| Investopedia: "Letters of Credit are letters from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. Often used in international transactions to ensure that payment will be received." (credit: investopedia.com) |
| Investorwords: "Letters of Credit are binding documents that a buyer can request from his bank in order to guarantee that the payment for goods will be tranferred to the seller. Basically, a letter of credit gives the seller reassurance that he will receive the payment for the goods. In order for the payment to occur, the seller has to present the bank with the necessary shipping documents confirming the delivery of goods within a given time frame. It is often used in international trade to eliminate risks such as unfamiliarity with the foreign country, customs, or political instability." (credit: investorwords.com) |
For Example: An importer/wholesaler of machinery has a line of credit with a local bank or factor. However, the client needs an additional line of credit to open letters of credit to the manufacturer/supplier of the machines. Otherwise, the manufacturer would not put the machines into production for the client. In response, STAR is prepared to open letter of credit financing to the manufacturer/supplier, provided the client has purchase orders from good customers for the merchandise purchased under the letter of credit. When the inventory arrives from overseas, the client ships the product to his good customer. By prior agreement, the lender's initial advance against the receivables will be used to pay out STAR'S exposure.
| Investordictionary: "Letters of Credit are documents issued by a financial institution on behalf of a buyer stating the amount of credit the buyer has available, and that the institution will honor drafts up to that amount written by the buyer. It gives the buyer the prestige and financial backing of the issuing institution and satisfies the requirements of the seller in completing the transaction. The accepting institution has a prior agreement as to how the buyer will pay for the drafts as they are presented." (credit: investordictionary.com) |
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