Letters of credit are not a very common way for a small business to get
financing. A letter of credit is an important financing tool for companies
practicing international trade.
A letter of credit is a promise of payment between a buyer and seller. In
generic terms, it is really a two-way IOU used to for international
purchases.
The process is as follows: The buyer goes to their bank and requests a
letter of credit. The bank will only agree to this if you have a
sufficient line of credit. The bank will promise to pay the debt to the
seller if all the contract conditions are met.
The contract conditions could be any of the following:
- A complete, on-board, ocean bill of lading.
- A commercial invoice, original, six copies.
- A Packing slip, original, with six copies.
- Insurance certificates.
- Inspection certificates.
- Strict contract and delivery date limitations.
- The precise name, and address of the seller.
- Complete references to the mode of transport.
- Any of the Dozens of other conditions covered by the "Rules."
The "Rules" were drafted by the International Chamber of Commerce (ICC)
in 1933 and revised as recently as 1993. They oversee the standard
letter of credit format accepted internationally and is known as the
"Uniform Customs and Practice for Commercial Documentary Credits (UCP)."
The buyer's bank works as a transfer agent, usually with the seller's
bank, to exchange the purchase price for title or claim to goods. The
parties thereby use their banks as intermediaries to limit the risks of
doing business with foreign partners. These risks include foreign
currency exchange rate fluctuations and frequent shipping delays.
Letters of credit come in a wide range of types and have differing
levels of a banks commitment. If you are the importer you will want to
be confident that the goods will be delivered intact, on a date certain,
in good condition, and at the arranged cost. The sellers need to comply
with the terms you've outlined in the letter of credit so they can be
paid on time. The most important aspect is that everything must be
carefully documented at both ends.
Remember that banks deal with paperwork, not merchandise. If the
paperwork is incorrect, the letter of credit can be worthless even if
the goods arrive as promised. This is true if any party to the agreement
has made a mistake in the paperwork. The other scenario is that the
paperwork can be perfect but the wrong goods might be delivered. This
will also make the letter of credit worthless. You need to have a
customs broker or a freight forwarder certify that what you ordered is
what was shipped and that all the goods arrived in good shape.
The key point to remember about a Letter of credit is the need for
accuracy when dealing with the paperwork. Attention to detail is a
mandatory process that must be followed. If an error is made or
adjustments are needed, an amendment will have to be made to accommodate
all parties to the transaction. This also must be accurate because banks
will follow these instruments exactly. The details are time consuming,
but the security a letter of credit offers to both buyer and seller is
worth the effort.
© 2001 Missouri Innovation Center