Why is it important to define the payment terms clearly in the purchase order?

With the globalization of supply chain, purchasing principles, practices and strategies are continuously changing. Take any item of daily use like a car, scooter, TV, air conditioner, washing machine, laptop, cordless telephone, mobile or anything one may think, the terms of payment is an important consideration in purchasing among various other issues to be considered. The price quoted by the supplier may be very different in its real value of the product in case of two different basis of payment terms. It is true that today’s products are not fully manufactured under one roof. For example, a car manufacturer will not be making piston, crank shaft, battery, dynamo, fuel pump by its own workshop. The strategy in today’s purchasing management is to outsource whatever can be obtained from others at a better price even if it involve additional movement of the parts from one place to another place. It must be clear here that a visible low cost may not be the really low but may be having many invisible or hidden costs, which must be examined in advance and taken into consideration while agreeing to the final price.

Purchasers usually specify the terms of payment in his RFQ (Request for Quotation). Some of the suppliers quote a price on a different payment term. For example, the purchaser wants an offer on CIF payment term. Some supplier quotes FOB payment terms, which is lower than the quotation of another supplier who has quoted on CIF basis. CIF means cost, insurance and freight whereas FOB price means free on board. In case of CIF price basis, cost of insurance of the goods and freight charges are included. Obtaining insurance for protecting the buyer against the damage of the goods during handling and transportation is important. In addition, the goods have to be transported from the supplier’s works to the destination defined by the buyer. Who will take action for arranging the freight of the goods, is an important part of the agreement. Under CIF, it is the responsibility of the seller to arrange for the transit insurance and also the insurance of the goods for loss or damage during handling, loading on the truck and unloading from the truck at any intermediate location or even at the destination. The seller in this case is also responsible for arranging the freight for the goods. But the seller takes care of the insurance and freight of the goods on behalf of the buyer. Once agreed on CIF terms of payment, the buyer is free from these responsibilities as the same have been passed on to the seller. FOB price basis does not takes care of insurance and freight and the same has to be arranged by the buyer, who should have resources to manage these aspects properly. The responsibility of the buyer increases in FOB price basis to arrange both insurance and freight for the goods ordered. The buyer wants to take advantage of the resources of the supplier in arranging the insurance and freight at much lower costs due to large volume of goods being dispatched by him to many buyers. This is only one important aspect of cost differentiation but the cost has many other elements too.

Other cost differentiation factors are techniques and modes of transport, cost of documentation, cost of custom clearance at the dispatch and the receiving points, packaging, inspection of goods etc. In order to have smooth business dealings, both the buyer and the seller has to be in agreement on such costs. The purchasing will be trouble free and efficient by properly defining the terms of payments. Purchase orders based on clarity of payment terms will develop good business relationship between the buyer and the seller.

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