What is it?
For businesses that export or import, letters of credit are the financial security of international trade. As an exporter, you want an assurance that you will get paid when you ship goods to an overseas buyer.
To facilitate the payment for an export shipment, the buyer goes to his bank and establishes a letter of credit or commonly called L/C. Your bank confirms with the buyer's bank that the L/C is valid.
You can then ship your goods with the knowledge that you will get paid. When all of the terms of your deal have met, your bank collects on the L/C and passes the money on to your business.
A letter of credit discount occurs when your bank offers to advance you the L/C payment before you have completed the steps needed to present the sales and shipping documents. It is called a discount because you do not receive the full payment amount. The discounting of L/C allows you, the exporters, to get your money quicker and therefore, improving your cash flow.
Benefits
- Enables you to receive payment more promptly – you won’t have to wait for your buyer to pay you at a future date
- Helps you to improve your cash flow
- Gives you the ability to offer your trading partner longer payment terms, which can put you in a stronger negotiating position and improve your relationship
- Allows you to pay your suppliers early and can help place you in a position to negotiate better pricing