Letters of Credit: Seven Types and How Customers Can Help Fund You
Customers sometimes serve as a source of financial aid. One way is the issuing of a letter of credit, a tool that guarantees payment to a seller of commodities, mainly to ease trade finance. The person purchasing the goods takes on the obligation with the assurance to pay later, and the payment obligation shifts from the buyer to the issuer of the letter. You can be issued a letter of credit by your customers and use it as security to purchase goods from a supplier. Letters of credit are common in foreign exchange. There are several types.
Revocable letter of credit. Most beneficiaries do not approve of it, and the Uniform Customs and Practice for Documentary Credits makes no provision for it. In this kind of letter you can legally cancel the exchange at any point in time.
Irrevocable letter of credit. This is the standard, since it is not legal to cancel the exchange at any point. It can only be confirmed or unconfirmed. A confirmed letter needs another financial institution to guarantee the payment, which comes from distrust between the beneficiary and the bank or second party.
Revolving letter of credit. People can use it for more than one transaction, especially parties who expect to do business together regularly. It often has an expiry date, most commonly a year.
Red clause letter of credit. This carries an unsecured loan by the purchaser, which comes as an advance. It is often requested when funding is needed to transport or manufacture goods.
Commercial letter of credit. Also called an export and import letter of credit, it is used for international trade and works with the rules brought out by the International Chamber of Commerce.
Standby letter of credit. This is mostly used as insurance instead of financing. If any party fails to get paid, they can present this letter as proof that they have been unable to receive payment.