Managing Supplier Payment in China

As the world's leading sourcing location, China offers buyers the potential for increasing their profits, but not without bringing risks – especially for newcomers to Asian markets. Many companies unfamiliar with the market fail to foresee risks involved in managing payment arrangements with their suppliers that may cause irretrievable losses to their companies. Paying attention to several important aspects of supplier payment can help to limit the financial risks of sourcing from China, and ensure your profits.

Payment Terms

In most cases, especially if it is an initial purchase order, China suppliers will rarely offer “net terms” .

Keep in mind that for the Chinese factory, “net 30” terms of sale, which means the buyer pays 100% of the purchase order value within 30 days after delivery, really mean 120 days of project finance -- 30 days to buy the material, 30 days to process, 30 days to ship across the Pacific and 30 more days to wait for payment. It certainly is possible to achieve net 30 terms in China, but it will probably be easier for you to move to better terms with your supplier after both sides have established a working relationship and trust. Be prepared not to operate on these terms during the initial phases of the relationship.

Don’t be surprised if a supplier asks for 100% payment in advance. Realize this is negotiable, just as you wouldn’t necessarily accept the first offer of price without a negotiation. I have found that “30-40-30 terms” are often an acceptable middle ground on payment terms, and are fair to both parties.

Under 30-40-30 terms, the initial 30% of purchase order value is placed as a deposit. This allows the supplier to buy materials and lock in the price (especially important if you have a long lead time or deal in materials which face great price fluctuations, or example metals.) The second payment, of 40%, occurs at shipping upon confirmation of quality. The final 30% is paid upon receipt and inspection at the final destination.

“30-40-30” Works for Both the Buyer and Seller

The seller is worried that the buyer will default on payment, so getting 70% (40+30) before the goods leave port limits their exposure. As the average factory in China makes between 10 and 30% mark up, the 70% covers at least the majority of his internal costs, so even if the buyer defaults it won’t put him out of business.

The buyer’s biggest concern is that the goods will have quality issues or not arrive at all. By holding out on the final 30% until delivery, the buyer has leverage if quality problems require re-work or replacement parts. It is also important to remember that the 40% is not paid until after the goods are inspected in China, so quality confirmation must be a key part of the payment process.

Financial Exposure is Really Quality Exposure

Quality problems are the biggest source of payment friction between buyers and sellers. New-to-China buyers may think they are protected by good payment terms, but if you want real protection, you need to see that quality risk and financial risk are one and the same. Let us assume you were able to extract some great payment terms, for example Net 30. So you have plenty of time to inspect the product at your warehouse before making final payment. But, what happens if you find a problem? Who pays for rework, costs to ship back defects, and/or delays to the customer?

What many new-to-China buyers don’t realize is that third-party quality assurance agents are readily available and inexpensive (a few hundred USD per shipment) in China. Utilizing third-party agents to inspect the goods before the buyer pays the 40% (under a 30-40-30 system) is an excellent way to mitigate your financial and quality risk.

Currency Issues

You may have heard your supplier say “sorry, we can’t accept payment in US dollars, we must have reminbi.” This is especially true these days, as the reminbi is no longer linked to the US dollar at a fixed rate. To accept foreign currency, your supplier may ask you to send funds to a private account (often the General Manager's) or to a third-party trading company.

My point is two-fold:

• Bring up currency issues early in the negotiation process rather than after the purchase order is placed.

• Due to currency regulations and business licensing, it may be true that the factory can’t accept foreign currency. But if you must send money to a third-party, only do it if you get the vendor’s seal on an official document stating that payment to the third-party equates to making payment directly to the vendor and the vendor bears the risk if things go wrong with the third-party. Having said that, this should only be applied to small value orders. Anything over USD 10,000 should go to a formal business account.

Traditional Financial Risk

There is a concern that the supplier will “run away with your deposit” or not be in business long enough to ship your goods. Luckily there are tools to manage this risk.

• Ask for references. If they can’t give you a number of happy clients, then a red flag should be raised.

• Financial Due Diligence. Financial Due Diligence is affordable (a few hundred USD per audit) and readily available. Use it to learn the ownership and financial stability of your supplier.

• Site Visit. Most important is visiting the factory to ensure they are not a trading company. Trading companies can disappear into thin air more easily than a legitimate factory, which has physical assets, a real address and employees.

   

   

Mike Bellamy is founder and China Operations Director of PassageMaker which is an independent company committed to helping buyers conduct quality inspection and avoid IP infringement in China. Recognized as expert on China sourcing, Mike has been a featured presenter for a number of high profile events including Global Sources Asia Expo HK, Global Sources Dubai, Boat Tech China, Rotary Foundation, US Chamber of Commerce, British Chamber of Commerce.

Founded in 2002, PassageMaker owns and operates Assembly Center in S. China which provides clients with inspection, final assembly and branding services. To learn more about Mike and PassageMaker please visit www.PSSchina.com.