Letters of credit or documentary letters of credit mean financial security for international trades and are used very commonly by exporters and importers. They are a guarantee to the importer that the goods have been shipped and a guarantee to the exporter that payment for his or her goods will be made. Letter of credit discounting is done once the goods have been shipped and the exporter wants the money before the importer makes the payment. This is mostly done because the importer processes the payment within a specified period as mentioned in the agreement and the exporter might need the money immediately to continue the business. Let us understand the letter of credit discounting in more detail.
The buyer's bank guarantees the payment
Before shipping the goods overseas, you want assurance as an exporter that you will get paid. To give this assurance to the exporter, the buyer goes to his or her bank and establishes a letter of credit. This letter of credit is then submitted to the exporter’s bank to validate its credibility. Once the bank confirms it, the exporter can ship his products with the assurance that the payment will be made. When all terms of the agreement are met, the exporter’s bank collects the letter of credit and transfers the amount to the exporter’s account.
Documents have to be presented for the payment
Before getting paid for the order, the exporter has to submit the documents to the exporter’s bank that will verify that the order has been filled and shipped to the importer. These documents are then sent to the importer’s bank that issued the letter of credit and after verifying the documents with the importer, the bank transfers the money to the exporter’s bank that is then paid out to the exporter’s business. An exporter can only claim the letter of credit payment once the export and shipping documents are verified and sent to the seller.
Discounting the letter of credit
Letter of credit discounting or cheap letter of credit means an exporter can ask for the letter of credit payment in advance from the exporter’s bank before the shipping document verification process is complete. The term discount is used because the exporter does not receive the full payment of the exported goods. A certain percentage of the total amount is deducted by the bank as a processing fee for paying the amount before meeting the agreed terms as mentioned in the sales agreement.
LC discounting speeds up cash flow
There are various ways in which letter of credit discounting can benefit the export business. For instance, it will take some time to prepare the goods and ship them after receiving an order. During this period, funds will be required to continue the production and ensure that the order gets delivered within the agreed period. By letter of credit discounting, the exporter can get the funds available immediately and use them to continue production. Letter of credit discounting is also done when the importer requires more time to pay.
