There are a number of ways in which customers can make payment for sup-plies. Technological advances, coupled with changes in working practices, have dictated much of the progression over the years from one form of payment to another, but what remains is the fundamental purpose of transferring funds from buyer to seller.
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Cash: Although convenient as a quick method of payment, especially when small sums are involved, cash is cumbersome and has the great disadvan-tage that, once it has changed hands, it is unrecognizable against the debt to which it refers. Serial numbers on bank notes are seldom recorded and large sums of cash should be regarded with the greatest caution – the legislation now in force in most industrialized countries in respect of money laundering is quite rightly extremely severe. In any event, large sums of cash also bring problems of security, insurance and safe handling. Generally speaking, credit managers require accounts to be settled by ways other than cash.•
Cheque: A cheque is a bill of exchange, ordering a bank to pay a specifi c sum to a named party, or to that party’s order. It must be presented within six months, and it is one of the most common forms of account settlement.Cheques, however, have drawbacks. After being deposited in the creditor’s bank, they take two to fi ve days to clear, that is, to be paid from the drawer’s bank account. Banks have been under pressure to reduce this ‘clearance’
time to 24 hours, and there is no doubt that this is technically feasible.
Progress is being made, but many of the former building societies, now banks, are still not tied in to the ‘High Street’ banks’ system, so clearance remains two to fi ve days in general. Also, cheques can be invalidated by errors such as the words and fi gures differing, the cheque being undated, post-dated, unsigned or signed by an unauthorized person. There may be insuffi cient funds from which to make payment. On this latter point, there is growing pressure to introduce legislation in the UK which would make it an offence to issue a cheque knowing that there are insuffi cient funds in the ac-count to pay. This is already the position in France, for example, and the Eu-ropean Commission has been reviewing the situation across the EU. Despite these risks, cheques are a convenient and fl exible method of payment, and millions of commercial cheques are cleared every day through the banking system. Security in recent years has been improved by adding the words ‘Ac-count Payee Only’ to cheques, so that payment of these cheques can only be made to the named payee’s bank account.
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Debit cards: Based on EFTPOS (Electronic Funds Transfer at Point of Sale), debit cards are a form of electronic cheque, most widely known as ‘Switch/Maestro’ or ‘Delta’. When a sale is made, the card is swiped through an elec-tronic reader at the seller’s till, the buyer’s bank account is debited and the seller’s bank account is credited. Debit cards are increasingly popular with both buyers and sellers – buyers need not carry cash, and sellers do not need to get involved in cumbersome cash handling. Transactions are quickly
73 completed at the point of sale with minimum clearance delay through the bank computer system and offer a safer and quicker alternative to cash and cheques at retail outlets.
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Banker’s draft: Instead of sending his own cheque, a risky customer may be persuaded to arrange for his bank to provide its own cheque which should have the words ‘Bank (or Banker’s) Draft’ printed across the top. The payee shown on the bank cheque is the supplier to be paid. The full fi nancial stand-ing of the bank replaces that of the customer.•
Traveller’s cheque: Issued by banks in sterling or foreign currency, usually in standard denominations of 10, 20, 50 or 100 (pounds or US dollars). Hold-ers of traveller’s cheques may exchange them ovHold-erseas for cash in local currency at banks, hotels, various trade premises and exchange bureaus. If unused, they will be bought back by the issuing bank. The risk is limited to the face value of the cheque, but loss or theft is a constant problem, and great care should be exercised by the holding traveller.•
Eurocheque: Identifi ed by their EC logo, these can be bought from clearing banks, and are honoured in many countries with advantages compared to traveller’s cheques, as they are drawn in local currency and can be used to pay for purchases or to obtain cash. Holders of these cheques look for the EC logo in banks, shop windows, hotels, garages, etc. Clearance through bank-ing systems can take from six days to six weeks before the debit arrives on the holder’s bank account, and large fees can be deducted by some banks.•
Postal order: These can be particularly useful for sending money through the post when individuals do not have a bank account. They are obtainable from Post Offi ces and should be ‘crossed’ in the same way as cheques. They are only suitable for small transactions, however, and are increasingly rare in commercial trading situations.•
Bank standing order: The customer instructs his bank to make a series of fi xed amount payments to the seller’s bank account, usually at monthly in-tervals. The customer, on providing the written instruction to the bank to do this, advises the sum to be transferred, the date of transfer and the recipient’s bank account details. Bank standing orders are particularly suitable for the regular payment of insurance premiums, rents and other similar fi xed sum.•
Direct debit: This operates in the reverse way to the standing order. The debt-or gives his supplier a written authdebt-ority to make future charges, on ndebt-ormal due dates, to his bank account. The amounts can be fi xed in sum or variable, and are increasingly popular with both suppliers and customers. In the case of variable direct debits, the supplier is required to give notice each month of the amount to be collected, ensuring that at least 14 days elapse between the date of the last invoice to be collected and the date of the collection. Charges are then made through BACS (Banker’s Automated Clearing System).•
Just as standing orders gained acceptance through consumers in the fi rst in-stance, so too direct debits gained acceptability through consumers paying utility bills, council tax, TV licences and the like. The process is still grossly underused in trade transactions, however, and many organizations offer74
their customers one-off incentives to persuade them to change to direct debits.
