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How To Use A Letter Of Credit

Knowing how to use a letter of credit is an important part of international trade as it’s a very versatile instrument and when used correctly, a very import method of payment to have in your arsenal.

Simply put, under a letter of credit a bank guarantees payment which can allow the seller to receive funds before the goods are delivered, which can be advantageous if capital is needed up front.  This may sounds little confusing to start but we will break this down.

The Four Types of Letters Of Credit

Firstly, lets start with the four most common types of letter of credit and when to use them.

IRREVOCABLE:  An irrevocable letter of credit, once it’s born, cannot be changed or amended without the consent of both the buyer and the seller.

RED CLAUSED:   This clause is very useful when the seller needs to raise funds from the letter of credit, for example to buy raw material for a building contract. The amount available is usually printed on the letter of credit in red ink, hence the name “red claused”.

TRANSFERABLE:  This can used by the seller  to purchase goods needed to fulfill the contract from a third party. For example, steel, concrete and brinks to complete a building contract. This is extremely useful when the seller may not have available funds to purchase the goods to complete the contract, so could use this method to raise those funds by guaranteeing payment to the third party supplier.

CONFIRMED:  This is used when the seller is unsure of the buyers’ bank’s ability to honour the letter of credit perhaps due to political or financial unrest in the buyers country. The letter of credit is confirmed by a second bank which usually the sellers bank. The confirming bank becomes the prime payer and seeks reimbursement from the buyers bank.  This is a little complicated but will be made clear as we dive into the detail.

Types of Letters of Credit

Are Letters Of Credit A Method To Make Money Without Money?

A transferable letter of credit enables the seller to buy products to fulfill the sales contract from a third party without using their own funds, instead using the funds from the contract itself. Think of it as an advance on the payment that will be received on completion of the contract.  Once this “mother” letter of credit has been born, it can be split up and transferred to as many parties as needed as long as the total does not exceed the amount of the original “mother” credit.

Transferable letters of credit are often successfully used to purchase high value goods without having to dip into company funds where cash flow may be tight and the company may not be sitting on bundles of cash.  Be warned however, they are not as simple to obtain and use as some would like you to believe.  It certainly should not be a way to make money, without money.

Why Aren’t Letters Of Credit Always Used?

Letters of credit as you can see are a versatile method of payment and an excellent way for the seller to deliver a contract even if they don’t have the needed funds to hand.  However, as with anything in life, there’s advantages and disadvantages.  Here’s some of the pitfalls that you would be wise to be aware of:

  • The buyer may not want to give you a transferable letter of credit as they can be very expensive to establish. As we all know, banks seldom do anything for free and establishing a letter of credit is no different.  The bank will charge the buyer a fee for this service, something that the buyer may not be willing to pay.  This could be where your negotiating techniques will come in very handy in convincing your buyer that this is the best course of action.
  • If you are not familiar with letters of credit and do not have a good track record of trading under a letter of credit, you can make costly mistakes. Make sure you know what you’re doing.  There could be a lot of money at stake and you you certainly don’t want to chance it.
  • Some third party suppliers take a lot of persuading to release their goods against a transferable letter of credit, especially when they have no previous experience of trading under such a credit. It could take some time and reassurance explaining why a transferable letter of credit is a guaranteed payment and trust between you will have to be established.
  • You may have to do a lot of “hand holding” with your third party supplier and allow them gain their confidence in you and your ability to successfully negotiate the original “mother” credit and ensure that their “child” credit is a guaranteed payment. One way to establish confidence is by explaining once the contract is delivered, it is the bank themselves that will pay out all the “child” credits to the debtor, so there is no need to chase any payments.
  • You must be confident in your own ability to utilise a transferable letter of credit which really only comes about from hands on experience and training.

See below for a handy print guide that we have developed on letters of credit:

Letters of Credit

A Real World Example

Not so long ago we were asked to work with a small London based building company who had been awarded a nicely sized contract to build a brand new, modern sports facility in the United Arab Emirates.

The high end sports facility would include a swimming pool, saunas in the changing rooms, two basketball courts, a full size gym with aerobic equipment as well as a lounge area complete with table tennis and pool tables and health bar.  As you can imagine, this type of facility doesn’t come cheap and the contract value was negotiated and agreed at just over £1.6 million (GBP). This included the raw materials, exporting of the required materials that could not be sourced within the UAE and the construction of the facility.

