A Guide to Letters of Credit

The current global financial situation is a concern to us all, but many businesses are successfully rising to the challenge by looking to overseas markets in order to diversify, spread risk and increase sales.

What is a Letter of Credit?

International payment terms can represent a significant financial challenge, particularly as overseas buyers often insist on credit periods well in excess of 60 or even 90 days. If you are sourcing raw materials, components or finished goods, such terms can put tremendous pressure on cash flow, particularly if supplier credit periods are less generous.
One major consequence of the global credit crunch has been the resurgence in use of more secure methods of payment such as Letter of Credit, a form of guarantee, which transfers the payment risk from a buyer to their bank.

What are the benefits of using Letters of Credit for buyers and sellers?

Advantages to the Exporter:

  • Where there is no existing relationship with a customer, a Letter of Credit provides an assurance of payment from an independent party (ie: the bank), subject to conditions being met.
  • Opens the door to new or potentially difficult markets (eg: where unstable economic or political conditions exist), particularly where a nominated bank acceptable to the exporter is prepared to add its confirmation that payment will be made.
  • Payment is guaranteed upon presentation of complying documents to the bank. Banks deal in documents and are not concerned with the goods, services or related performance of the exporter (article 5, UCP 600).
  • Predictability of cash flow. The structure of a credit includes timeframes for shipment and subsequent presentation of documents, therefore the exporter can be fairly certain when payment will be effected (subject to compliance with the terms and conditions). The bank may also be prepared to negotiate / discount the value of the documents presented under ‘term’ or ‘usance’ L/Cs.
  • A structure / framework within which payment is triggered. The skilled exporter will provide copies of the credit to all interested parties / departments, including the freight forwarder with clear instructions with regard to accurate preparation and disposal of documents.

Advantages of Letters of Credit to the Importer:

  • Stipulates the terms and conditions which make it more likely that goods will be received in order and on time.
  • Removes the need to release cash in advance to the supplier, thus reducing the risk of non-delivery or delayed delivery of the goods.
  • Predictability of cash flow. By stipulating a period for shipment and subsequent presentation of documents, the importer can be fairly certain when payment will be triggered.
  • By providing the supplier with a Letter of Credit, the bank is guaranteeing payment (subject to compliance with the credit terms) and therefore the importer could request longer periods of credit to finance the transaction.
  • Banks may be prepared to finance greater amounts for longer periods under Letters of Credit as opposed to overdraft, due to heightened visibility and knowledge of the transaction.

How do I produce a Letter of Credit?

Notwithstanding the above benefits to both parties, Letters of Credit, whilst very effective in reducing payment risk, represent a much more expensive method of payment, not only in terms of bank charges, but also the significant investment in time and paperwork in order to meet potentially onerous conditions.
Our handy Export Sales Guide to Letters of Credit provides a list of considerations for companies arranging to be paid by letter of credit from overseas customers, whilst our popular Letter of Credit Request Template can be downloaded from our Resources page.
Companies issuing letters of credit to overseas suppliers will find our guide for importers useful.

It is vital that all key people involved in such transactions are equipped with the necessary skills and knowledge in order to minimize unnecessary and unexpected costs.

We provide Letters of Credit Training across the UK and Europe.




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