Best practices to effectively utilize letters of credit

Small business | 7 Oct, 2015 |

In brief, a letter of credit is a document from a bank guaranteeing that a seller will receive full payment, as long as certain terms and conditions have been met. In the event that the seller is unable to cover the full payment the bank will put up the outstanding amount. A letter of credit is among the most secure ways of guaranteeing payment for the seller, however utilizing it effectively requires serious attention to detail.

Although, by strictly following these best practices, as outlined below, you can ensure that this method works the way it is intended to.

Get Rid of Discrepancies

It is not uncommon for companies to actually understand what is required of them in a letter of credit. Simply put, a letter of credit will not pay if there are any discrepancies. These are easily avoidable, but here are a few common examples to prevent such issues from occurring:

• Match incoming letters of credit against purchase orders and sales orders.

• Send copies of the letter of credit to the sales and shipping department to review. This will help ensure that the terms and conditions can be met.

• Once a discrepancy is found ask the customer to have the changes made. In most circumstances it is the customer who has the relationship with the bank and will be able to get this changes implemented more quickly.

• Fill out a template version of a letter of credit and provide it to your customer. By using such a document you will have guided your customer in the right direction.

• Send the letter of credit back immediately if you are unhappy with the terms and conditions; it’s much easier to have the issue(s) resolved before any goods have left the premises.

Create Solid Partnerships

A letter of credit is only as secure as the bank standing behind it. It is important to do your homework and evaluate the issuing bank. Here are some tips to help you:

• Show your banker a copy of the letter of credit. This can help avoid obvious banking errors.

• Work with a large local bank.

• If a letter of credit comes to you from a foreign bank it is highly likely it is a fake. It should usually come from an American bank.

• Ask your bank to confirm the bank that is issuing the letter of credit. If the dollar amount is large it is wise to get a confirmation. Confirmed letters of credit are often paid faster.

• A bank that confirms a letter of credit is not obliged to verify amendments. This is just one more reason to check your letter of credit quickly.

Follow the Rules of the Letter to the Letter

Letters of credit are extremely specific and if the customer does not meet all the requests the issuing bank will not pay. Here are the rules that you need to be aware of:

• When you hear the term, full set of documents that means three originals and three copies, unless the shipping line issues it. A deck bill of lading is not typically acceptable if a clean bill of lading is required.

• Present your papers in exactly the same manner required by your letter of credit. Never make any assumptions or take short cuts. A letter of credit is not a contract between you and the bank, but rather a financial obligation based on your capability to present perfect documentation.

• Never ship before receiving the letter of credit. As soon as the goods are gone you’ve lost all negotiating power to get your documents in order. If the letter of credit never shows up the fact of the matter is that there is little you can do, and you run the risk of having to translate the sale to an open account with unlimited terms.

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