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There are many advantages to direct debit, such as:– payment is made accurately on due date
– account queries are brought to light earlier as customers do not want to be debited for disputed items
– customers are relieved of the task and costs of making payments – customers have no ‘hassle’ from suppliers chasing overdue accounts – there is no risk of stopped deliveries due to late payment
– from all the above, customer/supplier relationships are improved.
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All customers who sign a direct debit authority receive a bank indemnity that should any error be made (for example, too much deducted or too early), it will be corrected immediately with no penalty to the customer. If an hon-ourable customer intends to pay the supplier on time, there is absolutely no reason why he should not pay by direct debit.•
Bank transfer: If the supplier gives the customer details of his bank account, the customer can arrange to make payment via BACS. The supplier should establish the bank transfer date to be used by the customer, to match the agreed credit terms. The supplier should also request a remittance advice from the customer, so that the supplier knows how much is being sent, and which invoices are covered by the payment. Bank transfers are increasingly replacing cheques as a preferred method of payment, and unlike cheques they cannot be lost in the post and are cleared funds on arrival. However, unlike direct debits, timing of payment is in the control of the customer, not the supplier, and BACS payments can be delayed, and are not received by the supplier on the same day as they are released by the customer.•
Bank telegraphic transfer: Designed for transfers in excess of £5000, the main advantages of telegraphic transfers are that they are very rapid and are cleared funds on receipt. The customer completes a bank form instructing his bank to transfer payment to his supplier, advising details and amount to be transferred. Internationally, the system can be further speeded through the banking SWIFT system (Society for Worldwide Interbank Financial Telecommunications), which combines bank computer systems and the electronic messaging method.•
Credit card: Worldwide there are many hundreds of organizations issuing credit cards, predominantly for use by individuals, though many compa-nies now have ‘corporate’ credit cards for employees to use for authorized purchases and for travel expenses, for example. The main issuers in the UK were the big banks in the early days, but many organizations now issue cards. In addition, charge cards are issued to approved customers by depart-ment stores, retailers, garages, etc. Sellers paid by credit card obtain rapid reimbursement but pay the credit card companies a percentage of the sales value. (See Chapter 25, which is devoted entirely to credit cards.)•
Postal collection (COD): Companies that sell directly to the public should be aware of the Royal Mail’s ‘Postal Collection’ service by which suppliers may send goods and packages through the post on a ‘cash on delivery’ basis.75 Postal staff will take small packages requiring cash payment in their house-to-house delivery service. For items of high value, the postal worker delivers an advice, notifying the addressee to collect them from the sorting offi ce.
If the recipient pays cash at that time, he may take the goods. If he pays by cheque (above the cheque card guarantee value), he must wait seven days before collection of the goods. The charges for this service are modest.
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Bill of exchange: This is defi ned by the Bills of Exchange Act 1882 as ‘an un-conditional order in writing addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at a fi xed or determinable future time, a sum certain in money to or to the order of a specifi ed person or to bearer’. There are therefore three parties to a bill: the ‘drawer’, the ‘drawee’ and the ‘payee’. The drawer (nor-mally the creditor) draws up and delivers the bill to the drawee (the debtor).If the drawee is a bank acting for a debtor, the bill is called a bank bill. The drawee is ordered to pay the sum stated to the payee. Bills are negotiable and may be transferred from one payee to another by endorsement. They can be made payable at sight or any future date, and are thus very appropriate for long credit arrangements. Inland bills are those drawn and payable in the UK, and foreign bills are those drawn on drawees abroad. A bill payable at a future date requires ‘acceptance’ by the drawee, who writes ‘Accepted’
across the face of the bill and adds his signature. Only after acceptance does the term bill have value. It may be ‘discounted’ at a bank which provides the funds, deducting an interest charge for the credit period. Otherwise, the payee can await the maturity date for payment in full. A cheque is also a bill of exchange but is drawn by the debtor (the drawer, in this case) ordering his bank (drawee) to pay the amount shown to the payee (the supplier), im-mediately on presentation.
