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What is a Letter of Credit

What is a Letter of Credit?

What is letter of credit?

Every business needs funds for running its operations. Be it for starting a company, expanding a company, purchasing machinery, or working capital need. The major requirement of finances for many businesses is for working capital. Traditionally, most of the working capital financial instruments were secured. One must have some kind of collateral against the loans. But, now there is an instrument called unsecured working capital. That avail loans even without collateral. So, let’s Understand what the Letter of Credit is about?

LC Discounting

A banker issues the letter of credit as the financial document. In this Bank gives a guarantee to pay to the seller for the buyer’s obligation, In case a buyer fails to make the payment. So, LC discounting takes away the risk. It gives assurance to the seller for the funds. Such an instrument is used in international trade. Mainly where the buyer and seller are unknown and have to risk in a transaction between each other. There is the involvement of majorly 4 parties in such a transaction. Namely: Exporter, Exporter’s Bank, Importer, and Importer’s bank. A buyer and seller both request for LC. So, both of them mutually decide the terms and conditions.

Features

  1. LC Discounting speeds up the cash flow of the business organization. Thus, assist in working capital management effectively.
  2. The risk of a transaction is resolved by such an instrument. Hence, gives assurance to both the parties involved.
  3. The following are the benefits to the parties.
    • The seller gets immediate cash flow for his business
    • The buyer gets a credit period for making payments
    • The bank receives interest for the said services
  1. After checking the authenticity of the payment from the buyer, LC gets a discount. Thus, proves that the instrument is safe and secure in funding.
  2. For both domestic and international customers LC discounting is available. It is majorly used in international transactions.
  3. The relationship between the exporter and importer is developed well. So, there will be the smooth working of the entire procedure.

Process of LC Discounting

  1. In the case of a manufacturing or trading company, the sellers may require funds immediately. He cannot wait for the due date. So, in such a case, LC Discounting plays a major role in assistance to the eligible sellers.
  2. Buyers on-demand from the seller request Letter of credit (LC) from the respective banks before shipment of goods. And send the same towards the seller/exporter bank.
  3. The exporter bank checks the document and communicates the acceptance to the seller.
  4. The exporter receives the Letter of Credit and requests it for discounts.
  5. Hence, the bank discounts the LC after deducting the charges or discounting fees. The exporter gets the money and uses the same for his business expenses.

Learn the process of letter of credit from case study.

Example

Let us suppose that “ABC Private Ltd” company engaged in manufacturing situated in India. The company receives an order of goods from a foreign country “XYZ Private Ltd”. It is asking for a credit period of 60 days for the payments of goods. Being unknown to each other, “ABC Pvt Ltd” demands a Letter of Credit from “XYZ Pvt Ltd”. It sends it for confirmation towards “ABC Pvt Ltd”. It will check the letter and accepts it. And can discount the same. Thus, by discounting the LC, the seller will get immediate cash flow. So, he does not have to wait till the end of the credit period.

What are the advantages of LC?

How Terkar Capital help you?

Terkar Capital is the leading financial consultant in India. We arrange both conventional and non-conventional debt products for our clients. We have a team of experts who constantly help the borrower in all the steps. At Terkar Capital we assist right from the first meeting till the repayment of funds. Thus, our timely and efficient services make us different from others.

So whenever it is about raising funds, Terkar capital is ready to serve you at best!

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