INTRODUCTION
L/C is the most used payment term in International Trade and I'll be fairly specific on this topic. L/C is a perfect procedure to equally protect your interests and your buyer's interests. Using L/C as a term of payment, you risk almost nothing and at the same time it
ensures the buyer that goods are shipped before the payment has occurred. However, you only will be paid if all terms stipulated in the L/C are met and all documents specified in the L/C strictly comply with agreed conditions and are presented in time.
Before choosing L/C as a term of trade, you must understand what it is, how it works and what you can do to minimise risks involved in the L/C payment process.
OBJECTIVES OF STUDY
The objective behind our study is to learn about the LC’s As a business tool of exports and also to learn different types of Letter of Credit. After this study, we can understand this export tool and Its Importance
EXPLANATION:
Letters of Credit are regulated by International Chamber of Commerce under the Uniform Customs and Practice for Documentary Credits (UCP 500). L/C is a conditional bank guarantee of payment for supplied goods. "Conditional" means that to get paid you have to present the bank-guarantor with documents, which strictly comply with the terms and conditions specified in the L/C.
There are different forms and types of L/C, which you may (or should not) use in your operations, viz
Revocable and Irrevocable L/C
"A revocable L/C may be amended or cancelled by the Issuing Bank at any moment and without prior notice to the Beneficiary. This is as simple, as that. Agree that the L/C is irrevocable before you go any further in your L/C negotiations.
Confirmed L/C
When you export to a country with economical or political instability or if you are unfamiliar with the Issuing Bank, you should require that the L/C be confirmed by a first-class bank. If L/C is confirmed, the confirming bank is liable for the payment.
Transferable L/C
Transferable L/C is a perfect financial tool for middlemen to secure their margin without involving any funds. It allows dealing with more than one beneficiary. When a transferable L/C is issued in your favour, you can transfer it to your seller and use it as a payment.
L/C "can be transferred only if it is expressly designated as "transferable" . Transferable L/C must correspond with the original L/C, "with the exception of:
- the amount of the L/C,
- any unit price,
- the expiry date,
- the last date for presentation of documents,
- the period for shipment.
L/C payable at sight
"Payable at sight" means that you'll be paid "immediately" (in fact, it may take up to 7 days) after presentation of the documents stipulated in the L/C to the Issuing Bank or to the Confirming Bank if it was confirmed.
L/C payable on the maturity date
If deferred payment was agreed, you'll be paid on the maturity date indicated in the L/C after presentation of the documents stipulated in the L/C to the Issuing Bank. One should not forget to specify the date from which the deferring period starts (e.g. 90 days after date of transport document).
HOW LC WORKS?
There are at least four participants, when dealing with L/C:
- The buyer – the Applicant
- You - the Beneficiary
- Bank, the payment will come from – the Issuing Bank
- Bank, the payment will go to – the Advising Bank.
The diagram below shows how participants are involved in the process of payment under L/C:
1. The Applicant and the Beneficiary negotiate terms and conditions of the L/C
2. The Applicant applies to the Issuing Bank to issue the L/C
3. The Issuing Bank issues the L/C and forwards it to the Advising Bank
4. The Advising Bank checks the apparent authenticity of the L/C and advises the L/C to the Beneficiary
5. The Beneficiary checks if the L/C complies with the commercial agreements and if all terms and conditions specified in the L/C can be satisfied and ships the goods
6. The Beneficiary assembles the documents specified in the L/C, checks the documents for discrepancies with the L/C, draws the draft and presents the draft and the documents to the Advising Bank
7. The Advising Bank bears the draft and the documents against terms and conditions of the L/C and forwards them to the Issuing Bank
8. The Issuing Bank checks if the documents comply with the L/C and makes a payment immediately (if the L/C is available by sight) or on a certain date (if L/C is available by deferred payment)
Another party, which may be involved in the L/C procedure, is the Nominated Bank.
There are additional charges for the confirmation of the L/C, which depend on the risk involved in dealing with the particular country. The responsibility to pay for the confirmation is negotiable and usually is paid by the buyer. However, if it wasn't agreed prior to the issuance of the L/C, you are the one who will pay for this service.
