For any business with global reach, collecting payment from overseas customers can be a real headache. Laura Delany offers sound advice on the Small Business Trends Blog on how to get paid on international transactions. While the article also deals with advance payment and payment online, I’ll focus on the letters of credit portion here because that’s what my clients typically use.
Collecting money from your overseas customers with letters of credit can be a breeze if you follow the guidelines below. Using letters of credit with the help of a solid international banker will allow you to confidently secure payments from customers all over the world. Then sit back and watch your global business empire grow.
Letters of Credit — Security with Flexibility
After payment in advance or payment online, securing payment with a letter of credit is the next best option to collect money from overseas customers. We will take a detailed look at how letters of credit work, who participates in the transaction, and what variations and modifications are available to help the parties negotiate mutually acceptable terms.
THE FOUR KEY PLAYERS IN THE LETTER OF CREDIT PROCESS
There are four participants in a letter of credit transaction — two businesspeople and two banks:
The buyer. That’s your customer.
The opening bank. This bank normally issues the letter of credit, so it is sometimes referred to as the “issuing bank.” They assume responsibility for the payment on behalf of the buyer.
The paying bank. This is the bank under which the drafts or bills of exchange are drawn under the credit. A paying bank in an L/C transaction might also act as the negotiating bank, advising bank or confirming bank, depending upon what responsibilities it accepts.
The seller. That’s you.
To summarize the process: Once you and your customer agree on payment by letter of credit, it is the customer’s responsibility to take your proforma (an invoice that reflects all estimated costs involved to move product door to door) to her bank and open the L/C (letter of credit) in your favor. Once the opening bank has all the appropriate information from the customer, it advises you, the seller, that the L/C has been opened. Oftentimes this will be done by cable or e-mail to the paying bank. Your bank then forwards that information to you. The letter of credit is final and subject to correction only for errors in transmission.
It is not unusual to find differences between the L/C and the proforma invoice, such as incorrect product descriptions or reference numbers. So always consult with your banker before attempting any informal deals like this.
Accuracy in all details of your letter of credit is critical. There are a number of different kinds of L/C, but here are two are important types:
IRREVOCABLE LETTER OF CREDIT
An irrevocable letter of credit is a commercial document issued by a bank at your customer’s request in your favor. Once issued, it cannot be modified without both parties’ consent. Here “irrevocable” means that the bank must pay you even if your customer defaults, provided the documents presented are “clean,” meaning that they are in complete compliance with the language of the L/C. It’s the most secure method of payment. You can also request that the L/C be confirmed by a U.S. bank. This arrangement provides the greatest degree of protection because the U.S. bank must pay you even if your customer’s bank defaults. If the L/C is unconfirmed, the U.S. bank must wait until it receives funds from the foreign bank before it will credit your account.
REVOCABLE LETTER OF CREDIT
A revocable letter of credit is a commercial document issued by a bank at your customer’s request in your favor, which can be modified without both parties’ consent at any point. Once this L/C has been issued, you have the following assurances as the beneficiary: the bank can assure you that, yes, your customer has arranged for them to pay you such and such an amount; and, yes, your customer is known, respected and has been banking with them for decades. Unfortunately, you cannot rely on this L/C since the bank is under no obligation to cover the L/C if your customer defaults. You may as well just run a credit check on a customer and ship open account.
A letter of credit may be modified or restricted in a variety of ways. If you get stuck on negotiating payment terms with your customer, check with your banker to see if you can find a mutually agreeable option. Be creative and cooperative in investigating payment arrangements that will accommodate your customer, but always make sure YOU end up with secure and timely payment.
If you have a few extra minutes, I suggest you read “Methods of Payment: Terms, Conditions and Alternative Financing Sources For Export Sales.” More than 53,000 small business owners have already found it useful. You might, too.
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