What Is Documentary Collection?
Documentary collection is a form of trade finance in which an exporter is paid for its goods by an importer after the two parties' banks exchange the required documents. The exporter's bank collects funds from the importer's bank in exchange for documents releasing title to the shipped merchandise, usually after the goods arrive at the importer's location.
- Documentary collection is method of trade finance in which an exporter's bank forwards documents to an importer's bank and collects payment for shipped goods.
- Documentary collection is less common than advance cash payment and open account terms, particularly in countries with weak enforcement of contracts.
- Documents against payment require the importer to pay the amount of the draft at sight. Documents against acceptance require payment by a specified date.
Understanding Documentary Collection
Documentary collection is so-called because the exporter receives payment from the importer in exchange for the shipping documents. Shipping documents are required for the buyer to clear the goods through customs and take delivery. They include a commercial invoice, certificate of origin, insurance certificate, and packing list.
A key document in a documentary collection is the bill of exchange or draft, which is a formal demand for payment from the exporter to importer.
Documentary collection is less common than other forms of trade finance, such as letters of credit and advance payment. It is less expensive than some methods but also somewhat riskier, so is generally limited to transactions between parties who have developed trust or are located in countries with strong legal systems and contract enforcement.
A sight draft reduces the exporter's risk because the buyer's bank will not release the documents without payment from the buyer, but neither side's bank assumes any financial responsibility in a documentary collection transaction.
Two Types of Documentary Collection
Documentary collections falls into two basic categories, depending on when the payment is made to the exporter:
- Documents against payment require the importer to pay the face amount of the draft at sight. In other words, the payment must be made to the bank when the buyer is presented with the draft, and before any shipping documents are released. This is the most common form of documentary collection because of the reduced risk for the seller.
- Documents against acceptance require the importer to pay on a specified date. Once the buyer accepts the time draft, the bank releases the documents to the buyer.
Steps in Export and Documentary Collection
Below is the step-by-step process:
- The sale is made when the buyer and seller agree on the amount to be paid, the shipping details, and that the transaction will be a documentary collection. Then, the exporter delivers the goods to the port or location where the merchandise will be exported from, which is usually through a freight forwarder.
- The documents are prepared and sent to the exporter's bank, which is also known as the remitting bank. The exporter's bank then forwards the documents to the importer’s bank, which is known as the collecting bank.
- The importer's or buyer's bank receives the documents and notifies the buyer that documents have been received. The buyer's bank requests payment from the buyer in exchange for the documents.
- Once the buyer's bank has been paid, or the buyer has accepted the time draft, the bank releases the documents to the buyer. The buyer uses the documents to collect the merchandise.
Other Considerations: The Risks of Documentary Collections
The exporter's risk is higher with a time draft versus a sight draft, as the buyer's bank would have released the documents with the buyer's acceptance of the time draft—meaning the buyer could already have possession of the merchandise by the time payment is due.
The seller's risk is limited with a sight draft. This is because the buyer's bank would not release the documents needed to take possession of the goods before payment is made. At worst, the seller would have to find another buyer or pay to have the goods shipped back.