
- Bills of Exchange: This is a written order used in international trade that binds one party to pay a fixed amount of money to another party at a predetermined future date.
- Documents Against Payment (D/P): A type of documentary collection where the exporter holds the shipping documents through their bank until the importer pays for the goods.
