Usance, often encountered in international trade and finance, is a term that might seem complex at first glance. However, it’s a concept with real-world applications and implications. This article aims to explain the term “usance” in easy-to-understand language, shedding light on its importance in trade, finance, and commerce.
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What is Usance?
Usance is a term used in trade finance and banking to refer to the permitted time, typically in days, when a buyer can pay for goods or services they have received. It is often associated with trade credit. In other words, it represents the period during which a buyer can delay payment to the seller. This arrangement allows businesses to manage their cash flows more effectively and can be seen as short-term financing.
Understanding Usance in Trade:
Usance is particularly relevant in international trade and is commonly used in letters of credit (LCs) – a widely used payment mechanism in global trade transactions.
Here’s how it works:
- The Agreement: In an international trade deal, a buyer (importer) and a seller (exporter) agree on the terms of the transaction. These terms include the period within which the buyer should make the payment.
- Incorporating Usance: The LC or trade agreement specifies a usage period to provide the buyer with a reasonable time to inspect the goods and arrange payment. For example, “60 days usance” means the buyer has 60 days from receiving the goods to pay.
- Trade Credit: This delay in payment, or trade credit, allows the buyer to sell the goods, collect the proceeds, and use that income to settle the debt.
Key Points about Usance:
Let’s highlight some crucial aspects of usance:
- Duration: Usance periods can vary. They are typically stated in the LC or trade agreement and can be 30, 60, 90 days, or more.
- Risk Management: For sellers, offering usance terms can be a way to attract more buyers. It can also serve as a risk management tool.
- Interest Implications: The longer the usance period, the more interest costs a buyer might incur if they need to finance the payment. Sellers can consider this when setting usance terms.
Examples of Usance:
- Case 1: Usance in International Trade Company A in the United States agrees to sell machinery to Company B in India.
- The LC, issued by Company B’s bank, specifies “90 days usance.”
- Company A ships the machinery, and Company B receives it.
- Company B now has 90 days to make the payment to Company A.
- Case 2: Usance in Commercial TransactionsA bakery orders a large quantity of flour from a supplier with 45 days of usance.
- The bakery receives the flour, uses it to produce various baked goods, and sells them to local stores.
- Over 45 days, the bakery collects payments from these stores and uses the proceeds to pay the supplier.
Why is Usance Important?
- Cash Flow Management: Usance allows businesses to manage their cash flow better. Buyers can sell goods and collect revenue before having to pay the seller.
- Risk Mitigation: In international trade, usance can reduce risk. Sellers are assured of payment, and buyers have time to inspect the goods before releasing funds.
- Competitive Advantage: Offering usance terms can make a seller’s products more attractive to buyers, potentially leading to increased sales.
Usance vs. Sight Credit:
Usance stands in contrast to sight credit. In a sight credit arrangement, the buyer is required to pay immediately upon presentation of compliant documents. In use, there’s a deferred payment period. The choice between usance and sight credit depends on the mutual agreement of the buyer and seller, the nature of the goods, and the buyer’s financing needs.
Conclusion:
Usance is a fundamental concept in trade finance and international commerce. It enables buyers to defer payment for a specified period after receiving goods, which, in turn, aids in better cash flow management and risk mitigation. Sellers benefit from usance by making their products more appealing to buyers. Understanding and utilizing usance is crucial for businesses buying and selling goods and services on credit in international trade or domestic transactions.