Are you asking yourself what the heck is a Letter of Credit?
Then you have come to the right place.
Letters of Credit are indeed intricate and complicated but very advantageous to your business once you know how to manage them.
I have worked with over hundreds of Letters of Credit and I will explain it as simple as possible what are they, when to use them and how to expand your current business with them.
First let’s understand the concept:
Letters of Credit are simply put a financial agreement.
This financial agreement binds the issuing Bank and the applicant company to pay the beneficiary at a certain date which will be stipulated in the Letter of Credit itself.
The company issuing the Letter of Credit (LC for short), is usually buying goods from a company overseas, the company selling the goods is the one receiving the Letter of Credit.
Let’s imagine company A is in the USA and wants to sell its products to company B in Australia.
Company A never worked with company B, therefore can’t afford to give company B payment terms, specially being an international client there’s the risk of non payment and tracking international receivables is much harder.
However company A really wants to export its products into Australia, therefore it goes into agreement with company B, to be paid via a Letter of Credit.
The Letter of Credit is issued by company B with an issuer Bank in Australia that meets all the criteria for the receiving Bank in USA. Once the LC is issued and the goods are shipped, company A gets paid.
Even tough the LC has a maturity date (for this example we will use 180 days) technically company A would only get paid for their goods once the LC reaches the 180 days. This is where experience is gold, because company A has already received payment at the time of export.
On the other hand, Company B didn’t even receive the products yet, but company B is not worried because its cash is still in the issuing Bank waiting for the 180 days maturity.
The above it’s the beauty of Letters of Credit. Win Win Situation.
So how is that possible?
Company A studied much in advance of the issuance of the LC, therefore it ensured early payment. LC requires several documents to be prepared in advance.
The Issuing bank therefore advanced the money to company A by applying a small fee. This is called an “ Early Discount “.
That’s the basic of basics on LC concept.
When to get paid via Letters of Credit:
When your client can’t pay in advance.
When you want to provide payment terms but need fast payment.
When you want payment assurance from a international client.
When you want to safeguard your exports shipments.
When to issue a Letter of Credit:
When you want payment terms but your vendor can’t offer them.
When you want to import goods and ensure its quality.
When you want to place contingencies prior to payment.
The above is simply a summary, there’s much more to LCs and how you can use them to expand your business!
Now that you know the basics on Letters of Credit it’s very important that you safeguard your payment in advance, specially because there is companies that can play tricks on the LC language and take advantage of beginners.
If you would like to learn more details on Letters of Credit and acquire training in LC documentation, check out the following books: