Let’s say your business receives a big order from an overseas company. A letter of credit helps mitigate the risk of either party not living up to their obligations, which can be essential for a business of any size. The bank serves as an intermediary for payment, issuing a letter of credit that offers protection against a deal going south. In this instance, a letter of credit is the way for an impartial third party-in this case, the bank-to guarantee that your customer can (and will) pay you for the goods or services provided. As a business owner, you may request a letter of credit from a customer to guarantee payment for products or services you’re providing. Article Table of Contents:Ī letter of credit, or credit letter, is a bank guarantee that a specific payment will be made. In this guide, we’ll break down what a letter of credit is, how a letter of credit helps small business owners, and how you can take advantage of one if the occasion demands it. Ī letter of credit is a more complicated financial transaction than those you might be more accustomed to, but it might be the best course of action for your business at some point. A letter of credit serves as a way to help ensure your vendor will remain true to their word to pay you, all without having to rely on a personal guarantee or verbal agreement. One of the best and most common methods, in this case, is a letter of credit. If you have a more complicated transaction-say with an international party-you may need a surefire way to make sure you get the money you’re due. Others are a little more tricky, depending on the situation. Some are simple, like cash, checks, or wire transfers. In general, exports from developing countries under different terms of payment other than a letter of credit require a special approval by the exporter's government.When you’re a small business owner, there are a variety of ways to get paid by your customers and vendors. Most developing countries do not allow exports even to related parties without a letter of credit to prevent capital flight. In fact, shipments other than air usually arrive at the port of importation long after the payment for the goods has been made to the exporter against the shipping documents by opening bank of letter of credit. Payments under a letter of credit are made against the shipping documents regardless of the quality and conditions of the goods at the time of arrival. With a letter of credit, the exporter gets paid for the goods he has shipped upon presentation of shipping documents. In most cases, the exporter will not start manufacturing until he receives a letter of credit because most export goods are made only for that importer according to the specifications provided by the importer. The exporter relies on the credit-worthiness of the issuing bank instead of the importer.
The exporter should obtain export credit insurance to protect against an importer's non-payment.īy issuing a letter of credit, the issuing bank assumes the responsibility for payment for the imported goods. Banks do not have any responsibility to honor the accepted draft on behalf of the importer.
In D/ A transactions, the banks simply act as intermediaries facilitating the transactions between the exporter and the importer. The importer is obligated to pay the draft amount on a due date to his bank, which, in turn, remits the payment to the exporter's bank.
The time draft can also be made at a specified number of days from the draft date. The shipping documents are released to the importer with his acceptance which is his promise to pay at a future due date such as 30, 60, 90 or 120 days or longer from the acceptance date. Acceptance is done by the importer by marking the word "ACCEPTED" across the face of the draft and signing his name and dating it. He then can pick up his shipments after the customs clearance. If the exporter's draft is drawn at a tenor such as 30, 60, 90 or 120 days sight, the importer can obtain the shipping documents from the bank simply by accepting the draft.