An Open Account is identified as a method of payment used in international trade. It is categorized as a form of trade credit.
Trade credit, in general, arises when a firm purchases goods from another firm and is not required to pay for them immediately. During the period before payment becomes due, the buyer has a debt outstanding to the supplier. The sources indicate that trade credit can manifest in the form of an open account or bills payable.
Specifically, the Open Account arrangement is described as an informal agreement established between a business (the supplier) and a customer (the buyer). This agreement allows the customer to acquire goods and services with payment being deferred to a later date.
The process under an Open Account arrangement involves the supplier, after first satisfying themselves regarding the credit-worthiness of the buyer, dispatching the goods that the buyer has requested. Along with the shipment of goods, the supplier provides an invoice. This invoice details key transaction information, including the quantity of goods shipped, the price per unit, the total price payable for the goods, and the specific terms agreed upon for payment.
A key characteristic of the Open Account method, as highlighted by the sources, is the level of trust required. The exporter (seller) relies entirely upon the financial creditworthiness and integrity of the importer (buyer). For this reason, this payment method is stated to be used only when the exporter and the importer have mutual trust and a significant amount of prior experience conducting business with each other. Despite the inherent dependence on the buyer’s reliability, Open Account transactions are widely utilized. This method is particularly common among industrialized countries, specifically mentioning North America and Europe.
Under the terms of an Open Account, the customer is expected to pay the business at a later date, specifically by the agreed-upon due date. An important financial aspect noted is that, typically, the seller does not impose interest charges on the buyer within this particular arrangement.
From an accounting perspective, the transaction is recorded by both parties. In the buyer’s accounting books, their liability to the supplier arising from purchases made under the Open Account is recorded as payables on open account. When presented in the buyer’s balance sheet, this debt is shown as creditors (accounts payable). Conversely, in the seller’s balance sheet, the corresponding outstanding amount owed by the buyer is recorded as debtors (accounts receivable). The supplier’s accounting records show the buyer as a debtor.
The sources discuss the role of trade credit, including Open Account, as a source of financing. The extent of financing provided through trade credit is influenced by the volume of purchases made and the timing of the payments. It is noted that small and newly established firms often rely more heavily on trade credit compared to larger, more established businesses. This increased dependence for smaller and newer firms is attributed to the potential difficulty they may face in securing funds from alternative sources.
Payables management, from the buyer’s perspective, involves handling unpaid debts to vendors for credit purchases and includes activities like seeking trade credit lines, negotiating favourable purchase terms, and managing payment timing and flow. Open Account is listed as one of the types of payables or trade credits, alongside Promissory Notes and Bills Payable.
For context within international trade finance, Open Account is presented as one of several methods available. The sources list other popular payment methods for international trade, which include Prepayment, Letters of Credit, Drafts, and Consignment. Beyond these payment methods, other trade finance techniques mentioned in the sources include Accounts Receivable Financing, Factoring, Banker’s Acceptances, Medium-Term Capital Goods Financing (Forfaiting), and Countertrade. Open account shipment may precede accounts receivable financing by the exporter.
In summary, based on the sources, Open Account in International Trade is a trust-based, informal trade credit method where the supplier ships goods based on the buyer’s creditworthiness, sends an invoice, and expects payment at a later agreed-upon date without typically charging interest. It is recorded as receivables by the seller and payables by the buyer, widely used between trusted parties in certain regions, and serves as an important, sometimes critical, source of short-term finance, particularly for smaller and newer businesses.