A letter of credit, or a credit letter, is a document from a bank guaranteeing that a buyer’s payment to a seller will be received on time and for the correct amount.
If the buyer is unable to make a payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase. It may be offered as a facility.
Letters of credit are particularly important in international trade. They can help an importer or exporter make deals with a great amount of security and comfort since the business will be assured of payments.
How a Letter of Credit Works
It starts when two parties have a transactional need. One party will go ahead to request a letter of credit to be provided to the receiving party.
The process is similar to applying for a loan, in which the applicant prepares and submits an application (usually includes a purchase contract, copy of the purchase order, export contract, and a few other documents. Then – again, like a loan – the applicant waits for approval.
After approval, the bank sends a letter of credit. It will charge a fee, typically a percentage of the letter of credit, in addition to requiring collateral from the buyer. Among the various forms of letters of credit are a revolving letter of credit, a commercial letter of credit, and confirmed letter of credit.
A buyer must prove to the bank that they have enough assets or a sufficient line of credit to pay before the bank will guarantee the payment to the seller.
If a letter of credit is transferable, the beneficiary may assign another entity, such as a corporate parent or a third party, the right to draw.
Again, although commonly used for international trade – particularly importing and exporting, businesses can get letters of credit for domestic transactions as well.
Why Should Your Business Use a Letter of Credit?
Letters of Credit can act as indispensable tools for guaranteed payments to buyers and sellers in many situations in both international and domestic transactions.
This not only helps payments to go smoothly in deals with complicated details but also helps build and strengthen relationships between new vendors just beginning to do business together.
With a letter of Credit from the Cooperative Bank, you can assure a beneficiary of payment once the terms of a contract are fulfilled, thereby eliminating risk and setting the beneficiary’s mind at ease.
Consider taking this option to ensure that your business projects aren’t held up due to credit concerns.