An open account is a contractual relationship between an exporter and an importer in which a trade credit is extended by the former to the latter whereby payment is to be made to the exporter within an agreed period of time. The seller ships the merchandise to the buyer and separately mails the relevant shipping documents. Terms of payment range from 30 days to 120 days after date of shipping invoice or receipt of merchandise, depending on the country (Reynolds, 2003).
As in the case of consignment sales, open account is rarely used in international trade between independent exporters and importers. Exporters are often apprehensive about potential defaults by overseas customers. They lack accurate information or may doubt the reliability of available data on foreign buyers to evaluate and determine their creditworthiness to purchase on open account. Unlike consignment sales, importers are expected to remit payment within a certain agreed-upon period regardless of whether they resold the product to third parties.
Open account is often used to increase sales by assisting foreign distributors to start new product lines or to expand existing ones. It could also be used when a seller wants to test- market a new product or try a new market in a different country.
This arrangement gives the buyer/distributor enough time to resell the product to domestic customers and then pay the exporter, while generating business goodwill for future dealings. Many developing nations prohibit purchases on open account and consignment sales because of currency restrictions and lack of control over their balance of payments (Shapiro, 2006).
A major weakness of this method is that the importer could delay payment until merchandise is received, even when the importer is expected to pay within a specified period after shipment. This method also carries a greater risk of default or nonpayment by the buyer. This makes it difficult to sell the account receivable.
Open-account financing is often used for trade between parent and subsidiary companies. It is also used for sales to well-established customers with good credit ratings. When open-account sales to third parties are contemplated, it is important to verify the integrity of the buyers through a credit investigation. This should also take into account the importing country’s political and economic conditions. Sources range from commercial credit agencies, such as Equifax and Dunn & Bradstreet, to chambers of commerce, trade associations, commercial banks, and public agencies, such as the Department of Commerce. It is advisable to insure trade debts to protect the seller against default by the importing company. Another safeguard would be to secure collateral to cover a transaction.
Source: Seyoum Belay (2014), Export-import theory, practices, and procedures, Routledge; 3rd edition.
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