When L/C is to be confirmed the payment process is different and is shown in the following diagram:
1. The Applicant and the Beneficiary negotiate terms and conditions of the L/C
2. The Applicant applies to the Issuing Bank to issue the L/C
3. The Issuing Bank issues the L/C and forwards it to the Advising Bank
4. The Confirming Bank confirms the L/C to the Advising Bank
5. The Advising Bank checks the apparent authenticity of the L/C and advises the L/C to the Beneficiary
6. The Beneficiary checks if the L/C complies with the commercial agreements and if all terms and conditions specified in the L/C can be satisfied and ships the goods
7. The Beneficiary assembles the documents specified the Issuing Bank in the L/C checks the documents for discrepancies with the L/C and presents them to the Advising Bank
8. The Advising Bank bears the documents against terms and conditions of the L/C and forwards them to the Confirming Bank
9. The Confirming Bank checks if the documents comply with the L/C and makes payment immediately (if the L/C is available by sight) or on a certain date (if L/C is available by deferred payment)
10. The Issuing Bank reimburses the funds to the Confirming Bank immediately after the payment
There is another advantage in using confirmed L/C. Assume that after long negotiations your potential buyer is ready to strike a deal, which is very profitable for you. The only condition you are not comfortable with is the deferred payment of 90 days after the shipping date. You feel that you may have some problems with cash flow, because you have to pay for the freight, packaging and so on. Well, with the confirmed L/C you won't.
A confirmed L/C may be used not only for securing the payment under the L/C but also as a security to obtain additional funds from the Advising Bank. Generally, the Advising Bank can discount the L/C in your favour as soon as the documents stipulated in the L/C are presented to the bank and checked. The funds will be considered as a loan, which will be automatically reimbursed by the Confirming Bank on the maturity date indicated in the L/C.
LC MUST CONTAINS FOLLOWING:
Although the buyer applies for L/C, it is essential for you to be absolutely sure that the L/C was prepared correctly and there is no legitimate ground for refusal of payment under the L/C.
L/C must enclose:
- Full Applicant's name and address
- Full Beneficiary's name and address
- Issuing Bank details
- Advising Bank details
- Form and type of credit (e.g. irrevocable, transferable)
- Issue date
- Expiry date
- The latest date of shipment (usually "no later than")
- Expiry date for presentation of documents
- Amount payable under L/C
- Currency of payment
- Port of loading
- Port of discharge
- Terms of delivery
- Indication of the payment of the freight (Freight Prepaid/Freight Collect)
- Allowances for partial shipment or transshipment if needed
- Type of payment availability (e.g. at sight, on the maturity date)
- Description of goods (must correspond with the description given in the invoice)
- List of documents required for the payment
- Accountability for bank charges
CONCLUSION:
Letters of credit are still an important tool used in international trade. They provide security for both buyer and seller where conditions may be uncertain or there is little or no previous trading relationship between the parties. However, letters of credit only provide this security when they are used in a prudent manner – it is essential that exporters remember that documents must be in strict compliance with the credit to secure payment. Treating letters of credit in a casual manner will remove the very level of security the exporter is seeking when selecting them as a method of payment. To ensure that letters of credit are dealt with in a competent and professional manner it is important for companies to have an action plan or checklist when dealing with letter of credit trade. Those companies who are dealing with letters of credit on an infrequent basis (and in some instances perhaps others who deal more often with letters of credit) may feel that it is not appropriate to have the expertise to deal with letters of credit in-house. In this case use may be made of outside expertise and experience for example their freight forwarder. This should be seen as a positive step taken to help ensure that the letter of credit process runs smoothly. However, using outside expertise does not preclude taking steps during contract negotiations to ensure that the credit is set up appropriately.
GLOSSARY OF COMMONLY USED TERMS
The Advising Bank
The bank, usually but not necessarily in the beneficiary's country, through which advice of the letter of credit is sent by the issuing bank.
The Issuing Bank
The bank which issues the letter of credit on the instructions of the importer (usually, but not necessarily, the importer's own bank)..
The Nominated Bank
The Nominated Bank is the bank, which is authorized by the Issuing Bank "to pay, to incur a deferred payment undertaking, to accept Draft(s) or to negotiate. The Issuing Bank may authorize the Nominated Bank to negotiate the drafts and/or documents. Negotiation means that the nominated Bank – in this case the Negotiating Bank - gives value to such drafts.
Confirmation of L/C
The confirmation of the L/C by another bank - the Confirming Bank - means that if the Issuing Bank refuses to make the payment, the Confirming Bank is responsible for this payment.
The best-case scenario is when the Advising Bank confirms the L/C. If the Advising Bank does not agree to confirm the L/C, ask the bank to recommend you another bank to be the Confirming Bank.
WEBLIOGY:
http://en.wikipedia.org/wiki/Letter_of_credit
http://www.unzco.com/basicguide/c13.html
http://www.scribd.com/doc/90191/Methods-of-Payment-Terms-Conditions-and-Alternative-Financing-Sources-For-Export-Sales
http://www.answers.com/topic/letter-of-credit
http://www.sail.co.in/lc.pdf