Letter of Credit: Pros and Cons for Global Importers

US imports from China reached $34.33bn in 2023, while UK imports from China reached $110bn by the end of 2022. International imports are at an all-time high. A key part of these international imports is secure methods of payment. If an importer business cannot make secure payments in advance, they risk not receiving goods from exporters or sellers. With secure payment methods, you can make shipment schedules easier. You can even align sales with the timely receipt of goods.

If you need to guarantee that you will receive your shipment or import at the right time, a letter of credit (LOC) is one payment option that can help. However, there are multiple types of LOC, each with its advantages, disadvantages, and alternatives. Thinking about each option is important, helping you pay for and receive imports effortlessly. So what is a letter of credit? In today’s article, we will look at the main LOC options and the advantages and disadvantages your business can receive.

If you are wondering, “What is letter of credit?” they are secure import payment methods your business can use. They ensure your importer business will make timely payments to exporters or sellers and that the exporter will ship goods per the LOC’s terms. This payment works to protect your import business and the exporter. It means you are guaranteed to receive the goods you intend to sell on, and the exporter or seller will receive payment.

We can look at a letter of credit example to understand how they work. Each party shares a transactional need if an exporter based in China wants to do business with an importer overseas. The seller or exporter based in China can ask the other party to provide an LOC. In that case, the applicant or buyer must find a lender to establish an LOC.

If you are wondering how to get a letter of credit, you must apply with a lender. You will submit a purchase contract and purchase order during the application for this finance option. If you are approved, the international trade department of your bank will agree to support your payment in the worst-case circumstances, such as when you experience cashflow difficulties.

A letter of credit is a document and contractual agreement. It is a document your bank issues on your business's behalf to simplify international trade. As a buyer, you can use the letter of credit as a trade finance option. The document is also called a “documentary credit” or financial instrument. A few LOC options are available, which we have listed below.

With a standby LOC (SLOC), you put forward a guarantee that a bank will support your payment if you default or cannot complete the purchase. This payment option works to protect the exporter or seller. For example, if your business becomes bankrupt, the exporter will still receive funds for the shipped goods. The conditions in this agreement should be precisely followed. Even the slightest shipping delay might mean that your exporter will face delays in receiving payment.

Using an irrevocable LOC (ILOC), you or your bank makes a guaranteed payment, as established in the ILOC when purchasing goods from exporters; this document, issued by your bank, cannot be canceled during a specific timeframe. The only circumstance this document can be canceled or altered is when all parties agree. This precaution ensures that all parties eliminate international trade risks, such as non-payment or receiving goods that do not meet the conditions. The ILOC can expire after a specific duration, and the expiry date will be shown in the document.

Importers do not frequently use revocable LOCs because their terms are not fixed. If your business uses a revocable LOC (RLOC), your bank can change or cancel the agreement or payment terms. These changes can happen between shipping and the delivery of relevant documents from the exporter (documents may include commercial invoices, insurance certificates, or bills of lading). Your bank will not need the approval of trading parties to change this agreement.

With a transferrable LOC, your business as an importer can transfer the right of payment to an exporter and, potentially, a secondary beneficiary. With this agreement and document, the importer can pay the exporter and any middle person involved in the international trade. One example is the need to pay logistics costs. The importer can pay the logistics provider directly with the issued transferrable LOC.

Although a LOC is a secure payment method, it can be costly. If you are wondering, “How much does letter of credit cost?” they can equate to approximately 0.75% of the purchase cost. In some cases, extra letter of credit fees worth between 2% and 8% of the total purchase cost are added. Therefore, you may be searching for an alternative, less costly payment arrangement.

At Axton Global, we offer an excellent alternative method. We make accessing credit limits from exporters or sellers in China easy. We allow you to use credit limits with any of the suppliers you work with. Our services include credit limit increases, transfers to different suppliers, and consulting services for SINOSURE credit insurance. With these services, you can gain the trust of suppliers and smooth trading outcomes for your company.

The professional services and tools we offer at Axton Global make setting up a credit limit easy. A new credit limit and deferred payment process of 90 to 180 days are available after a fast assessment. We can ensure you begin your international trading journey and achieve successful trading terms with suppliers in China.

No matter whether you are importing from Canada or the United Kingdom, Axton Global can support your business. Arrange a consultation with us for more information about credit limits. Discover more about SINOSURE at Axton Global.