Documentary letters of credit (LCs) are indispensable when it comes to international trade. They ensure that payment will be received and allows the seller to significantly reduce the risk of non-payment for delivered goods.
However, if an organisation is new to the industry or has only recently started to trade internationally, then they might not be aware of how they could benefit.
That’s why this month we wanted to explore the advantages and benefits of documentary letters of credit.
What is a letter of credit?
The LC is a written commitment provided by a bank, stating that payment is to be made to a seller by the buyer, provided that the terms and conditions stated in the LC are met.
They are particularly useful when the buyer and seller are separated by distance, different import/export laws in each country and different trading customs. In short, they protect both parties.
Planning and budgeting
One of the main benefits of an LC is that the seller is able to forecast their income and budget for the rest of the year accordingly. They know that they are going to receive their payment within the pre-determined timescales, so are able to adjust their spending accordingly.
An LC is quick to execute, meaning that the seller gets their payment within a specific period of time. As per the initial terms and conditions of the contract, the seller has to give proof of the types of material and their quantity, along with the shipping documents to support the claim that they’ve been sent.
The advising bank will be able to verify these documents and release the payment immediately.
An LC helps to guarantee an income to the seller. This is because the buyer isn’t able to hold up or deny payment, based on objections over the quality of the goods shipped. The bank that releases payment simply needs to see the documents that show the shipping terms and conditions have been met.
Transfer of ownership
Another benefit to using an LC is that the ownership of the shipped goods is transferred from the seller to the buyer within the period indicated in the LC. This helps to avoid any disputes in the future, whilst ensuring that the goods are transported in a timely, careful manner.
Additional safety and security
Using a documentary letter of credit in case the buyer or importer goes bankrupt. Since the worth of the letter of credit is transferred to the issuing bank, it is the bank’s obligation is pay the agreed amount. This protects the exporter from the importer’s business risk.
- Having opened an LC, the importer shows that they are able to pay goods, and can count of a more favourable payment term next time
- Using an LC means that the buyer can avoid or reduce pre-payments
- An LC means that the importer can structure the payment plan under the contract according to their interests
- The importer is able to control the time period of shipping the goods
- There is a reduction in production risk, especially if the buyer is likely to change or cancel the order
- The buyer is unable to withhold payment based on the quality of goods
- The risk of non-payment is transferred to the buyer’s bank (or banks)
- Payment is secure, as long as you adhere to the terms and conditions of the LC
- The risk of losing money based on currency exchange rates is eliminated when the LC is issued in the currency of your country
In summary, documentary letters of credit have numerous benefits to your business. However, if you’re unsure about completing the application process, then it’s always worth seeking advice from an organisation such as ours, who have extensive experience in the sector.
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Alternatively, if you need help with Documentary Letters of Credit, then we’re more than happy to help. Call our office on 02380 623789 or get in touch with a member of our team here.