Finance for Commerce: Methods of Payment

Hello future commerce experts! Ready to dive into one of the most fundamental parts of business? Every time a customer buys something or a business pays a supplier, money changes hands. This chapter, Methods of Payment, is all about how that happens.

Don't worry if this seems technical at first. We will break down every method, from simple cash to complex digital transfers, using easy steps and real-world examples. Understanding these methods is crucial because the choice of payment affects speed, safety, and cost for both buyers and sellers!

Why the Method of Payment Matters

When a business decides how to accept payment, or how to pay its own bills, it needs to consider several factors. These factors often create trade-offs—for example, the fastest method might not be the safest.

The four key criteria for selecting a payment method are:

  1. Speed (or Time): How quickly does the seller receive the usable funds?
  2. Security: How protected is the transaction from fraud, theft, or loss?
  3. Cost: What are the charges (fees, transaction costs) associated with using this method?
  4. Convenience: How easy is it for the payer (customer) and the payee (business) to use?

Quick Tip: Think of these four criteria as the "Four C’s" of payment choice: Cash flow (Speed), Confidence (Security), Charge (Cost), and Comfort (Convenience).

Section 1: Traditional Methods of Payment

These methods have been used in commerce for decades, and while their popularity is decreasing, they are still important in certain contexts.

1. Cash (Legal Tender)

Cash means physical notes and coins. It is the most immediate form of payment.

How it works:

The payer hands over the required notes/coins directly to the payee.

Advantages (Why use it?):
  • Payer: No transaction fees; immediate settlement (debt is instantly paid).
  • Payee (Business): Instant access to funds; no risk of payment failure (e.g., a cheque bouncing).
  • Did you know? Cash is often preferred by small market vendors or individuals because it doesn't require any bank accounts or technology.
Disadvantages (What are the risks?):
  • Payer & Payee: High security risk. If stolen or lost, the money is gone forever.
  • Payee (Business): Requires careful handling, counting, and transportation to the bank (risky and time-consuming).
  • Inconvenient for large transactions (imagine paying for a car entirely in coins!).

Key Takeaway: Cash is fast and universally accepted, but it carries the highest physical security risk.


2. Cheques

A cheque is a written instruction telling a bank to pay a specific amount of money to a specified person or business (the payee) from the payer’s account.

How the Process Works (The Clearing Cycle):
  1. The Payer writes the cheque, signing it and specifying the amount and the Payee.
  2. The Payee receives the cheque and deposits it into their own bank account.
  3. The Payee's bank sends the cheque to the Clearing System.
  4. The Payer's bank checks if enough money is available and debits the Payer's account.
  5. The funds are finally transferred to the Payee's account.

Common Mistake to Avoid: Just because a business receives a cheque doesn't mean the money is immediately available! The cheque must first "clear," which can take several business days.

Advantages:
  • Payer: Secure way to send large sums without carrying cash; provides a paper record of the payment.
  • Payee (Business): Can be easily mailed or posted; safer than receiving large amounts of cash.
Disadvantages:
  • Time Delay: Funds are not instantly available (slowest method).
  • Risk of Bouncing: If the payer doesn't have enough money, the cheque will "bounce" (be returned unpaid), incurring fees for the payee.
  • Inconvenience: Must be manually processed, reducing efficiency.

Section 2: Modern Electronic Methods

The vast majority of commerce today relies on electronic payment methods, which offer greater speed, security, and convenience than traditional methods.

3. Debit Cards

A debit card allows customers to pay directly from funds they already hold in their bank account. If the money isn't there, the transaction is usually declined.

Analogy: Using a debit card is like reaching into your own wallet; you can only spend what you physically have.

Advantages (Compared to Cash/Cheques):
  • High Speed: Instantaneous transaction settlement.
  • Security: Requires a PIN or digital authentication; reduces the need for businesses to hold large amounts of cash.
  • Convenience: Usable online and internationally.
Disadvantages:
  • Fees: Businesses must pay transaction fees (merchant fees) to the card processor for every sale.
  • Requires terminal equipment (Point of Sale, or POS terminal) and internet connectivity.

4. Credit Cards

A credit card allows a customer to purchase goods or services now and pay for them later. The card issuer (like a bank) is essentially lending the customer money for a short period.

How is this different from a Debit Card?

Debit uses your money; Credit uses borrowed money.

Key Feature: Protection (Chargebacks)

Credit cards often offer better protection for consumers. If a product is faulty or a service is not delivered, the customer can request a chargeback, where the credit card company reverses the payment to the business. This offers high consumer confidence.

Advantages for the Business (Payee):
  • Allows customers to buy even if they are low on cash, potentially increasing sales volumes.
  • Guaranteed payment (if authorised, the risk of non-payment is taken by the card issuer, not the retailer).
Disadvantages for the Business:
  • Higher Fees: Credit card fees are generally higher than debit card fees because the credit card company takes on more risk.
  • Risk of fraudulent transactions if the card is stolen.

5. Electronic Fund Transfers (EFT)

EFT is a broad term for moving money between bank accounts electronically. This is typically used for paying salaries, suppliers, or utility bills.

A. Direct Transfer / Wire Transfer

A single, immediate transfer of a specific amount from one bank account to another. Often used for high-value B2B (Business-to-Business) payments.

B. Automated Regular Payments (For recurring bills)

Businesses use automated transfers to manage predictable recurring payments easily. This significantly improves efficiency and cash flow management.

1. Standing Orders

A Standing Order is an instruction given by the customer (Payer) to their bank to pay a fixed amount to a specific payee on a regular date (e.g., £500 rent every 1st of the month).

  • Set up by the Payer.
  • Fixed and predictable.
2. Direct Debits

A Direct Debit is an authorisation given by the customer allowing the Payee (the business, e.g., an electricity company) to take variable amounts from their account, usually on a regular basis.

  • Set up and controlled by the Payee/Business.
  • Variable amounts (perfect for utility bills that change monthly).
  • High Security: Customers are usually protected by a guarantee scheme (e.g., Direct Debit Guarantee) if an incorrect amount is taken.

Memory Aid: Standing Orders are fixed (stand still); Direct Debits are variable (debit amount changes directly with usage).

Section 3: Comparing Methods – Selection Criteria Review

The best method depends on the context: Is it a small retail purchase? Is it paying an overseas supplier? Is it a monthly bill?

Here is a quick overview summarizing how the key methods stack up:

Method Speed Risk (for Payee) Cost (for Payee) Record Keeping
Cash Instant Theft Risk (Physical) Low (Only handling costs) Poor (Requires manual logging)
Cheque Slow (Days to Clear) High (Risk of bouncing) Low Good (Paper trail)
Debit Card Fast/Instant Low (Guaranteed funds) Medium (Transaction fees) Excellent (Automatic records)
Credit Card Fast/Instant Very Low (Guaranteed by bank) High (Highest transaction fees) Excellent
Direct Debit/EFT Fast Very Low Low to Medium Excellent (Automated)

Important Consideration: International Payments

When goods are bought or sold across borders, the method of payment becomes more complex, especially regarding currency exchange rates and transfer fees.

For international commerce, Wire Transfers (EFT) are the most common method, although they often involve high fees and require careful consideration of fluctuating exchange rates (the value of one currency against another). Businesses often use specialised banks or services to reduce these costs.

Did you know? Large commercial transactions between countries sometimes use complex secure systems like a Letter of Credit, which is a bank guarantee that the seller will be paid, reducing the risk of international trade.

Quick Review and Encouragement

We covered a lot of ground! Remember that the world of finance is moving rapidly toward digital and electronic methods because they offer speed and security that cash and cheques simply cannot match, despite the associated transaction costs.

Final Study Checklist:
  • Can you define cash, cheque, debit card, and credit card?
  • What is the difference between a Standing Order and a Direct Debit?
  • If a business prioritizes low cost, which method might it choose? (Hint: Cash or Cheque, despite the risks).
  • If a business prioritizes speed and security, which method is best? (Hint: Debit/Credit Card or EFT).

Great job! You now understand the tools businesses use to handle their money. Keep reviewing these concepts, and you’ll ace the finance section!