For certain business transactions such us purchases between buyers and sellers, there are instances where the purchases may be significant in amount. In these cases, a form of payment entered in by both buyer and seller for a more secured type of payment is possible. This type of secured payment is coursed through a bank instrument which is popularly referred to as a letter of credit.
A letter of credit is a form of payment that is considered by the seller as payment and will consequently consign the goods to a carrier. The carrier will then hold on to the goods and provide a detailed list of the goods that have been consigned. This list of goods is considered as the “Bill of Lading”. The bill of lading document will then be secured by the seller to the seller’s bank and receive payment coming from the seller’s bank. The seller’s bank will then create a bill that includes the bill of lading and send the bill to the buyer’s bank. The buyer’s bank will then bill the buyer and will be required to pay. Once buyer has paid the bank, only then will the carrier release the goods to the buyer where physical delivery of the goods may be completed.
The importance of using a letter of credit to pay transactions that buyer and seller enter is often related to transactions that require high value payments and are often international transactions. There are also certain countries where the buyer would require a letter of credit for completing the transactions. These letter of credit prove to be advantageous as it offers a good balance of security to both the buyer and the seller. The reason behind this is that banks are primarily involved as both the buyer and the seller are dependent on the security of the banks.
These simple methods can often assist a business do transactions with another entity who is located in another country. The letter of credit provide security and allows the buyer enough time to come up with the money to pay the goods. The seller on the other hand has already claimed payment while carrier is waiting for the buyer to give payment.