Cash in Advance: Why, Where & Who Uses It?
Trade agreements between two parties often invoke the term “Cash in Advance”. This refers to an advance payment that the buyer has to make to the seller, either before receiving the shipment or even before it has been shipped by the seller. It is often required in transactions where delays in goods delivery occurs frequently, though there are many other scenarios where trading partners may choose the cash in advance option. For example when doing business when a new customer or a customer with highly specific product requirements that require customization, a seller may request for cash in advance in order to reduce risk of not getting paid.
Why use Cash in Advance?
It goes without saying that the basic purpose of cash in advance is to protect oneself against non-payers. Its structure is basically beneficial to the seller only, who gets the cash for his/her products in advance. On the other hand, the buyer pays the money without receiving the products, which increases his/her risk and leaves him/her vulnerable to dishonest or fraudulent sellers.
You will find a number of examples where cash in advance transactions are used. Very often, you will see it being used in international trades or online marketplaces.
International Commercial Trade
The use of advance payment in international trade has to be negotiated. When buyers are dealing with a exclusive seller of unique products, the seller may have the advantage in pushing for a cash in advance transaction. It must be mentioned that just like Incoterms, cash in advance arrangements do not specifically determine the point of title transfer or revenue recognition rules.
It must be mentioned that just like Incoterms, cash in advance arrangements do not specifically determine the point of title transfer or revenue recognition rules.
Most people are quite comfortable paying upfront for goods online on big name platform, trusting the company’s promise to deliver those goods on time through a trusted courier service. Businesses like Amazon, Walmart, and eBay among various other names are reliable and hence customers do not hesitate to pay them upfront. This is also due to there being some level of trust that the platform will mediate any complaints of non-delivery or poor quality.
In many online marktplaces, the cash in advance option is the only way to make payment. Once the buyer makes an upfront payment, this initiates the shipping process. Since the seller hasn’t shipped anything at the time of receiving the money, his/her risk is zero. Similarly, he/she usually doesn’t need to handle any documentation regarding payment demands at the port or by any other authorities.
The reason why people do not hesitate to pay upfront on online platforms isn’t just trust. Online merchants like Amazon and eBay offer refund guarantees in case the goods don’t arrive or in case the items received aren’t as expected or defect. In case of disputes between buyers and sellers, they sometimes offer mediatory services but most of the times, the buyer is protected, which is what results in long term trust between the company and the customers.
When it comes to worldwide trade, matters get a little more complicated as many firms do not like write-offs for their inventory. They demand cash in advance to keep the business running.
Whether businesses demand cash in advance or not also depends on their size. Bigger firms can easily absorb any losses due to non-payment and are therefore more flexible and tolerant in giving customers different options. Smaller companies have the risk of running big losses due to non-payment. Sometimes these losses can threaten the very existence of their business, so they always demand cash in advance.
Quick Summary of Cash in Advance:
- When a seller demands that the buyer pay upfront, he/she is asking for Cash-in-Advance.
- The term Cash in Advance is applicable to any business where the product or service is delivered at a later date instead of immediately.
- While cash in advance is really advantageous to the seller, it isn’t always possible to use it due to industry standards, competition or buyer’s reservations and risks.
- One can also set up a customized cash in advance agreement. This is especially useful when the seller wants to remain competitive and wishes to lower the buyer’s risks as well.
Other International Payment Options:
While cash in advance transactions are the standard in online transactions such as those on e-commerce websites, they aren’t the only option available. For instance, some vendors allow payment after the buyer has received his goods (such as clothes) and decided which one he/she wants to keep and which ones he/she wants to send back. Such a payment system gives the buyer the luxury to pay only for things he/she likes as well as at a later date. For the online merchant, this system potentially saves some administration work and costs when dealing with returns and refunds.
When one moves to more serious and sensitive businesses, especially those carried out on a large scale, cash in advance is usually not acceptable to buyers. One good alternative in such circumstances is the letter of credit.
Cash on Delivery
In some way the opposite end of the spectrum is the “cash on delivery” option, where the payment is made moments before the transfer of ownership or handing over of goods. In such cases, the buyer can see that the goods have arrived and will be given into his/her possession as soon as he/she agrees to pay. There is also the possibility that the buyer is not prepared to pay when the goods have been delivered. This will create a lot of difficulty for the seller, who will incur extra costs if there arises a need to store the cargo in a suitable place before the buyer is ready to pay.
Due to the risks involved from the buyer’s perspective, cash in advance transactions are usually not preferred by sellers.
One thing to note however is that online payments are susceptible to fraud. While the websites may be reliable, sellers on those websites may have other purposes. Similarly, some fraudsters clone websites to make them look like a famous vendor when in fact they are not.
Letter of Credit
A letter of credit gives a guarantee that the payment will be made as long as the agreed conditions have been met. It is usually a banking institution that gives such a guarantee. There are mainly two types of letters of credit; funded and unfunded.
A funded letter acts like an escrow, where the bank holds the funds on behalf of the buyer and releases it either way only when certain conditions have been fulfilled. On the other hand, an unfunded letter of credit acts as a promise from the bank that it will make the payment in case the buyer fails to do so.
Both the above types involve availability of funds to the buyer so that he/she can complete the transaction with a seller. Usually with a funded letter, interest is charged immediately whereas on an unfunded letter the interest is charged once the funds are moved.
The whole point of instruments like the letter of credit is to ensure smooth running of businesses while minimising risks for both the buyer and the seller. Other similar tools include payment collection processes and standard invoicing. In order to lower their risks and accommodate industry standards, many firms simply adjust their days of invoice receivables. Depending on the industry, the credit terms can sometimes go up to 90 days and beyond.
A company can also deploy its own staff or hire another company to ensure payments are made according to the agreed terms. Late payment fees and legal actions are other options that the companies can use to reduce their financial risk levels.
In modern times, financial tech has improved massively and better technologies for managing supply chain and payments are being introduced. Despite all that, the risks for sellers are still high and to manage seller’s risk, the cash in advance is by far the preferred and best option available.