Credit makes the world go around and if you are thinking about doing business with a foreign company or want to attract large-scale domestic clients then you may require a letter of credit. There are many different terms whether you are using standby letters of credit or letters of credit it is essentially the same thing. A letter of credit is a document where a 3rd party, typically a bank or some type of financial institution agrees to make whole the beneficiary on the letter of credit should the company that had the letter drafted fails to meet its obligation.
Reasons Letters of Credit are Used
When doing business internationally you could have a client from overseas place a substantial order but they will only pay for the goods when it is delivered as promised. While you want the sales you also know that collecting payment from an overseas customer could be problematic if they decide not to pay. By asking the buyer for a letter of credit the prospective buyer has to go to their local financial institution who promises to pay you should the buyer renege on their commitment provided you fulfill your end of the deal. Since the bank is assuming the risk they will make sure the prospective buyer has the means to facilitate the transaction and will charge your customer a fee for the benefit of having this letter of credit.
You will need to check with your financial institution to determine whether the letter of credit being offered by your prospective customer is acceptable before any additional agreements can be made. These letters of credit allow international businesses to flow smoothly so it is something that has a tangible impact on the quality of our life so it is something that everyone should familiarize themselves with.