How To Raise £1.6m

As you can probably imagine, most businesses don’t have £1.6m sitting in their company bank account so raising the funds to complete the project was something that needed to be handled.  This company took the traditional avenue and approached their bank for finance but for one reason or another weren’t granted the entire amount.  They subsequently approached other finance companies who offered them funds but the terms of repayment weren’t suitable.  At this point, the project looked to be in jeopardy and the contract had to be reconsidered.

On contacting ABTS Training, we suggested that they ask their client in the UAE for a transferable letter of credit from their bank.  What this meant was that the client approach their bank and ask them to issue a transferable letter of credit for the value of £1.6 million, which is passed to the UK building company.  This assures that funds are available and that the payment will be made if the correct documents are presented by the UK company, such as invoices, bills of lading, packing list and others.  The bank is guaranteeing the money and becomes responsible for the payment.  Negotiation skills need to be on point with this as, as mentioned before, there is a cost to the client in the UAE to issue this transferable letter of credit.

Breaking Down The Transferable Letter Of Credit

As this is a real-word example, lets break down what was actually included in this letter of credit and the inner workings of it.

CONFIRMED
This particular letter of credit was issued from the clients bank in the UAE via a bank located in the UK, so it was this UK bank that was ultimately responsible for paying out the £1.6m.  This UK bank was unknown to the building company in the sense, they had no relationship with the bank, so in order to minimise their risk, they asked their bank, Natwest to “confirm” the letter of credit.

What this means is, Natwest confirms the letter of credit exists (taking away the risk of any fraud, which unfortunately does happen) and that they (Natwest) will honour it on the presentation of all the relevant and correct documents.

As you may have guessed, Natwest do not do this for free and charge our building company a fee for this service but it’s a fee that gives our building company peace of mind.

TRANSFERABLE
A transferable letter is a letter of credit that simply means the building company can “break up” the letter of credit and use it to pay who they need to pay, for example, steel suppliers.  As mentioned earlier, a transferable letter of credit can be broken up from one “mother” credit, into “child” credits and distributed as long as the combined value does not exceed the mother letter of credit.

RED CLAUSED

As mentioned above, a “red clause” allows a stated percentage of the value of the credit to be received by the building company, effectively in cash and be used for immediate expenses, such as paying staff during the building period.

In this case of the UK builder requested a 5% red clause and used this money for up front costs such as architects fees and plans, staff costs and engineer’s site visits.

Know What Your Doing

Almost half of letters of credit received in the UK are unworkable according to some research, the buyer requests documents which the seller is unable to produce, so be aware and be proactive, not reactive.

As you can see, letters of credit are a great way to fulfill projects when cash is tight but it’s really important to know what you’re doing as they can be complicated. If you get it wrong, you could be left holding the can and unfortunately there are many horror stories of contracts going desperately wrong due to people not understanding how to properly establish and use letters of credit.  Don’t be one of them!

Profit From Britain’s Greatest Export For Next To Nothing

Britain is a country of innovation and excellent quality products. There’s so many incredible exports the United Kingdom has to offer that the opportunities are literally endless.

“Can Do”

I’m a big believer in the “can do” mentality. Elon Musk, Jeff Bezos, Warren Buffet, Bill Gates and Walt Disney all started with an idea. They took that idea, believed in it and never stopped running with it. Here’s a reality check, the photo on the left was Jeff Bezos office in 1999.

He is now the world’s richest man and he achieved it in less than 20 years.

Britain’s Visiting Tourists Will Spend £26.3 billion In 2018

A friend recently asked me to help him think up a business importing exporting. As I got to thinking, I realised his biggest advantage is where he lives, Oxford. On doing just a small amount of research, the figures show that Britain’s tourism industry is huge and only getting stronger. Here’s a few facts from Visit Britain:

  • 2017 set a record for inbound tourism to the UK in terms of both visits and spend. There were 39.2 million visits to the UK in 2017, up 4.3% on 2016, with these visitors spending £24.5 billion, an 8.7% increase on 2016. The growth in visits was in line with the trend seen over the past five years. The growth in spending was the highest since 2013 and the second highest since 2006; spend per visit rose by 4.3%.
  • Our revised forecast for visits for the calendar year 2018 is for continued growth. We are forecasting 40.9 million visits in 2018, an increase of 4.4% on 2017. Our forecast for spending by visitors in 2018 is £26.3 billion, an increase of 7.1% on 2017.
  • London obviously receives the most visitors but Oxford is already 8th on the list

A very interesting article in The Guardian gave interesting statistics on the amount of Chinese tourists that are now travelling the globe and the UK.

