For this example, we assume that an importer buys goods from an exporter. HOWEVER, LOCs are useful for different types of transactions. Stand-by letters of credit can work at .B in the United States for a variety of services, including construction projects, registration for electrical service and much more. If you want to see how an LOC works for general domestic transactions, replace the terms “importer” and “exporter” with a customer or service provider in your sector. For example, why does the seller apply for credit? The seller wants more confidence for the buyer to pay. Maybe this buyer and seller never collaborated, or the order could be large enough to cause serious financial hardship if something goes wrong. For example, if the seller spends money on the manufacture and shipping of goods, the seller wants to recover those costs. The buyer cannot pay for several reasons (the buyer`s property could be confiscated for some reason, the buyer could go bankrupt, and so on). First, a buyer (importer) and a seller (exporter) opt for a common activity. They agree on a price, quantity and other conditions and determine how and when the goods are delivered to the buyer. As part of the contract, we assume that the seller requires the buyer to use a creditor (LOC). A loan-to-pay (LOC) is a promise made by a bank to make a payment after verifying that someone is meeting certain conditions. The details are important: it is important that the bank gets all the details correctly.
The LOC is a legally binding document and these documents are interpreted exactly as they are written. Here too, the LOC is separate from the sales contract and is based on documents – not executed actions – so you can`t assume that everything works if an error occurs in the LOC. Even a seemingly insignificant element, such as a typographical error, can cause problems. If the document is not perfect, it must be corrected before anyone moves forward. The sales contract is not part of a credit intake. The sales contract is only between the buyer and the seller, and LOC is based on information contained in the agreement, but the LOC is a separate document issued by a bank. Financing: when the bank issues the LOC, the bank makes a promise and the bank is responsible for sending money. This is what makes a letter of credit so safe for sellers – the fact that the bank assumes responsibility for the payment. For this reason, the bank must have confidence in the fact that the buyer can finance the payment.
Before the bank issues the LOC, the buyer may be required to deposit money with the bank or the bank may arrange financing for the buyer under the LOC. Delivery is not necessary: according to LOC thought data, it doesn`t matter if the goods deliver it to the customer one day. A storm can damage or destroy products during shipping, but the seller may not be responsible for this loss if he only had to ship goods. The easiest way to understand how LOCs work is to see an example, and this tutorial describes the step-by-step process. You can also simply read a preview if you prefer a pure text explanation without the visuals. Banks and intermediaries: after the issue of the LOC, the bank sends it to the seller`s bank. This bank is usually located in the seller`s country and is probably a bank with which the seller already has a relationship. There may be several banks in between that act as intermediaries, but they are omitted for simplicity.
When will the seller be paid? The date of payment depends on the type of LOC used. The seller can be paid within days of filing documents with a local bank. In other cases, the seller waits for certain conditions to be met.
