There’s a lot of risk involved in the buying, supplying, and shipping business. You’re dealing with dozens of different parties throughout the supply chain, many of which you may not have ever worked with. On top of this, the concerns over payment details, invoicing, and unknown company credit scores can cause businesses to shy away from good deals in fear of it backfiring.
The international trade industry is often risky, as dealing with new suppliers/buyers overseas can be scary – particularly in the realm of payments. Luckily, a system of payment assurance has been created – Letter Of Credit – which mitigates the risk between buyers and sellers by assuring payment will be made.
Letter Of Credit: How It Works
As much as we would all like to trust all involved transactional parties to pay for their purchases, it simply isn’t always the case. Bad credit scores, mismanagement, disconnected internal departments, and many other factors can cause a buyer to fall out on a payment, leaving their supplier counterpart’s accounting out of balance.
A Letter Of Credit is a buyer agreement that assures payment will be made to their supplier. Essentially, in a new transaction, a buyer’s bank will assure the seller of the goods that the buyer is able and has set aside money with the bank to pay for the goods. This way, a supplier can ship the goods to the buyer with security that the buyer’s bank will hold them accountable for payment in the end.
How Letter Of Credit Reduces International Buying and Shipping Risk
A Letter Of Credit reduces many risks associated with international transactions. While money is the most prevalently impacted factor, there are many other risks which are mitigated through the use of a Letter Of Credit. Here are a few worth noting:
1) Financial Risk
The most obvious of all. A Letter Of Credit is created, first and foremost, for the security of payment. Once a buyer has signed a Letter Of Credit with their bank, payment to the seller or supplier is guaranteed and the financial element of shipping risk is largely reduced.
2) Business Partnership Risk
This one is a little tricky, because it’s two-fold. On one part, you have concern over your business partnership with your buyer – if they don’t pay for the goods, your partnership is essentially over. On the other hand, you have concern over your partnerships with all other vendors. If you aren’t paid, you can’t pay them.
A Letter Of Credit can greatly reduce (or eliminate) the shipping risk associated with business partnerships by solving financial accountability issues and reintroducing previously cautioned trust. Regardless of if you’re the buyer or seller of the goods, including a Letter Of Credit in new business situations is a great way to set the stage for a trustworthy and mutually beneficial relationship.
3) Corporate Accountability Risk
This is particularly prevalent in new buyer relationships. When a supplier/shipper works with a new buyer, there is always a certain degree of distrust involved in the transaction.
In the event of a buyer not following through on paying for a transaction, questions of corporate accountability are brought into the light. Often, the decision maker who is working with the buyer who didn’t pay ends up with their own head on the line.
Using a Letter Of Credit in an international transaction can help keep internal corporate accountability in check without the need for awkward conversations and accusations.
Conclusion
A Letter Of Credit isn’t needed for every type of transaction – when working with current customers, reputable businesses, or people you’ve done work with in the past, there isn’t much need for an LC. However, a Letter Of Credit is a great way to reduce the financial, corporate, and relational risks associated with venturing into new international business opportunities.
If you have been burned in the past by buyers failing to pay their bills and are looking for ways to secure your financial responsibilities and obligations in the future as it relates to shipping, reach out to one of our team members! We have tons of experience in the industry and are happy to offer help wherever we feel capable.