Advantages of letter of credit as a mode of payment

Many companies take part in international trade because it promises better returns for them. International trade is common and encouraged between different companies because it allows nations to access goods and services that they cannot produce locally. However, most countries and organizations struggle with payment methods in this trade. One of the most widely accepted form of payment in international trade is letter of trade because its advantages outweigh the disadvantages.

One advantage of a letter of credit is that it is banks, rather than the buyer that issues it, which improves accountability and transparency. It is an actual commitment that a bank makes to pay for the goods that the buyer receives from a seller from any jurisdiction. As a result, failure to pay will give right of action against bank, which is a large organization with enough assets and credibility to cover the costs of the goods shipped to a buyer. A letter of credit encourages customers from different jurisdictions to work with a particular company because they know that they can comfortably follow up on payments products or services offered. Consequently, it is a sure way of acquiring and maintaining international clients, who raise the reputation of a company. Therefore, a letter of credit offers sellers an actual commitment from a bank to pay, which encourages and fosters international trade.

Moreover, a letter of credit mitigates the production risk for a seller working with international clients. Sometimes buyers cancel or change their orders, which could result in devastating losses for the seller. A letter of credit reduces this risk because the bank involved in the transaction must offer the payment. Moreover, a letter of credit provides an opportunity for a company to get financing from various creditors to continue with its activities in the period between shipment and receipt of payment. This process ensures that a corporation does not halt its operations due to lack of funds. The buyer cannot refuse to make a payment even when they complain about the products, which further mitigates production risk. Therefore, a letter of credit is advantageous for a seller because it mitigates the production risk associated with cancelled orders.

A letter of credit also offers advantages to a buyer who uses it. Firstly, it enables the buyer to avoid or reduce pre-payment, which saves money. Secondly, a letter of credit allows a bank to pay the seller for the goods, on the condition that they provide determined documents in line with the terms of the letter of credit. Thirdly, a letter of credit enables the buyer to demonstrate their solvency and control the shipping time. Additionally, it allows a seller to grant credit to the buyer when they delay payment for goods or services rendered. It is also a secure means of transacting because it does not require the buyer to transact the business using a way that attracts fraud. As a result, a letter of credit is advantageous to the buyer because it ensures that they receive their goods on time and it reduces pre-payment.

However, using a letter of credit as payment for international trade has some disadvantages. It may be challenging for a seller to establish buyer’s credit rating if they are in different jurisdictions, which is often the case in international trade. This condition may pose a problem in case of a lawsuit that requires the buyer to refund the seller if the former does not have assets in seller’s jurisdiction. As a result, the seller faces double losses, which many hinder or damage international relations between the affected countries. Additionally, the bank involved in the process may not operate in seller’s jurisdiction, which will require both parties to try and locate a bank that operates in both jurisdictions. This process delays business and affects the productivity of both parties. Therefore, a letter of credit has some limitations, which include establishing buyers’ credit and locating a banking institution that operates in both jurisdictions.

A letter of credit as a means of payment also offers some benefits for the seller involved in an international business transaction. Firstly, the stipulated documents that they require for confirmation may be impossible to obtain, which increases the risk. Secondly, the seller could receive a shipment schedule that is impossible to meet, which risks their business reputation. Thirdly, the buyer could make an order in a quantity that the seller did not anticipate, which could strain a company. Additionally, the product description that the buyer provided could prove to be too insufficient or too detailed as compared to the letter of credit they offer. As a result, the price may become too low due to exchange rate fluctuations and cause losses for the seller. Therefore, a letter of credit has some disadvantages for the seller, which include a shipment schedule that is impossible to meet.

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