Definition
Documentary Collection is a method of trade finance where an exporter’s bank acts to collect payment for shipped goods, directly from a bank in the importer’s country. The exporter sends the shipping documents to the bank, which then transfers them to the importer’s bank, only releasing them once payment is made. Hence, it acts as a way to ensure that the payment for the goods is received, and the goods are only delivered to the importer after the payment is made.
Key Takeaways
- Documentary Collection is a payment mechanism in international trade where the exporter hands over the task of collecting payment for goods supplied to his or her bank, which sends the documents that the importer needs to the importer’s bank, along with payment instructions.
- This financial instrument helps to maintain trust between exporters and importers, as the importer’s bank won’t release the documents needed for the goods until they confirm the payment or payment commitment has been made.
- Despite offering a balance between payment security and credit flexibility, the Documentary Collection process does not provide an irrevocable payment guarantee unless the payment commitment is supported by the bank, unlike a Letter of Credit. Therefore, the risk of non-payment still exists.
Importance
The finance term, “Documentary Collection,” is crucial as it represents a key method used in international trade to ensure that both the buyer and seller uphold their responsibilities.
It involves an intermediary, typically a bank, which acts on behalf of the seller to collect payment from the buyer, providing an additional layer of financial security.
The seller supplies the bank with documents proving shipment of goods, and the bank only hands these documents to the buyer after receipt of payment, or a promise to pay.
This process significantly reduces the risk of non-payment for the seller while also assuring the buyer that the goods have been dispatched effectively.
Consequently, Documentary Collection fosters trust, maintains financial security, and facilitates smooth transactions in international trade.
Explanation
Documentary Collection is a key trade finance instrument that serves as a method of payment in international trade transactions. It helps to ensure that the procedures and transactions of global trade are carried out in a secure and efficient manner.
This instrument is used to facilitate and regulate transactions between an exporter (or seller) and an importer (or buyer) in different countries, providing them with a level of protection to guard against default or delayed payments, while also ensuring the quality and timely delivery of goods. The main purpose of Documentary Collection is to act as a bridge between the exporter and importer through their respective banks.
When a trade transaction is initiated, the exporter’s bank (remitting bank) sends important trade documents detailing the goods and payment terms to the importer’s bank (collecting bank). Only upon receipt of these documents can the importer either accept or make payment to finalize the deal, thus guaranteeing the exporter the assurance that payment will be made. In essence, Documentary Collection reduces the potential risks in international trade transactions by providing a secure pathway for the transfer of goods and payments.
Examples of Documentary Collection
Importing Raw Materials: A company in the United States wants to import raw materials from a supplier in Brazil. Once the supplier prepares all goods, they submit documents to their bank in Brazil. The bank then sends these documents to the importer’s bank in the U.S. By doing so, they’re using a method called Documentary Collection to ensure both parties meet their obligations. The U.S. company can only retrieve the documents (and therefore the goods) once they’ve paid or accepted a draft, while the Brazilian company is assured it will not lose control of the goods without a corresponding payment or commitment.
Exporting Machinery Equipment: A machinery manufacturer based in Germany is exporting a piece of equipment to a construction company in India. To safeguard the transaction, the German company uses Documentary Collection, sending shipping and title documents through their bank to the Indian company’s bank. The Indian company only gets the documents to claim the equipment once they’ve made payment or accepted to commit to a payment at a certain date.
Overseas Distributors: A wine producer in France has a distributor in Japan. To ensure they get paid, the French company sends the documents (including the Bill of Exchange) related to the shipment of wine to their bank, which then sends those documents to the distributor’s bank in Japan. The distributor can only access these documents to clear the customs and gain control over the goods after agreeing on the payment terms. This use of Documentary Collection ensures the French wine producer will either receive immediate payment or a formal commitment to pay.
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FAQs on Documentary Collection
What is Documentary Collection?
Documentary Collection is a method of trade finance in which an exporter’s bank acts to collect payment for shipped goods, forwarding the necessary documents to the importer’s bank.
What are the types of Documentary Collection?
There are two types of Documentary Collection: Documents Against Payment (D/P) and Documents Against Acceptance (D/A).
What are the benefits of using Documentary Collection?
Documentary Collection offers certain advantages aspect of control, cost, simplicity and financing; while providing an element of security in international trade.
What are the risks associated with Documentary Collection?
The main risk associated with Documentary Collection is that the importer/buyer may refuse to pay for the goods, leaving the exporter/seller with no payment.
What’s the difference between Documentary Collection and Letter of Credit?
A Letter of Credit is a promise from a bank on behalf of the buyer to pay the seller upon receiving the goods, while Documentary Collection relies on the promise of the buyer to pay the funds himself.
How cost-effective is Documentary Collection?
Documentary Collection tends to be more cost-effective than other methods of trade finance, such as Letters of Credit, as it requires less admin and bank intervention.
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Related Entrepreneurship Terms
- Bill of Exchange
- Drawer
- Drawee
- Sight Draft
- Time Draft
Sources for More Information
- Investopedia – A comprehensive online financial education platform with a wealth of information on various financial terms including Documentary Collection
- Trade Finance Global – A platform focused on providing information on trade finance.
- U.S. Small Business Administration – It is a U.S. government agency that provides support to small businesses, including financial terms education.
- J.P.Morgan – It’s a leading global financial services firm and its website contains a lot of financial terms definitions and articles including Documentary Collection.
