Managing payment terms with your China manufacturer must be done wisely. There is a lot more to it than simply making a wire transfer. Read more on how to go about it
How and when to pay the Chinese factory making your products is always open to negotiation. An importer that has been in business for many years and the manufacturer will have calculated the financial consequences and risks from choosing certain payment terms over others. Based on this assessment, they set preferences and deal-breakers. On the other hand, new buyers often seek advice on figuring out terms that protect their business and don’t hurt their China supplier partner either. Here are some relevant insights into managing supplier payments.
Payment terms are negotiated on the basis of trust that both parties will honor their obligations. You trust the manufacturer to make products to your specifications and meet the agreed-upon delivery schedule. The factory trusts that you will release payment by set due dates to ensure they protect their already-thin margins.
How much to pay and when to take risks, applies to both the supplier and the buyer. It is the reason why western importers micro-manage the production process, arranging for multiple quality checks and safety certifications before taking delivery of their order. For manufacturers, the risk of non-payment from a new buyer cannot be overlooked. It is why a majority of Chinese factories don’t offer net terms to importers.
In choosing payment terms, consider potential risks to you but don’t overlook the manufacturer’s point of view. Negotiations can be pleasant and yield high results if counterparts understand the stakes and remain open to trade-offs that don’t compromise either business greatly.
Chinese manufacturers accept multiple payment methods. Common options including wire transfers and letters of credit.
Wire transfers/Telegraphic transfers (T/T): International wires or SWIFT payments are among the most common ways to pay suppliers in China. Your bank will give you a form to fill out. Refer to the manufacturer’s pro forma invoice to fill in the bank account information requested in the form. Share a digital copy of the form with your supplier.
You pay a flat fee for each wire transfer and the supplier also pays a fixed fee on incoming wire transfers. Some banks offer savings of a few dollars for recurring wire transfers, so make sure you check if you can get a discount from your bank. Processing takes 3-5 working days.
Letters of credit: A letter of credit is a letter from your bank guaranteeing full payment to the supplier upon delivery of goods. It is not as popular as a bank transfer because it favors the buyer.
Full payment occurs after you’ve taken delivery of your order. If the order doesn’t meet acceptable quality standards during the pre-shipment inspection, you can choose to cancel the letter of credit. Both you and the supplier will need to prepare a list of documents by a certain date to avoid issues with the transaction. For these reasons, some Chinese manufacturers may be reluctant to accept this payment mode.
PayPal: For smaller order values or the initial sample, PayPal is a good option. Transfers from one PayPal account to another occur instantly, and PayPal offers excellent security against fraudulent transactions. While PayPal offers convenience, expensive fees associated with international transfers, along with poor exchange rates are disadvantages. You have the option to use your credit/debit card to fund your transaction, but that will pile on more fees.
Chinese suppliers have to use a third-party payment service to remit money from their PayPal account to their local bank account. The risk of buyer chargebacks is another reason why Chinese suppliers generally tend to be wary of using PayPal for large orders.
Western Union carries the risk of being scammed by suppliers. As such, legit manufacturers never insist on this payment method. When purchasing from a new supplier, never agree to using Western Union. You could consider it once you have established a trusted relationship with your manufacturer, leveraging the benefit of sending and receiving cash quickly.
What to keep in mind when making overseas payments
1. The remittance company should be reliable, and ideally, an established name in the financial services industry. If your China supplier allows the use of online money transfer services, make sure you review the provider thoroughly before sending thousands of dollars abroad. Check the rates and charges available at different providers, as well as reviews of their customer service. If you face an issue during your first international transfer, you’ll need a 24/7 support team to step in and fix your problem at the earliest. Also consider the speed of transaction, and the costs and convenience to your Chinese supplier.
2. Be aware that manufacturers that make their email and bank account information publicly available on supplier directories are at a risk of being hacked. While rare, such attacks against the supplier’s email account occur silently, so there’s no way for either party to suspect anything. It can be as straightforward as receiving a pro-forma invoice seemingly from your supplier but with the bank account details of the hacker. Once you’ve sent the money, there’s no way of recovering it, resulting in a loss for you and the Chinese factory.
3. Plan remittances ahead of time. Fluctuations in cash flow or a sudden event can create stress, pushing you to make hasty decisions. Ensuring that payments aren’t affected will help you remain on good terms with your China partner, which is especially important in the early stages of the relationship.
What if you agreed to paying your supplier 100% of the purchase order value in advance? Making such a payment up front can be a gamble and you potentially risk unknown service and quality. If you then receive inferior quality items or the manufacturer has missed the deadline you would then be left with no option but to call the manufacturer up and negotiate a refund or replacement. The Chinese company can refuse, and not be affected if you terminate the manufacturing contract. Meanwhile, you’ve lost your money and now need to start over and find another supplier.
