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Trade Financing Terms -
Draft

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WHAT IS A DRAFT OR DOCUMENTARY COLLECTION?

The Draft or Documentary collection method is employed when either cash in advance is not acceptable to the buyer, or an open account is not acceptable to the seller. With the draft or documentary collection method, the seller or exporter ships the goods and draws a draft or bill of exchange on the buyer or importer.  The draft is an unconditional order to make such payment in accordance with certain terms, which specify the documents needed before title to the goods is transferred. The draft, the demand for payment made by the seller on the buyer, together with shipping documents, are presented to the exporter's bank, and the collections department assists its client with payment settlement. In the typical collection process, the exporter draws a draft- or bill of exchange- on the buyer and presents it to his bank, so the bank in turn can forward it to the buyer through a collecting bank located in the buyer's country. The draft drawn may require the buyer to pay the face amount either on sight (sight draft) or on a specified date in the future (time draft).  If the trade draft is converted into cash at a lower price than the real face value before is it is paid, it is known as a Draft Discounting of Trade Acceptances.

When the draft is paid, the title documents are released to the buyer so he can obtain possession of the goods. Because title to the goods is not transferred until the draft is paid or accepted, both the buyer and seller are protected. However, nothing prevents the buyer from refusing a draft for payment. In such cases, the exporter, who has already shipped the goods, faces the problem of getting his merchandise back, which may involve warehousing or insuring the goods, or even disposing of the merchandise at collection. If the buyer refuses or defaults on payment of the draft, the seller may also have to pursue collection through the courts (or possibly, by arbitration, if such had been agreed upon between the parties). The use of drafts involves a certain level of risk; but they are less expensive for the purchaser than letters of credit.


Sight Drafts
If the exporter and importer have agreed that payment should be made immediately upon receipt of the draft and/or shipping documents by the buyer's bank, the draft is said to be drawn at sight. When payable at sight, the collection procedure is known as documents against payment.


Time Drafts
If the exporter has provided credit terms to the buyer, thereby allowing the merchandise to be released before payment is received, it is called a time draft. The exporter will need a written promise from the buyer that payment will be made at a specified future date. When a bank receives time drafts, the bank is requested to deliver documents only against acceptance by the buyer. The buyer's acceptance of the draft is his agreement to pay at the agreed upon future date.


Draft Discounting of Trade Acceptances
In cases where a draft drawn by an exporter on a foreign importer is payable at a specific future date, the draft may be discounted by a bank so that the exporter may receive funds before the maturity of the acceptance date. The exporter receives less than the full face amount of the draft and the bank presents the trade acceptance to the importer's bank for full payment at maturity. Often, banks will discount the trade acceptance with recourse to the exporter. In such a case, the bank retains the right to demand payment from the exporter should the importer fail to honor the trade acceptance.

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