When conducting business abroad, you need to be sure of receiving payments for goods sold. Otherwise, you risk being violated when supplying goods without pay. Here is where a letter of credit comes in.
A Letter of Credit, LC also called the documentary of credit, or a banker’s commercial credit, is simply a document that is issued by a bank of a buyer, to the one of a seller in a different country that payment is made as long as all the agreed conditions above are met.
A letter of credit falls under the financial law. It is simply a form of the position that gives a seller a form of guarantee that as long they do not violate the terms of sales, they will receive payment by the bank upon recoupment of a letter of credit.
Benefits of a Letter of Credit
Here are a few benefits of a Letter of Credit to both the supplier, the buyer and the other parties involved;
To The Seller
More Confidence Means More Transactions
When conducting international trade, letters of credit gives a seller the confidence that as long as they do not breach the terms of the contract they will always get paid. This is the required for trade.
When conducting business, especially with new clients, businesses always do not give goods on credit. This is because it is very difficult to know really if the customer is creditworthy.
Repeat customers, however, can also try to take advantage of their reputation and end up taking goods on credit and either hold payment or not pay in the long run.
With a letter of credit, however, you are sure to get paid in cash thus reducing the risk of bad debt.
Easy and Efficient International Trade
Letters of Credits, LCs have really made international trade easier and more efficient. This is by ensuring an efficient method in which money is transacted between the seller and the buyer fostering strong institutions and globalization as a whole.
This has enabled the business to grow and look for markets both locally and internationally making them grow. This efficiency has also reduced the recourses wasted in resolving issues legally or any other misunderstandings as buyers are able to assure sellers pay for the goods sold.
Creation of More Simple Methods of Payment
When operating an international trade business, it is very important you secure efficient and simple methods of payment. Using payment methods that take long, have a lot of costs incurred and are likely to be ineffective might lead to a collapse of business due to a negative working capital, to find more about working capital, check out our working capital solutions.
Creation of Strong Institutions
Institutions such as banks, financial markets as well as the simple seller and the buyer are now able to relate in a mutually beneficial way. This enables each to feel as part of the whole system making the international trade profitable as each receives a profit by involvement on the process.
As a buyer gets the opportunity to access different products corking to his or her needs, the banks involved are able to create profit, this has created a platform to facilitate trade like never before.
Creating a profit out of the transactions, the government also opens up to more opportunities for international trade. Sellers are also able to access markets they could have never imagined.
Government Revenue in form of Taxation
While a letter of credit LC has enabled international trade governments too are ye to make revenues through taxation. This is a win-win situation for governments that allow international trade and have favoring policies can attract trade leading to more revenue collected in the long run.
How it Works
A letter of credits works in a very simple way when a contract is reached upon by the buyer and a seller.
- The buyer’s bank issues the seller with a letter of credit.
- The seller then issues the goods to a carrier in an exchange with a bill of lading
- The seller then produces the bill of lading to his or her bank to receive payment.
- The seller’s bank then provides this bill of lading to the buyer’s bank
- The buyer’s bank then provides the bill to the buyer for payment
- The buyer then provides the bill of lading to the carrier then picks the goods