When companies in India sell or export products to other countries, ensuring flawless payment transactions is essential. A Letter of Credit (LC) is the most important document that assists in securing payment for the exporter, making it a crucial part of the export procedure.
What is a Letter of Credit?
A Letter of Credit is a legitimate guarantee by the foreign buyer’s banking institution to pay when the exporter transports the products and furnishes the needed documentation to the exporter’s bank as valid proof.
As a business finance instrument, Letters of Credit are devised to protect both buyers (importers) and sellers (exporters). They can assist both in winning business with new customers in overseas markets. This signifies that the exporter gets payment assurance while the importer is provided with fair payment terms.
Types of Letter of Credit
There are many types of LCs that Indian exporters might employ based on particular transactional requirements:
1. Confirmed and Unconfirmed
A confirmed type includes a second bank (generally in the importer’s country) that assures payment if the issuing bank declines to pay. An unconfirmed type does not include this extra surety.
2. Revocable and Irrevocable
A revocable type can be altered or cancelled by the issuing bank at any time with no previous notice to the exporter. At the same time, an irrevocable type cannot be modified or cancelled without the permission of all parties involved.
3. Sight and Usance
A sight LC needs the issuing bank to generate payment as soon as the documents are provided. On the other hand, a usance authorises for payment at a subsequent date, generally within thirty, sixty, or ninety days.
Advantages of Using a Letter of Credit
- It gives security to exporters in international business.
- It helps exporters and Importers create trust and lasting business relations with each other.
- In the complicated global business surroundings, it helps the easy flow of funds from one party to another.
- Banking organisations and finance providers can offer highly personalisable Credit Letters written to fulfil the terms and conditions of individual business deals.
- Neither the buyer nor the seller is entitled to long-term repayment contracts.
Global trade is usually complex because of factors such as local laws and rules, international payments, money conversions, and challenges in verifying the trustworthiness of trading associates. A credit letter reduces various worries that exporters face by placing a globally identified and standardised finance provider as an underwriter at the midway of the contract.
Why is a Letter of Credit Important for Indian Exporters?
Selling or exporting goods from India includes many risks, like late payments, currency variations, and political amendments. An LC is helpful in lessening these risks by offering a safe and trustworthy payment method. So, here we have discussed its importance for Indian exporters:
1. Assured Payment
One of the most essential benefits of an LC is that it guarantees payment to the exporter as long as they fulfil the terms and conditions listed in the letter. This signifies that the exporter does not need to worry about the buyer declining to pay or making late payments.
2. Decreased Risk
Since the buyer’s bank gives the payment guarantee, the exporter does not need to worry about the importer’s credibility or financial strength. This removes the risk of bankruptcy, specifically when dealing with new or unauthorised buyers.
3. Easier Financial Access
Banks and financial organisations are more likely to offer financing to exporters who have a credit letter because it ensures the loan security. This shows that sellers can get funds more effortlessly to complete big orders or make an investment in their businesses.
4. Increased Cash Flow
With an LC, exporters can ensure they get payment on time, which helps them look after their cash flow. This is specifically essential for small and medium-sized businesses that rely on timely payments to keep their business operations flawless. (3)
How to Apply for a Letter of Credit?
- Exporters and their banks should be fulfilled with the creditworthiness of the importer’s banking institution. Once the Sales Contract is done, the importer communicates with their bank to create an LC in support of the exporter.
- The Importer’s bank outlines the LC employing the Sales Contract terms and conditions and sends it to the exporter’s bank. The exporter’s bank checks and endorses the letter and dispatches it to the exporter.
- The exporter transports the products in the way given in the Letter of Credit and puts forward the needed documents to their banking organisation. A shipping or freight forwarder might be used to help in this procedure.
- The exporter’s bank verifies the documents to conform with the credit letter’s conditions. Any document mistakes and differences should be modified and submitted again. Once approved, the exporter’s banking organisation submits the compliance documents to the importer’s bank.
- The importer’s bank issues payment to the bank of the exporter. The importer’s bank issues the documents to the importer to claim the items and clear customs duties.
Documents Needed for a Letter of Credit
- Airway Bill
- Shipping Bill of Lading
- Insurance Certificate
- Commercial Invoice
- Certificate of Origin
- List of Packing
- Inspection Certificate
Final Words
A Letter of Credit is a significant document for Indian exporters, providing a safe way to ensure payment for products sold globally. By including a bank as an underwriter or guarantor, the risks linked to international business are decreased, and exporters are assisted in administering their cash flow more successfully. Whether you are a small trader or a big enterprise, knowing and using this document can be valuable in your export procedures.
