Many people search the Internet to find out what the term "Letters of Credit" refers to, and if these types of letters are the sort needed to fix a bad credit score.
Commonly referred to as "LC's" or "LOC" in a sort of shorthand description, letters of credit are in fact the name of secure instruments available to international traders to pay for goods.
All too often, however, the term "letters of credit" related to import/export financial products, mistakenly gets mixed up with the term "credit repair letters" -- but these two terms are quite distinct, and not related to one another at all.
An LOC is a bank's commitment -- on behalf of the buyer -- to process payment(s) to the seller once all the terms and conditions of a transaction has been met and verified through the presentation of all required documents.
They are the tools of the trade when it comes to operating an import and/or export business. Understanding how letters of credit are used is essential if you want to become successful in the import/export field.
According to Export.gov, three common types of letters of credit are known as:
Irrevocable Letter of Credit
The LOC can be issued as revocable or irrevocable. Most LC's deemed irrevocable. This means they may not be changed or cancelled unless both the buyer and seller agree to do so.
Confirmed Letter of Credit
Offers a much greater degree of protection to exporter when a LC issued by a foreign bank (the importer's issuing bank) is confirmed by a U.S. bank (the exporter's advising bank). U.S. bank adds its guarantee to pay the exporter.
Special Letters of Credit
When LC is issued as transferable, payment obligation under original LC can be transferred to "second beneficiaries." With revolving LC, issuing bank restores the credit to its original amount once drawn down. Standby LCs used in lieu of security or cash deposits.
So the question remains: "Just how are Letters of Credit used in international business today?"
There are essentially seven steps that Letters of Credit flow through between importers and exporters:
1. The importer arranges for the issuing bank to open an LC in favor of the exporter.
2. The issuing bank transmits the LC to the advising bank, which forwards it to the exporter.
3. The exporter forwards the goods and documents to a freight forwarder.
4. The freight forwarder dispatches the goods and submits documents to the advising bank.
5. The advising bank checks documents for compliance with the LC and pays the exporter.
6. The importer's account at the issuing bank is debited.
7. The issuing bank releases documents to the importer to claim the goods from the carrier.
Pros and cons of relying on letters of credit abound. The pros include: Safety of receiving payment after shipment. A variety of payment, financing and risk reduction options become available to the seller. The cons include these factors to beware of: The entire process can become quite complex, as well as very labor intensive. Often an expensive factor in terms of the total transaction costs in international trade. Best used only on quite large transactions.
Knowing what the term "letters of credit" refers to -- knowing that it has no relation to "credit repair letters" -- is an important step in learning that "LC's" or "LOC" are in actuality among the most secure instruments available to international buyers and sellers. Knowing what letters of credit are, and reviewing sample letters of credit to ensure that your own financial correspondence will help protect your firm get paid, are two of the most important steps you can make to stay profitable in the emerging international trade arena.
Steve Johnson is the writer and publisher who founded FindHow2.com, offering free sample credit repair letters, dispute letters, and letters of credit for business use. One of the most popular topics now on importing and exporting is the free informative review of letters of credit and how they are used in essential import/export financial transactions.