Letter of Credit (L/C)

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Letter of Credit (L/C) by Mind Map: Letter of Credit (L/C)

1. What is an Irrevocable Letter of Credit?

1.1. An irrevocable letter of credit is a financial instrument used by banks to guarantee a buyer's obligations to a seller. It is irrevocable because the letter of credit cannot be modified unless all parties agree to the modifications

2. Who is the...?

2.1. Beneficiary?

2.1.1. The person or company who will be paid

2.2. Buyer or applicant?

2.2.1. The person or company who needs the L/C

2.3. Issuer?

2.3.1. The issuing bank, the financial institution issuing the letter of credit

3. Application

3.1. A letter of credit is a payment method used to discharge the legal obligations for payment from the buyer to the seller, by having a bank pay the seller directly. Thus, the seller relies on the credit risk of the bank, rather than the buyer, to receive payment.

4. Advantages for the buyer

4.1. The bank will pay the seller for the goods, on condition that the latter presents to the bank the determined documents in line with the terms of the letter of credit

4.2. The buyer can control the time period for shipping of the goods

4.3. By a letter of credit, the buyer demonstrates his solvency

4.4. In the case of issuing a letter of credit providing for delayed payment, the seller grants a credit to the buyer.

4.5. Providing a letter of credit allows the buyer to avoid or reduce pre-payment

5. Advantages for the seller

5.1. The seller has the obligation of buyer's bank's to pay for the shipped goods

5.2. Reducing the production risk, if the buyer cancels or changes his order

5.3. The opportunity to get financing in the period between the shipment of the goods and receipt of payment (especially, in case of deferred payment).

5.4. The seller is able to calculate the payment date for the goods.

5.5. The buyer will not be able to refuse to pay due to a complaint about the goods

6. Disadvantages for the buyer

6.1. The buyer compromises to pay against correct documents, but the merchandise can noty be checked in advance

6.2. Once issued, a Letter of Credit is irrevocable and can not be cancelled by the buyer, unless both seller and buyer agree

7. Disadvantages for the seller

7.1. Putting together all the documents requires time

7.2. If the documentation is not correct the bank might refuse the payment

7.3. A Letter of Credit is normally more expensive as other methods and it might require a fee from the exporter to the issuing bank

8. Documents requested

8.1. Bill of Lading (B/L)

8.2. Commercial Invoice

8.3. Packing List

8.4. Insurance policy

8.5. Certificate of Origin

9. Is it a cheap mean of payment?

9.1. Letter of credit is a secure payment method in foreign trade. But security comes with a price. Letters of credit are one of the most expensive international payment methods available on the market. It is not advisable to use L/C on a low amount transaction because of the high fees.

10. Definition

10.1. A letter of credit, or "credit letter" is a letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make a payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase. It may be offered as a facility. Due to the nature of international dealings, including factors such as distance, differing laws in each country, and difficulty in knowing each party personally, the use of letters of credit has become a very important aspect of international trade.