Every U.S. company expects to get paid on an international sale and there are a variety of payment instruments available. Each payment instrument, however, carries varying degrees of risk to the seller as well as the buyer. One example is letters of credit, a payment that is considered slightly less secure to exporters as cash in advance. Letters of credit shift the payment risk and responsibility to the foreign buyer’s lender. It’s a legal contract valid for a limited timeframe, such as 90 days, and the fees to create one are typically paid for by the foreign buyer and exporter. There are two types: sight letters of credit and usance/deferred letters of credit.
Sales Terms as a Spectrum of Risk
A sight letter of credit is the most common type of letter of credit. It facilitates payment from the foreign buyer through their bank (issuing lender) to the U.S. exporter through their bank (negotiating lender). The exporter presents transactional documents (e.g., commercial invoice, ocean bill of lading, certificate of origin, etc.) to the negotiating lender and then gets paid when the documents are deemed compliant with the letter of credit. The required documents are specifically addressed within the letter of credit language.
A usance/deferred letter of credit is similar but involves a term which gives the foreign buyer more time to pay (e.g., when an exporter submits its compliance documents to the issuing lender, the issuing lender will remit payment within a specified period such as 60 or 90 days). The longer period gives the foreign buyer more flexibility to manage its cash flow and capital expenditures. This payment instrument is commonly seen in the agricultural industry which has long issuance periods.
An alternative to letters of credit is Export Credit Insurance from EXIM. This product enables exporters to sell on open account terms (generally up to 180 days) and therefore be more competitive by offering their foreign buyers payment flexibility. Meanwhile, exporters are also protected against foreign buyer nonpayment due to commercial and political risks and can bypass the lender fees associated with obtaining letters of credit. To learn more, please contact an EXIM trade finance specialist for a free consultation.