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Promissory note: This is described by the Bills of Exchange Act 1882 as ‘an unconditional promise in writing made by one person to another, signed by the maker, engaging to pay, on demand or at a fi xed or determinable future time, a sum certain in money, to, or to the order of a specifi ed person or to bearer’. It is therefore not a true bill of exchange. The best known examples of promissory notes are bank notes, which contain the words ‘I promise to pay the bearer on demand the sum of X pounds’. Commercial promissory notes are mainly used in relation to loan instalments. There is no required format and they may be written on plain paper. There are only two par-ties involved: the maker and the payee, and the main difference between it and a bill of exchange is that it is a promise to pay and not an order to do so. Whereas a bill is drawn by a creditor, a promissory note is made by the debtor, and, unlike a bill, it does not have to be ‘accepted’. Promissory notes are similar to post-dated cheques, which have no standing in law until their date of payment, but notes are a promise of payment and establish that the sum involved is indeed due to be paid. Depending on the standing of the is-suer they have a high degree of negotiability, and in the case of bank promis-sory notes, they can change hands many times. They can be supported by security, in which case they are usually known as ‘collateral notes’.76
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Letter of credit: Used principally, though not exclusively, in foreign trading, letters of credit are arranged by a buyer with his bank to open a credit pay-able usually through a bank in the country of the seller. The bank accepts responsibility for payment by standing in the place of the buyer, substantially improving the security of the transaction. Payment is passed to the seller’s bank on the date of maturity following presentation by the seller of the rel-evant shipping documents called for in the letter of credit wording. When the seller has been notifi ed of the arranged credit, it becomes irrevocable and the buyer’s bank cannot withdraw from its commitment to pay. ‘Con-fi rmed’ letters of credit are those which are further guaranteed by a bank outside the country of risk. Letters of credit normally cover transactions to be paid in 30 to 180 days, but can be for any length of time, or at sight. Inland letters of credit can be arranged for UK home trade business and there are special kinds which can provide funds in advance of delivery performance.Banks make very high charges for all types of letter of credit transactions, from opening through to fi nal payment (and for any amendments necessary in between). The contract should make the buyer liable for all charges, but in reality they are often shared between the parties.
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Sight draft: This is a bill of exchange payable as soon as it arrives – that is to say, when the buyer has sight of it. It enables a seller to obtain payment from a buyer, usually overseas, before releasing control of the goods. This is done by the seller attaching the shipping documents and an instruction form to the seller’s bank. These are forwarded by the seller’s bank to the buyer’s bank for payment. When payment is made, the documents are passed over to the purchaser to obtain physical possession of the goods.•
Peppercorn: The dried berry of the pepper vine has given its name as an object of minute value to be accepted in rent and lease agreements which require only a nominal payment. It is worth so little that the benefi ciary in the contract does not need to collect it. Nevertheless, the term ‘peppercorn rent’ serves its purpose as the essential consideration in a contract.•
Novel payments: When agreed by both sides as a fair consideration, novel payments are acceptable in law. For example, an arrangement whereby a philanthropist hands over a plot of land to a local council in exchange for one pint of ale each Michaelmas for the next ten years, could be legal and binding if properly agreed between the parties.•
Barter: Probably one of mankind’s oldest forms of trading, the bartering of goods and other commodities remains in widespread use today, particu-larly between less developed nations. One government, for example, may exchange oil for machinery. At the commercial level, barter is also practical if both products can be precisely regulated in quantity to match the sales value of each other. For example, a farmer may pay for livestock with wheat.Instead of straight ‘goods for goods’ agreements, there is now a prolifera-tion of ‘countertrade’ methods whereby separate contracts requiring actual payment are made for both products, linked by an agreement. These are described in some detail in Chapter 17 on export collections.
77 From the bartering of ancient times to the electronic transfer of funds today, pay-ment methods have developed and matured. A key role of the credit manager today is to be fully conversant with all the methods now available and being developed in the future. The main aim is to secure swift payment, and not act as either a bank or a philanthropic institution.
INSTITUTE OF CREDIT MANAGEMENT – JANUARY 2002 Introductory Credit Management – Certifi cate
Question 7
Explain any FOUR methods of payment from the following:
a) Cheques b) Bank drafts c) Bank transfers d) Standing orders e) Direct debits.