What is A Letter of Credit?

A letter of credit (also known as an LC, credit letter, or letter of undertaking) is a document issued by a bank, credit union or other financial institution guaranteeing payment between a buyer and a seller. If the goods or services are provided as agreed and the buyer doesn’t pay on time and in full, the issuing institution becomes responsible for covering the amount due.

Historically, letters of credit have played an important role in international trade, but in today’s globalized and digitized market, they aren’t always the ideal solution. Trade credit insurance is one possible alternative that businesses should consider – especially when time is of the essence.

Letters of credit are designed to facilitate business transactions in which the parties may not have an established relationship or a common legal system.

They can help protect both the buyer and the seller: the buyer doesn’t have to pay upfront, while the seller has assurance that they will be properly compensated. For buyers, this can mean improved cash flow as well as reduced risk. For sellers, letters of credit can also be used to collateralize working capital loans, which can help them fulfil orders more efficiently.

Letter of Credit Versus Credit Insurance

Letters of credit have been around almost as long as commercial trade itself.  Credit insurance is often a more compelling choice. More importantly, letters of credit place a burden on your buyers at a time when you want a transaction to go as smoothly as possible.

Consider the following issues buyers can have with letters of credit:

  • It is up to the buyer, not the seller, to obtain and pay for any letters of credit.
  • Buyers must obtain a letter of credit from their banks for every shipment.
  • Letters of credit can tie up the buyer’s lines of credit with its bank.
  • Even the smallest errors or problems with a letter of credit can cause a bank involved to refuse to issue payment once the shipment arrives.

Because of these drawbacks, buyers may resist using letters of credit, especially if they are used to dealing with open account terms that allow payment after they have received a shipment.

Trade credit insurance (also called accounts receivable insurance) protects businesses when a customer fails to pay a trade debt. This often occurs when a buyer becomes insolvent or is unable to pay within the contracted terms. Trade credit insurance from Allianz Trade in Canada can cover up to 95% of bad debt. This can protect your cash flow, enable you to borrow against insured receivables at reduced rates, and empower your expansion into new markets.

The Credit Insurance Alternative

Credit insurance can remove these burdens from buyers and simplify transactions. Using credit insurance, you can:

  • Create the means for easy payment that does not impact buyers’ access to credit.
  • Offer open terms and more aggressive credit limits to your customers.
  • Eliminate the need for invoices or shipping documents, unless a buyer defaults on payment.
  • Ensure that payment is based solely on compliance with the contract of sale.
  • Pursue safe sales expansion and gain access to more working capital to recapture the cost of credit insurance.

Offer your customers the best payment terms and expand your business using credit insurance.

Discuss how credit insurance can help your business with us.
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