Documentary collection: if an exporter sends the shipping documents through a bank, does the bank guarantee that it will be paid?

Q: What should be checked before agreeing to a collection?

On what terms the documents are released: D/P or D/A. This must be stated clearly in the bank instructions. If the buyer does not take up the documents, where the goods are stored and who pays the storage and return costs. Exactly which documents are needed to take delivery of the goods: if the buyer can take the goods without the documents, D/P protection does not work. Who bears the risk while the goods are in transit: this depends on the Incoterms term in the contract. At whose expense the two banks' fees are paid: the seller's, the buyer's, or each side pays its own bank.

Q: What is recorded in the accounts?

A collection is a form of settlement: it does not remove the receivable, it only determines the route by which the money arrives. Lines from the NAS No. 21 tables: The date on which revenue is recognised and exchange differences on the foreign-currency receivable are not included in this table: they are determined separately under the contract terms and the relevant NAS. A debt sent for collection but not yet paid stays on 4010; if the buyer does not pay, it is considered, like other receivables, when assessing the allowance for doubtful debts. The main conclusion for "Zarafshon Mag'iz": a collection is cheaper than an advance and safer than an open account, but it is not a letter of credit. The bank holds the documents, not the money.

"Zarafshon Mag'iz" LLC wants to sell 40 000 US dollars of shelled almonds to a foreign buyer for the first time. The buyer does not want to pay in advance and also considers opening a letter of credit too expensive. It proposed a third way: "Send the documents through the bank, and I will pay when the goods arrive." The director, Nodira, asked the chief accountant, Aziz: "In that case, does the bank guarantee our money?"

The short answer: no. In a documentary collection the bank carries the documents and controls the terms on which they are released to the buyer, but it does not pay in the buyer's place.

The contract amount, bank costs and probabilities are hypothetical and compiled by the author.

How does a collection work?

The seller ships the goods and hands the documents needed to take delivery of the goods (their exact list is agreed in the contract) not to the buyer but to its own bank.
The seller's bank sends the documents, together with instructions, to the buyer's bank.
The buyer's bank calls in the buyer and releases the documents on the terms written in the instructions.
The money paid travels back the same way to the seller.

In international trade this procedure is usually based on the International Chamber of Commerce's uniform rules for collections (URC 522). They describe the banks as intermediaries: the obligation to pay rests with the buyer alone.

How do D/P and D/A terms differ from each other?

	D/P: documents against payment	D/A: documents against acceptance
When the buyer receives the documents	after paying the money	after accepting (signing) a term bill of exchange
When the money arrives	immediately	when the bill of exchange matures
If the buyer does not pay, what the seller is left with	the documents for the goods (the goods have not been handed to the buyer)	only the accepted bill of exchange: the goods are already with the buyer
Risk for the seller	moderate	higher

Under D/P the main risk is different: the buyer may not take up the documents at all. The goods then stay in a warehouse or port abroad, and the seller has to bring them back or sell them more cheaply to another buyer.

Which of the four payment methods comes out cheaper on this deal?

For each method Aziz calculated two things: the bank cost and the expected loss (amount of loss × its hypothetical probability).

Method	Bank cost, $	Risk (hypothetical)	Expected loss, $	Total "price", $
100% advance	–	the buyer demands a 4% discount	40 000 × 4% = 1 600	1 600
Letter of credit	600	almost none if the documents are drawn up correctly	0	600
Documentary collection (D/P)	150	5% probability that the buyer does not take up the documents; loss from bringing the goods back and selling cheaply 6 000	5% × 6 000 = 300	450
Open account (goods are shipped, payment after 60 days)	30	8% probability that the money never arrives	8% × 40 000 = 3 200	3 230

On these terms the collection came out cheapest. But this result is very sensitive to one figure: the probability that the buyer does not take up the documents.

Break-even probability. For the collection to be cheaper than the letter of credit, 150 + p × 6 000 < 600 must hold, that is, p < 450 / 6 000 = 7.5%. If the buyer is new and little is known about it, it is hard to say with confidence that this probability is below 7.5%. So Nodira decided to sell the first two batches by letter of credit and, once the buyer had proved itself, the following ones by D/P collection.

Note the difference with the open account too: the bank cost is the lowest, but in case of non-payment the whole 40 000 dollars is at risk, whereas in a collection only the loss from bringing the goods back and selling them cheaply is.

What should be checked before agreeing to a collection?

On what terms the documents are released: D/P or D/A. This must be stated clearly in the bank instructions.
If the buyer does not take up the documents, where the goods are stored and who pays the storage and return costs.
Exactly which documents are needed to take delivery of the goods: if the buyer can take the goods without the documents, D/P protection does not work.
Who bears the risk while the goods are in transit: this depends on the Incoterms term in the contract.
At whose expense the two banks' fees are paid: the seller's, the buyer's, or each side pays its own bank.

What is recorded in the accounts?

A collection is a form of settlement: it does not remove the receivable, it only determines the route by which the money arrives. Lines from the NAS No. 21 tables:

Transaction	Dr	Cr	Basis (NAS No. 21)
Products sold, buyer's debt	4010 "Receivables from buyers and customers"	9010 "Revenue from sale of finished products" (9020 if goods are sold)	Paragraph 174, line 1
Foreign currency received under the collection	5210 "Foreign currency accounts in the country"	4010	Paragraph 229, line 2
Fee for bank services	9430 "Other operating expenses"	6990 "Other liabilities"	Paragraph 410; paragraph 412, line 12

The date on which revenue is recognised and exchange differences on the foreign-currency receivable are not included in this table: they are determined separately under the contract terms and the relevant NAS. A debt sent for collection but not yet paid stays on 4010; if the buyer does not pay, it is considered, like other receivables, when assessing the allowance for doubtful debts.

The main conclusion for "Zarafshon Mag'iz": a collection is cheaper than an advance and safer than an open account, but it is not a letter of credit. The bank holds the documents, not the money.