The Back of Your Hand

£26.3 billion is more than enough to go around so why not take your slice? My friend has lived all his life in Oxford and knows it like the back of his hand. His whole network is there so rather than think too far afield I suggested he start at home. Why not create tours of Oxford with your own flare. Sure there’s people doing it already but there’s no market in the world that’s untouched and without competition. He knows Oxford better than anyone and can take visiting tourists not just to the usual sites but his favorite places.

He can try and negotiate deals with local businesses, many of which he already knows, offering his tour groups a discount if brings them.

Home On The Range

One of the points we teach in our free import export training tips is the have a range of products. Always easier to come away with a sale if you offer a range of products opposed to just one. Our Oxford tours idea is no different, which could offer several tours to cater to different audiences:

  • The Pub Crawl: Who doesn’t love a pub crawl. Take your guests on a tour of some of the best local pubs, try some of Britain’s best beers and ale’s!
  • Food Tasting: Tour Oxford’s tea rooms, fish and chip shops, bakery’s, the many places that my friend knows and loves. Ask if they will cater for a group offering smaller portions as a few hours of eating at different places means you can’t eat the usual full size plate.
  • Movie Sets: There’s many movies and series that have been filmed in part in Oxford, running a tour visiting these and giving some local insight is something tourists love to see.
A Captive Audience

Once the tour group is in front of you, there’s a captive audience. Personality will make a difference so interjecting this would make the tour more enjoyable, interact with the group and this builds levels of trust. Building on trust then look to sell products to the group. We all love a souvenir, so negotiating with local businesses that offer fine, perhaps hand made products and these can be offered to the group.

I suggested my friend also makes sure to get the groups contact email and any other details as many tourists will return to a holiday destination. They may want to take another of the tours or hear about newly created ones.

Get their feedback and make changes as that feedback suggests.

Export Britain

Perhaps another piece of the jigsaw is to then get an online ecommerce site and promote this to the same audience and export Britain around the world. See our blog post with practical advice on how to go about getting online and exporting globally, without having to have a huge budget.

Offering tours as well as fine British products online is a double income stream.

You Won’t Know Until You Do It

As you can see, setting up this business really won’t cost a fortune and all you’re doing is taking the knowledge you have and using it to build a business. Take what interests you have and stick to what you know, this is key. Focus on one thing to start with, then grow your business organically.

Once you start to get the audience, you can market to them. The UK has some fantastic products and places to see and millions of people from around the world come here to experience it every day.

Creating your own import export business isn’t rocket science, it just takes a thought and a little imagination.

Validated By The London Institute Of Shipping And Transport

Our online international trade course has been validated by The London Institute of Shipping and Transport since 2005, giving our students the confidence in the practical, hands-on way we teach you have to import and export. Our course is streamlined, excluding any logistics theory, getting to the point and showing you what you’ll need to know and understand in order to move your goods from source to destination. We do this with a series of entertaining animated videos, opposed to asking you to read pages and pages of text, or listen to a teach at a whiteboard for hours.

We’ve trained hundreds of students and helped further their careers as well as helped setup countless successful businesses, with many of our students now their own boss running their own successful companies.

With over 30 years of experience, we’re here to offer you one-to-one support and bring your career or business to the next level.

Validated

Best Trade Education Provider 2017

ABTS Training was also awarded BEST TRADE EDUCATION PROVIDER 2017 by Trade Finance Global, a great honour to receive the award which recognises the high level of course presentation and content we deliever.

The judges comment, “We were impressed with the simple, straightforward and clear way that ABTS presents their course. The course covers vital introductory elements such as Transport types, Payment mechanisms and Incoterms.”
Trade Finance: The new funder on the block for importers and exporters

The construction sector is experiencing the fastest rate of hiring for over 15 years, the pound is stronger than it was 2 years ago across 18 major currencies, and countries are beginning to partner on deals which encourage trade globally.

