By Kevin in 'The China Sourcing Blog'

The payment procedure is an integral part of sourcing, ranking alongside desk research, initial contact, negotiation, and due diligence checks.

Generally, there are three types of payment terms: Telegraphic Transfer (T/T), Collection, and Letter of Credit (L/C). T/T, as the most popular payment method, is welcomed by all suppliers, especially in China in recent years.

Yet the T/T payment method is not always fully acceptable to buyers, as it involves the direct transfer of funds, and may cause some problems during negotiations between buyers and sellers. In essence, there are three reasons why suppliers would generally prefer T/T:

Reason 1: Minimizing Risk

Minimizing risk is naturally important for suppliers. They would always prefer to have 100% of the amount in hand or at least part of the money in hand in case the buyer cancels the order after they finish the production.

Reason 2: Maintaining Capital Flow

Maintaining the flow of capital in a firm is always important, yet even more so in the current climate. Getting all the money or a large part of the money in advance can significantly enhance the supplier's investment in new raw materials, for example.

Reason 3: Dealing with RMB appreciation

The exchange rate between the RMB and the US Dollar has been continuously climbing for about 3 years since China started exchange rate reform in 2005. In 2007, the RMB appreciated by about 13% to the USD, and in 2008 by about 7%. This added a great deal of pressure for suppliers to obtain the payment within 20 or 30 days as they are afraid of the rapid change of the RMB and want to get the money as soon as possible.

Aside from these three reasons, there are also other concerns leading Chinese suppliers to only prefer T/T payment. Some plants consider the T/T way as fast and convenient, while some plants just do not have enough experience to handle 'Collection' or 'L/C'. Some plants require T/T down payment for the purposes of preventing fraud. There are also other reasons which I do not mention here, but I believe that more communication and mutual understanding will definitely help both parties, the buyer and the supplier, to close the deal.

Hence it would seem obvious to suggest that a mixed payment method will be beneficial to both parties. For example, to use 10-20% of T/T down payment and 80-90% of L/C is a popular way to settle the payment term in the contract. Yet of course the buyer would base their contract negotiations on comprehensive due diligence checks and thorough investigation of the supplier.

The China Sourcing Blog is THE BEIJING AXIS online media platform to track the latest trends on sourcing and the Chinese economy. Taking on a multi-faceted, dynamic subject and carefully scanning everything from the mainstream media to the distant corners of the Internet, CSB strives to get to the bottom of all the best bits and pieces on China sourcing.