The Letter of Credit: How to Protect Your Imports Financially — and Up Your Reputation!

By | 2019-01-09T16:54:39+00:00 January 9th, 2019|Uncategorized|

We’re a little over a week into 2019 already, and we all know what that means: it’s make-or-break time for everyone’s New Year’s resolutions!

If you’re one of the many who aspire to exercise more, take up a new hobby, or finally clean up that one room in your home with stacks of old importation records, we wish you nothing but luck.

However, if your main resolution is to solidify your relationships with others, we have an excellent tip to help you stick with it all year long — it’s called the letter of credit.

For all importers looking to strike a good note to start the year on, this single document could just be the key to helping you establish more trust and reliability with your suppliers, particularly new ones with whom you might be working for the first time.

First Things First, What Is the Letter of Credit?

In essence, a letter of credit is written commitment supplied by an importer’s bank on their behalf. It guarantees the supplier will be paid, provided all conditions on the supplier’s end are met.

From that description, this sounds like the kind of standard regulatory document that should be a given — but it’s not required and it doesn’t always come into play. However, the letter of credit acts as a measure to protect importers if anything goes awry, increase your credit-worthiness, and ensure suppliers are submitting valid documents so as to not defraud you from receiving your goods.

Because payment risk is in effect assumed by your bank, and your import payment is guaranteed by way of the letter, it also opens up further opportunities for importers to negotiate better prices or extended credit terms to improve their cash flow.

Aside from having to pay a bit more in order to procure a letter of credit, the lone drawback is that you could end up with poor-quality or damaged items in your shipment — but that’s a risk anyway, so thoroughly researching which suppliers you work with is still critical.

A Brief History

The letter of credit is emphatically not a modern concept — it’s actually been in use throughout England and mainland Europe since ancient times. Originally, “credit” didn’t take the form of money from a financial institution, but rather an instrument (not of the musical variety, just any tool used to complete work) issued to a third-party who ensured terms of the deal were honored.

Americans eventually adopted the financial version of this system to conduct trade abroad, but also began using it for domestic transactions during wartime in the 19th and 20th centuries.

Best Practices

When issuing a letter of credit to your supplier, there are a few important points to keep in mind:

 

  • Be as specific as possible.Payments to suppliers are made on the basis of what’s in your document, so outline all terms as clearly as possible. According to the U.S. Department of Commerce, this includes detailing everything from the amount of days in which an amount is payable, to the currency in which the payment will be made.

 

  • Work with a commercial, credit-worthy bank. When you want all parts of your transaction to be reputable, it goes without saying that your financial go-to should be one of them. Your bank should be able to determine your financial viability to pay for your goods and establish the right set of conditions with your supplier’s bank.

 

  • Be fully aware of the terms of the letter.Once all details are written into a letter of credit, they’re locked in unless all parties agree to a change. Any further incurred charges on insurance, shipping, etc., even if documented, fall outside the scope of the letter.

 

Important Terms Worth Knowing

Similarly, before having a letter of credit drafted, take the time to note the difference between certain key terms, as they could end up impacting the details of your transaction:

  • Revocable vs. irrevocable: If a letter of credit is deemed “revocable,” it means the either party, the importer or supplier, can unilaterally make changes to the terms of the letter. “Irrevocable,” on the other hand, means that all parties must agree to proposed changes, which is, evidently, the less risky option for everyone involved.
  • Sight, time and date drafts: These are the three types of letters of credit, each outlining a different period in which payment is due. A “sight draft” is to be paid upon presentation, a “time draft” is to be paid within a certain number of days, and a “date draft” specifies a deadline by which payment must be received.

Want to ensure better reliability and payment results for your importation business? Contact us today and we’ll take you beyond the basics to help you draft your own letter of credit.