Letter of Credit

What is Letter of Credit?

A letter of credit is a formal document, guaranteeing payment by a bank (issuing institution) to a third party for a specific amount of money, if certain conditions are met.

Often this is a new area for business people, particularly with the expansion of Australian manufacturing and purchasing into China and India.

Why would I use a Letter of Credit?

Letters of credit are very useful for cash flow purposes. Often, suppliers ask for deposits upfront prior to the goods being manufactured. A letter of credit will often replace the need for placing a deposit with your supplier. Further, if letters of credit are allowed to be negotiated then some suppliers will grant credit terms such as 90 days from bill of lading, which is very useful for cash flow purposes.

Letters of credit is one of the most common methods of payment in international trade and are very useful when dealing with new suppliers. Although not a 100% guarantee that you will get exactly what you ordered, if structured correctly, letters of credit will ensure that suppliers have to meet all the terms of the document and you are more likely to get the quality and quantity of the goods your ordered in a timely manner.

Additionally, suppliers tend to like letters of credit as they can often transfer letters of credit to pay for their raw materials or indeed in some countries they can use these letters of credit as collateral to obtain business to business finance from their bank.

However, letter of credit facilities can be expensive and, because it is a specialist area, it is difficult to evaluate costs. Letters of Credit can seem bureaucratic and tedious but accuracy in print and translation are essential. A minor mistake could be costly.

Foreign Exchange

Most importers are purchasing or selling in foreign currencies. Historically, fluctuations in exchange rates can be the difference between a good year or an average one.

There are several cost-effective options where you can either use the lender's own facilities to hedge against exchange risks or Business Money can provide you with alternatives for spot or forwarding purchasing. The two most common methods are as follows:

• Forward Contracts

Achieves certainty of future exchange rates. Forward Contracts will allow you to commit to a rate now for your future currency purchase requirements. Can be for specific dates or for a certain period. The client must complete the contract even if exchange rates move in an unfavourable direction.

• Option Contracts

A contract that gives the buyer the right, but not the obligation, to buy or sell future currency at a specific price within a specified period of time. The seller of the option has the obligation to sell the foreign currency to or buy it from the option buyer at the exercise price if the option is exercised. The client pays a premium for the option which is paid whether or not the option is exercised.

I'm interested, what do I do?

Call Business Money on 1300 663 846 or send us an e-mail. We can assist in the preparation of Letters of Credit to your lenders or negotiation in the terms with your suppliers or customers.

Our lenders can open sight or term Letters of Credit in favour of your suppliers anywhere in the world. Lenders will then grant you credit up to 180 days from the date of payment to repay the amount paid. This allows you breathing space to clear, sell and be paid for the goods before actually paying for the goods.