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L/C, Advantage & Disadvantage, Ad & Disad - Coggle Diagram
L/C
Types
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Deferred payment L/C
A letter of credit under which the documents are forwarded to the importer’s bank, while a sight draft is presented at a later future date.
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Revolving L/C
A letter of credit calling for renewed credit to be made available when the issuing bank informs the beneficiary that the buyer has reimbursed the issuing bank for the drafts already drawn.
Revocable
A letter of credit that may be canceled at any moment without prior notice to the beneficiary
Example:
Back to back L/C
Two letters of credit with identical documentary requirements, except for the difference in the price as shown by the invoice and draft.
Risks
The issued bank does not involve in checking the quality of product (just documents) so cannot ensure for the sake of buyer
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Definition
a document sent from a bank or financial institution that guarantees that a seller will receive a buyer’s payment on time and for the full amount.
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Disadvantage
- Relatively expensive due to bank fees
- Letters of credit may not cover every detail of the transaction, potentially leaving room for error.
- Establishing a letter of credit may be tedious or time-consuming for all parties involved.
- The terms of a letter of credit may not account for unexpected changes in the political or economic landscape.
Advanatge
- One of the most secure payment instruments available.
- Makes it easier to define the specifics of when and how
transactions are to be completed between involved parties.
- Letters of credit can be personalized with terms that are tailored to the circumstances of each transaction.
- Can make the transfer of funds more efficient and streamlined.
Procedure
- The applicant (the buyer) completes a contract with the seller.
- The buyer fills in a letter of credit application form and sends it to his or her bank for approval.
- The issuing bank (the buyer’s bank) approves the application and sends the letter of credit details to the seller’s bank (the advising bank).
- The advising bank authenticates the letter of credit and sends the beneficiary (the seller) the details. The seller examines the details of the letter of credit to make sure that he or she can meet all the conditions. If necessary, he or she contacts the buyer and asks for amendments to be made.
- When the seller (beneficiary) is satisfied with the conditions of the letter of credit, he or she ships the goods
- The seller presents the documents to his or her bankers (the advising bank). The advising bank examines these documents against the details of the letter of credit and the International Chamber of Commerce rules.
- If the documents are in order, the advising bank sends them to the issuing bank for payment or acceptance. If the details are not correct, the advising bank tells the seller and waits for corrected documents or further instructions.
- The issuing bank (the buyer’s bank) examines the documents from the advising bank. If they are in order, the bank releases the documents to the buyer, pays the money promised or agrees to pay it in the future, and advises the buyer about the payment. (If the details are not correct, the issuing bank contacts the buyer for authorization to pay or accept the documents.) The buyer collects the goods.
- The issuing bank advises the advising (or confirming) bank that the payment has been made.
- The advising/confirming bank pays the seller and notifies him or her that the payments has been made.
Advantage & Disadvantage
advantages
For importer
- No payment is required until the goods are received and accepted.
- Reduce financial pressure due to late payment.
For exporter
- Is a simple, easy-to-implement, low-cost sales method, usually done between partners without doubts about credibility and no risks in payment arise
- Due to low selling costs, exporters can reduce selling prices to increase competitiveness, attract new orders in large quantities, and increase revenue and profit.
disadvantages
For exporter
- After receiving the goods, the importer may not pay, or cannot pay, or intentionally delay and prolong the payment time.
- In theory, although the title of the goods can be preserved, in practice, it is difficult for the exporter to control the goods once transferred to the importer. In addition, the importer may stage a quality dispute or claim for a defect or shortage of goods as grounds for requesting a discount.
- The exporter who sells goods by open account incurs the cost of credit control and collection
For importer
The exporter may not deliver the goods, or deliver the goods on time, with the wrong type and quality.
Open account
Definition
An open account is an arrangement between a business and a customer, where the customer can buy goods and services on a deferred payment basis. The customer then pays the business at a later date. This arrangement is typically apped by the maximum amount of credit that the organization is willing to extend to the customer.
An open account transaction is a sale where the goods are shipped and delivered before payment is due, which in international sales is typically in 30, 60 or 90 days.
Example
Madeline is the owner of a company which makes wedding cakes. Her products, tasty treats for a special occasion, are valued by all who try them. These cakes take many supplies to complete. Madeline has several open accounts in the name of her company: she has trade credit for her food products, has received third party financing for a delivery truck used for her business, and even has an unpaid balance with her landlord. This does not mean Madeline’s business is under financial distress and is experiencing open account debt; quite the contrary. Madeline is actually managing her finances well. She chooses to pay bills at the last moment in order to reserve cash for operations. An open account basis is the center of Madeline’s cash flow strategy. This does not mean that she neglects her bills, she just sends payment so that it is received on the last day before it is considered late. Madeline must manage this carefully but knows she can take advantage of the time and cash to better her situation.
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