Trying to negotiate a small down payment, say 20%, with the balance due after shipment creates a bit of risk for the supplier if you delay paying the balance for some reason. It can spoil your relationship with the manufacturer, and make it difficult to negotiate favorable terms in the future if you plan to continue buying from the same factory. Meeting payment obligations is a big part of creating mutual trust and respect between producer and importer. When one party fails to uphold their commitment, the relationship can weaken.
Paying 30% as initial down payment, 40% at shipping after a quality inspection, and the remaining 30% balance after you’ve received your order and reviewed quality- benefits you and your supplier. The factory uses the down payment to purchase materials and lock in the price, which also protects you against severe price fluctuations. When you pay the next 40%, at this point the manufacturer would have received 70% of the PO value, enough to cover all or most of their internal costs to fulfil your order. If you default on the remaining amount, the financial impact to the supplier is minimal.
This payment configuration offers you leverage if the order has not come out to your expectations. You can hold the rest of the payment, and ask for a rework or replacement.
Third-party quality control goes a long way in ensuring that orders conform to acceptable standards. Pre-shipment inspection is done on finished products after 80% of your order has been packed for shipping. Random samples are selected for inspection by the third-party QA agent you hire. If the agent reports minor defects that you don’t consider serious, then you can accept the order and figure out what can be done to ensure that quality better aligns to expectations the next time.
Importers in the United States and Europe pay Chinese suppliers in US dollars. Paying in USD is convenient for US buyers as they don’t have any FX risk to worry about. European importers are accustomed to managing euro/dollar or pound/dollar risk.
In 2009, China internationalized its official currency by launching the cross-border trade settlement in renminbi. Utilizing this system, participating banks can handle renminbi cross-border payments via a clearing bank in Hong Kong or a correspondent bank in Mainland China. The initiative provides more flexibility in payments for cross-border trade settlement. By choosing to pay in RMB, you will be reducing the supplier’s cost of currency hedging, and in return, receive lower pricing.
It also reduces the risk of being charged a premium for paying in USD by some suppliers for the FX costs and transaction fees they incur. This margin charged to importers may not accurately reflect the volatility of the RMB over the dollar, going up to 2%-3%.
Making payments in dollars to import from China into Europe creates an exchange rate risk for both parties for whom USD is not the base currency. By switching to the official currency of either party, one is spared the effort of hedging, removing some of the risk from the transacting system.
Any payment arrangement that reduces the cost of currency hedging for your manufacturer can translate into more favorable pricing for you. Compare the pros and cons of switching to RMB billing. For instance, to make RMB payments, you need to have a bank account with RMB in China. Or you could use a payment network like Veem to make RMB transfers, which claims that Chinese suppliers would receive 1-2% more funds than if they were to change USD to RMB through their bank.
When partnering with Chinese manufacturers, the signing of the manufacturing agreement heralds the start of real negotiations! It is imperative that your contract sets out expectations from the supplier as lucidly (in both English and simplified Mandarin Chinese) as possible.
The payment form, method, and period of payment should be clearly stated. It doesn’t hurt to be extra cautious and confirm payment terms with your manufacturer via phone or video call. The stakes are higher when you’re contracting with the factory for custom parts. In the event of a disagreement, the manufacturer will find it difficult to sell your order to another customer. You will have to restart your search for a Chinese factory that specializes in your product.
Any conflict that arises from misunderstandings around payment terms can typically be easily addressed as long as the factory has adhered to quality requirements and the consequence to your business is not significant. Working with professionals with boots on the ground in China and relationships with Chinese factories is an advantage, will help manage any conflict effectively, and prevent negotiations from breaking down.
Many new buyers prefer teaming up with China sourcing agents to handle every aspect of purchasing, from identifying the right factory, conducting a factory audit and working out mutually beneficial payment terms, to in-process quality inspections at different stages of production, and taking care of shipment and customs clearance.
Large or state-owned Chinese factories have more bargaining power simply because they have plenty of customers to keep their business going. Negotiating too hard on payment terms with a ‘powerful’ manufacturer never bodes well for a partnership in-the-making. Responding with a flat-out ‘no’ is considered impolite in Chinese culture, so ultimately your emails to the company will likely go unanswered.
On the other hand, upcoming manufacturers or factories with fewer customers may accommodate your terms. Even in this case, you never want to create too much risk for the supplier, such as negotiating a very small down payment. Anything that affects the manufacturer’s cash flow situation will affect you, in terms of production delays or poor quality.
Being too soft and missing out on opportunities to gain favorable payment terms is also something to guard against. You want to be fair but also firm, especially if you know that you’re not being offered the same deal as other importers and there is room for negotiation.
An understanding of common payment terms, risks to both parties, and negotiation opportunities will help you make informed decisions.
Sourcing Allies is a team of expert China sourcing agents that has helped western customers manufacture and source products from low-cost regions since 2006.
For more on China sourcing visit our website or write to us at info@sourcingallies.com.
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