Learn more about letter of credit
You’re probably sitting there wondering exactly what a letter of credit is, how it’s used and how it relates to a potential shipment you’re considering. You may or may not have ever used a letter of credit (L/C) before, yet when it comes to international shipping, they can save a lot of time and trouble.
- What is a letter of credit, exactly?
- When and how did letters of credit start?
- What are the types of letters of credit?
- Commercial letter of credit
- Standby letter of credit
- How does the shipment bill of lading come into play?
- What is the bill of lading?
- So how does the B/L effect the letter of credit? Or vice versa?
- Adam’s advice when handling bill of lading and letters of credit
What is a letter of credit, exactly?
Letters of credit have been used for centuries. They are, in essence, a cross between a check and a credit card. The L/C is a way for a person to make payments across international lines without the need to carry large sums of money or to move large sums on their own.
When and how did letters of credit start?
You must be wondering how letters of credit were created? Why was it made in the first place?
During the 16th up to the 9th century, a company has to carry as much money in gold or product for it to be exchanged with the locals. Thus, an East India Company merchantman wishing to acquire £4,000 of spices would sail from Britain to India and back, purchase the cargo with either gold or product then deliver it back to England.
Thus is the horror of trading back then. Just imagine the amount of gold or product he needs to carry for exchange each time he does the trade – the piracy, privateering and threat at sea he has to endure. It is simply too risky!
What’s the solution?
Have the vessel carry a letter of credit from a London bank. From there, the L/C is then used to purchase goods. The seller would then receive their funds from an Indian bank.
Whoa! That’s a whole lot easier, right?
Most definitely. Thus this method of payment for shipping has been adapted up to this date and the process remains virtually identical.
How does the letter of credit work?
One can bank can easily talk to another via phone or internet. But when it comes to international transactions, it’s not always that simple. So the L/C is still used and it works like this:
- Your bank – the issuing bank – issues a letter of credit for your shipment of widgets from the United States to Australia.
- You take this letter of credit and give it to whomever you’re purchasing goods from in the US.
- The seller then takes the L/C to their bank in the US and can draw the funds directly or have them put directly into their account.
- The transaction is totally predicated on the shipment and must have accompanying documentation as proof.
What are the types of letters of credit?
You’ll find two kinds of L/C – the commercial and standby.
Commercial letter of credit
A commercial letter of credit is a primary form of payment that’s used for the shipment transaction.
Standby letter of credit
A standby L/C is a secondary form of payment – a backup plan, if you will. In the event that the primary payment, say a cash or credit transaction fails, the beneficiary of the L/C – the seller – can still collect their funds.
How does the shipment bill of lading come into play?
When it comes to paying for shipments with a letter of credit, everything hinges on the bill of lading.
What is the bill of lading?
Think of the bill of lading as your contract between a shipper, transportation company and freight forwarder who provides and receives the cargo. It serves as:
- Document title
- Contract of carriage
- Receipt for goods
The bill of lading (B/L) is a vital component in a letter of credit purchase especially for the release of your consignment. To learn more about bills of lading, please check out this blog post.
Click here to learn more about the bill of lading.
So how does the B/L effect the letter of credit? Or vice versa?
Essentially, the bill of lading acts as a receipt, as evidence of who is in control of the goods and as an obligation for the carrier who is responsible for getting the goods to the proper location.
It’s very important, therefore, that your B/L be exact and in perfect order. You see, letters of credit aren’t about goods – they’re about the documents relating to the goods being shipped. Precision is critical, and if done correctly, everything should go off without a hitch.
Adam’s advice when handling bill of lading and letters of credit
The use of a letter of credit can both be beneficial and dangerous for a buyer or seller. Choose expert customs brokers and freight forwarders with years of experience handling these types of documents. However, here are some points for your to remember when working with letters of credit and bills of lading.
- Precision is key. So never ever do things in a rush.
- Check your bill instructions and documentation requirements before your booking to ensure you comply with the destination requirements
- It is always best to put as much contact details as possible on the bill of lading to avoid collection delays at the buyer’s end
- Ask the assistance of an expert to help you with letter of credit, especially if you are a first time importer or exporter.
Got freight forwarding questions? Ask the expert. Talk to us at 1-877-901-2004. Send us a message, today.
