Contributed by

Letter of Credit

Whether you work with securities, trade, or retail, you have likely encountered a letter of credit financing. Some organizations might refuse to do business with you unless you secure this documentation for their peace of mind. Sometimes, your business might be the one requesting that a buyer presents this document. So, what is a corporate letter of credit and what do you need to know before using one?

What Is a Letter of Credit?

Also known as an LC, this financial document guarantees payment for goods or services. Banks typically issue these on behalf of a buyer. It protects the buyer if the seller does not deliver the promised goods or services. Consequently, when looking for a way to finance your business operations, an LC often provides an ideal opportunity.

What Are the Main Types of Letters of Credit?

Whether you need an LC or have requested one, you need to know the appropriate type for the situation. Review these main types to see which one works best for you.

  • Standby Letters of Credit: This is the most common type and acts as a backup if the buyer defaults on their contractual obligations.
  • Irrevocable Letters of Credit: As the name suggests, this type of LC cannot be canceled. Government agencies tend to use these.
  • Revocable Letters of Credit: The issuing bank can modify or cancel this type of letter with notice to the beneficiary.
  • Transferable Letters of Credit: The beneficiary can transfer this LC to a third party.
  • Commercial Letters of Credit: These are for business transactions, such as when importing or exporting goods.
  • Revolving Letters of Credit: With this type, the credit limit renews itself after the buyer repays some of the money.
  • Traveler’s Letters of Credit: Commonly used by tourists or for international trade, this type guarantees payment for traveler’s checks while abroad.
  • Confirmed Letters of Credit: This LC has the added security of backing from a second bank.

What Are the Main Characteristics of Letters of Credit?

As one of the most versatile financial documents used in trade, the characteristics vary. However, the U.S. Department of Commerce recognizes four main features, especially when it relates to export arrangements:

  1. Applicability: You can use an LC for various transactions, including commodities, services, and securities. The administration recommends using this for high-risk trade agreements that do not involve established relationships.
  2. Risk: The issuing bank assumes the credit risk, not the seller. As long as both parties follow the terms of the LC, it spreads the risk so that no one entity becomes over-exposed.
  3. Cons: LCs do require labor-intensive procedures. It can also lead to higher-than-normal costs in some situations.
  4. Pros: Payments are received only after the shipment of goods. LCs also facilitate a wide range of payment options, which can further help to mitigate risk.

What Are Some Best Practices for Using Letters of Credit?

Knowing the best practices plays a crucial role because of the labor-intensive process and the risk of higher costs. Consider these tips:

  • Compare the LC to the pro forma quotations and ensure the terms match up before proceeding.
  • Understand all of the fees associated with the LC. These include issuance, amendment, and cancellation fees.
  • Get everything in writing, including confirmation from the issuing bank that they will honor the letter of credit.
  • Build a strong relationship with your issuing bank. They can help to facilitate payment if issues arise.
  • Do not use an LC for small transactions. The administrative costs associated with them usually outweigh the benefits for smaller deals.

Using a letter of credit financing can be a great way to protect your business interests. However, it is essential to understand the different types of letters of credit and know the best practices for using them. By following our tips, you can help to mitigate the risk and ensure that your transactions go smoothly.

Those that are familiar with the workforce management space need no introduction to Monday.com and its powerful work OS tool. Monday.com recently moved to an automated accounts receivable (A/R) collection system, powered by Gaviti, to replace its outdated annual reporting methodology.

From Monday.com’s accounts receivables department:

With our business and sales growing exponentially, Gaviti has been a key tool in ensuring our DSO has not only stopped increasing but also shown improvements over a relatively short period of time. The ease of use combined with a highly responsive and helpful team… We have been able to quickly implement a comprehensive and versatile collections process.

When you stop to consider the broader, organizational benefits of automated A/R solutions, it’s easy to understand why Monday.com was so successful. The right A/R collection software can improve cash flow as well as the performance of key metrics – such as days sales outstanding (DSO) – within your organization.

Improve DSO Collection Processes

At its core, DSO collection is a cash flow problem. According to a U.S. Bank study, 82% of businesses fail due to poor cash flow management.

Part of this issue is attributable to the time-consuming processes inherent in manual collections. DSO collections and cash flow already vary from month to month. When you add the time spent managing spreadsheets across late payments, grace periods, and lines of credit, you have an untenable system where staff spends more time corralling reports than processing payments. And while you may not enjoy managing the nitty-gritty details of your business’s finances, your financial processes are ripe for optimization. Consider just a few ways that accounts receivable collection software can streamline your enterprise DSO:

  • Collect on accounts when they’re due with automated customer reminders
  • Create a single source of truth with a centralized A/R database that eliminates the need for tracking/compiling across different spreadsheets
  • Faster invoicing through the elimination of unnecessary payment delays
  • Standardize your process for consistent, repeatable collections every time
  • Streamline payment collection for clients, decreasing the odds of entry errors and making it more likely you’ll get paid on time

When you work to improve your accounts receivable collection, you’re working toward a healthy financial process where DSO stays low. But that’s not the only benefit of an A/R collection solution.

Stay Informed

5 Benefits of Automated Accounts Receivable Collection

In any discussion about the benefits of accounts receivable automation, it’s important to cover the broader benefits it provides:

  1. Better staff efficiency by reducing the manual hours required to perform collections tasks – all those hours you spend chasing invoices, calling clients, or writing follow-up emails add up.

  2. Ensure your data’s accuracy – real-time accurate data will prevent your company from making errors.

     

The benefits of the accounts receivable collection software are clear, and once you’ve deployed
automation,
you’ll have a hard time going back.

A/R Collections Best Practices

Although automated accounts receivable software brings a new dimension to your financial processes, the fundamentals of accounts receivable best practices remain the same. It’s a straightforward process that nevertheless tends to get bogged down by inefficiency. This is where automation software pays off.

Consider how you can leverage financial technology like this throughout your organization to improve key financial metrics. Technology is one option. Outsourcing accounts receivable collections to a service provider that can handle all the details for you is another. You have plenty of options, and now it’s just a matter of selecting which improvements will yield the best results for your enterprise.

Related Terms

Top Articles:
Contact Us