A Letter of Credit (LOC) is an attractive option when you're dealing with a foreign supplier who has great pricing, but doesn't offer payment terms and insists on cash in advance. An LOC as your promise to pay offers you, as purchaser, a more attractive cash flow alternative than paying cash upfront.
What is a Letter of Credit?
Simply, a Letter of Credit is a formal document, issued by a financial institution, that acts as a promise to pay. Letters of Credit are commonly used in international trade because they bridge the differences that can arise from dealing with the complex world of foreign currencies, international banking policies, import/export laws and multiple time zones.
Instead of transferring cash in advance to purchase goods, the Letter of Credit sets out the terms under which payment will be made. This can include such things as the due date, quantity and location of goods to be delivered. It often allows a period of time after delivery (ex: 10 days) for you to inspect the goods first. The LOC also sets out the documents that your supplier must present to their bank in order to receive payment.
Why use a Letter of Credit in international trade?
You want to minimize risk and maximize cash flow: With a Letter of Credit, your foreign supplier gets the assurance before they ship their goods that they'll receive their money. You get the piece of mind that actual cash won't change hands until the terms you've laid out in the Letter of Credit are met.
Purchasing goods from foreign sources can be complex transactions: Purchasing goods through international trade can bring challenges, such as dealing in foreign currencies, different banking requirements, import/export laws and cultural nuances. Financial institutions, like Accutrac Capital Solutions, deal with LOCs on a regular basis and are experienced dealing with international trade. They provide a wealth of knowledge about the differences and pitfalls of purchasing goods from foreign sources.
A Letter of Credit may be the only option to cash upfront: Many offshore suppliers offer highly competitive pricingÉbut that often comes hand-in-hand with the stipulation of cash in advance or COD. Paying cash upfront can put a huge strain on cash flow. There's also the risk of limited recourse if products are received incomplete or flawed. Foreign suppliers will often accept an LOC as an alternative to cash upfront.