Advance Payment Guarantee

Introduction

In trading business, it’s common for buyers to request sellers provide advance payment guarantees. This is because buyers want to protect themselves against any default from the seller’s side or failing to deliver the goods or services as per the agreement. The workings of advance payment guarantee are enlightened in this tutorial.

Define Advance Payment Guarantee

An advance payment guarantee is a financial tool promising the buyer that as per the agreement, the goods or services will be delivered post advance payment to the seller.

The bank preserves this guarantee to protect the buyer from any loss caused by the seller.

How Advance Payment Guarantee Works ?

The buyer requests an advance payment guarantee from the seller. The seller then approaches their bank or financial institution to issue the guarantee. The bank or financial institution issues the guarantee to the buyer, promising that the seller will deliver the goods or services after receiving the payment.

Parties involved in Advance Payment Guarantee

Three parties constitute the advance payment guarantee: the buyer, the bank, and the seller. The buyer wants to protect the delivery of his requested goods or services, hence, requests assurance from the seller in the form of advance payment bond. This helps the buyer to reduce future losses in case the seller defaults or fails to meet the agreement.

Process of Advance Payment Guarantee

The process of getting an advance payment guarantee involves the following steps −

• The buyer requests an advance payment assurance from the seller.

• The seller approaches their bank or financial institution to issue the advance guarantee bond.

• The bank or financial institution evaluates the seller's credibility and issues the guarantee to the buyer.

• Payment is made to the seller by the buyer.

• The seller delivers the goods or services.

• The buyer has the full right to a refund by the bank or financial institution if there is negligence from the seller.

Advance Payment Guarantee Vs. Performance Bond

An advance payment guarantee is different from a performance bond. An advance payment guarantee protects the buyer against non-performance by the seller. The bond ensures the buyer that there won’t be any shortcomings in the delivery made by the seller.

The distinction between Advance Payment Guarantee and Performance Bond −

Purpose

The purpose of an advance payment guarantee is to assure the buyer that after the payment is received, the seller is obligated to deliver the goods or services. The purpose of a performance bond is to assure the buyer that the seller will perform the transaction as agreed and take care of any shortcomings.

Timing

An advance payment guarantee is typically used when the buyer has to make an advance payment before the seller starts performing the transaction. A performance bond is typically used when the seller has to complete the transaction before receiving payment.

Fig 3: Performance Bond

Coverage

An advance payment guarantee covers the risk of non-performance by the seller before the transaction is completed. A performance bond covers the risk of non-performance by the seller after completing the transaction.

Cost

The cost of an advance payment guarantee is typically lower than that of a performance bond. It is because the risk covered by an advance payment guarantee is lower than that covered by a performance bond.

In summary, while both advance payment guarantee and performance bond assure the buyer that the seller will perform as agreed, they differ in terms of purpose, timing, coverage, and cost. The nature of the transaction is decided upon the needs of the buyer.

Advance Payment Guarantee Insurance Explaine

The Bank also needs to protect itself if the seller defaults in payment, so insurance is sanctioned for the bank in this regard, known as advance payment guarantee insurance. The insurance company will compensate the bank if there is any fault from the seller. This is the additional cost to the seller as they should typically purchases this insurance.

Examples of Advance Payment Guarantee

• A construction company is awarded a contract to build a bridge. The contract requires the buyer to make an advance payment before work begins. The construction company obtains an advance payment guarantee from their bank, assuring the buyer that they will deliver the project after receiving the payment.

• A manufacturer receives an order for many goods from an overseas buyer. The buyer requests an advance payment guarantee to protect against the risk of the manufacturer failing to deliver the goods as agreed. The manufacturer obtains a guarantee from their bank, assuring the buyer that they will receive the goods after making the payment.

• A service provider is contracted to provide consultancy services to a client. The contract requires the client to make an advance payment. The service provider obtains an advance payment guarantee from their bank, assuring that the client will receive the services after making the payment.

Conclusion

An advance payment guarantee is a monetary mode of assurance that helps to ease the risk of negligence by a seller in a transaction. It assures the buyer that the seller will deliver goods or services after receiving an advance payment. The process of obtaining an advance payment guarantee involves the buyer, seller, and bank or financial institution. While it comes at a cost, it can help to secure business deals and contracts.

FAQs

Q1. Who pays for the advance payment guarantee?

Ans. The seller typically pays for the advance payment guarantee, although the parties involved can negotiate.

Q2. How much does an advance payment guarantee cost?

Ans. The cost of an advance payment guarantee is not fixed and can only be calculated by seeing certain factors like the guarantee amount and the seller's credibility.

Q3. Is an advance payment guarantee the same as a letter of credit?

Ans. No, an advance payment guarantee and a letter of credit are different financial instruments. A letter of credit guarantees payment to the seller after the buyer receives the goods or services.