To accommodate this, business funding has become a hot-topic amongst the SME and corporate community, with the rise of alternative debt and equity funders (e.g. the crowdfunding platform Crowdcube and invoice discounting companies such as MarketInvoice).

Yet 70% of businesses are struggling with getting funding, particularly for purchasing goods and services from overseas, which is surprising given the current position of the UK economy.

Sadly, many companies don’t know where to begin when it comes to funding their business, but what doesn’t help, is that business funding is complicated. Depending on the stage of your business, how much capital you already have, how quickly you need the funding and how long you’ll need it for, the funding you require could vary immensely.

Trade finance, an umbrella term for the ‘financing of international trade’, covers a range of financial products which can help importers and exporters trade. International import and export businesses have the added complications of understanding the mechanisms of trade finance, which involves jurisdiction across different countries, language barriers, understanding shipping protocol and insuring their order.

The most common form of trade finance is a Letter of Credit or Bill of Lading, which are both mechanisms to securitise the assets which are being transported or shipped; in other words, the goods or services are the security to which a funder will lend.

For companies looking to import or export, we’ve put together some tips for ensuring success:

1. Do your due diligence

Most business owners in the space will be aware of their competitors in their market, and the competitors of their suppliers. It’s not hard to pull import or export data from government website or through calling local experts on the field. It’s also worth sense checking your suppliers and customers – are they creditworthy and reliable, do they have trusted reviews?

2. Learn about importing and exporting

Aside from a Letter of Credit Trade Finance deal, it’s vital to understand the mechanisms of transporting and shipping – from freight forwarding, to Bills of Lading. It may be a good idea to go on an education course such as ABTS Training.

3. Talk to a broker

Brokers can offer recommendations or suggestions for a business which could save them time and money. Also, because of their established relationships with many funders, they may be able to negotiate a better deal or rate and find the option which is most suitable for your business.

4. Know your risks

Business owners should know from the outset what the risks and challenges are before undertaking a trade finance deal. Mitigating or reducing these risks through insurance, credit checks, independent analysis and understanding the market that they’re operating versus opportunity and financial benefit of a deal can help determine the go-no-go decision.

5. Don’t underestimate the power of negotiation

Whether it’s your customers, suppliers or financiers, negotiation can often be the make or break for your business. Being able to negotiate terms, prices and rates in a competitive market could give your business a financial advantage.

To conclude, raising funding to help succeed in your import or export business is not easy, but can bring unrivaled success and opportunity for your company. Understanding the fundamentals of the import/export market, mitigating risks and planning carefully though are crucial to protect yourself and the company.

 

Courtesy of our partner Trade Finance Global.  Learn more about trade finance and how it can help your import export business.

Emeralds Could Be A Girls Best Friend

I always dreamed of being my own boss . I wanted to source goods overseas and sell them to wholesalers and retailers in the UK.  I saw many opportunities on my travels to bring unique goods into the UK and sell them, in particular precious stones.

I couldn’t afford to leave my full time employment and devote myself  to my own business as like us all, I had financial commitments.  I did not have any knowledge of International trade so my first move was to get proper training.

I contacted many training companies who offered international trade courses but in the end I decided to go with ABTS Training services because they offered an Online course suited for beginners, so I was able to study in my own time.

I spoke to Alan Bracken of ABTS about my ambitions and current situation.

His advice was invaluable and gave me confidence to pursue my dream.  I remained in full time employment and enrolled in the Online  International Trade course. I studied at my own pace and in my own time.

Once I was confident that I understood what was involved in International Trade and after many phone calls to Alan, I took the plunge and set up a limited company.

As my funds were limited  I relied heavily on the knowledge I gained from the ABTS International Trade course and decided not to import direct from suppliers but to test the market and trade as a commission agent.

After analysing several offers for an agency, I decided to accept an agency for uncut emeralds from a company  and to represent them in the UK as their commission agent.

I made contact with many precious stone wholesalers in the UK. As the ABTS International Trade course advised me, I used the comments I received from wholesalers to refine my presentation and I am now very confident when I meet perspective customers.

I am now working with several wholesalers in the UK and high value orders are in the pipeline. It’s hard work as I am still working full time but it is well worth the effort.  I am looking forward to the day I can become my own boss full time, which is now, not too far away.

The online course gave me the knowledge and confidence I need to take the plunge and start up my own business. Thank you Alan and ABTS Training Services.

Miss. Lina Cardona