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Letters of Credit – Which One Should I Use?

Letters of credit are a hugely important part of international trade and import export.  They guarantee payment and allow the seller to receive payment which can be advantageous when capital is needed up front.  Our quick guide below shows you the four most common types of letter of credit and when to use them.

letters of credit

The Four Most Common Type of Letters of Credit:

IRREVOCABLE:  Cannot be changed or amended without the consent of both the  buyer and seller.

RED CLAUSED:   Useful when the seller needs an up front funds from the letter of credit, this could be to buy the raw material for the contract. The amount available was usually printed in red ink hence the name.

TRANSFERABLE:  Used by the seller  to purchase the goods of the contract from a third party. It enables the seller  the purchase  the goods   with  the funds from the Letter of Credit. Very useful when the seller is acting as a middle man and has not the personal funds to purchase the goods of the contract

CONFIRMED:  Used when the seller is unsure of the buyers banks ability to honour the Letter of credit. This could be due to Political or financial unrest in the buyers country. The letter of credit is Confirmed by a second bank usually the sellers bank, The confirming bank becomes the prime payer and seeks reimbursement from the buyers bank.

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.

Transferable Letters of Credit

Are transferable letters of credit a way to make money without money?

From time to  time I am invited by publishers to review recently published books on the subject of International Trade. I enjoy the experience as most times I learn something new.

One particular book which caught my attention was titled “How to make money without having any money”.  I thought this is  a winner and got stuck in. To my surprise, the book addressed the usual areas of International Trade but I could not find the section on how to make money without having any money.

When I arrived at chapter six, the chapter heading read  how to make money without having any money and the author simply said if you want to trade and don’t have funds available use a “Transferable Letter of Credit” and described for a whole paragraph telling his reader that they just ask the buyer for a Transferable Credit and use the credit to buy the goods from a third party to fulfill their contract with the buyer. That was it! Nothing more.

I was very disappointed as I thought after reading this book I could retire immediately and become a very rich man!

A transferable Letter of Credit can enable the seller to buy products of the sales contract from a third person without using their own funds. It is often used by middlemen.

I have often successfully traded under Transferable Letters of Credit to purchase high value goods without dipping into my own working funds but I must warn you they are not as simple to obtain and utilise as this author would like his reader to believe.

Lets first look at the definition of a Transferable Letter of Credit in my own words.

A Transferable Letter of Credit allows you to use the funds of the credit to open a fresh Letter of Credit on a third party. In other words, a Transferable Letter of Credit can be transferred to as many parties as you wish as long as the total you transfer does not exceed the amount of the original.

Let me give you a real world example of how we used a Transferable Letter of Credit to great success.

Some time ago, as a procurement house we received a request for a quote to supply and erect a leisure centre in Bengazi, Libya. We submitted our quotation and requested a Transferable Letter of Credit as we did not have the funds to support such a large Project.  As it was in Libya we also asked for the credit to be confirmed. The value of the contract was £1.5 million.

Over a period of approximately four months we purchased a pre-fabricated building, all the accessories required and shipped everything to Benghazi. This was followed up by sending out steel erectors  to erect the building and personnel to furnish it.

The project was a great success for all concerned but it was the busiest four months of my working life. Why? Because I had to visit about twenty suppliers and convince them to sell me their products on a Letter of Credit and ship them to Libya BEFORE they got paid. Not an easy task.  I had to transfer the original Letter of Credit into individual ones,  payable to each supplier.  This took much negotiation as you can imagine.

Here are some of the pitfalls associated with Transferable credits:

  • The buyer may not want to give you a transferable credit as they can be very expensive to establish.
  • 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 with a transferable credit.
  • Some 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.
  • You may have to do a lot of “hand holding” with your supplier, have to instil confidence in them as to your ability to successfully negotiate the original credit and their spin off credit.
  • You must be confident in your own ability to utilise a Transferable credit this comes about from hands on experience and training.

Our online International trade  course is a no nonsense training course which includes  in   details of how to trade under a Transferable credit.  For more information please contact us.

See below for a handy guide that we have developed on Letters of Credit:

Letters of Credit