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Letters of Credit are too Expensive
This was what an Asian Buyer from an Irish Exporting company stated when he convinced the Exporter to sell to them on open account terms. The Asian Buyer obtained 60 days credit, which was to be calculated from the date of the invoice. The value of the order was USD 100, 000 and the goods were despatched and invoiced by the Irish Exporter on the 15th April 2006.
The payment from Asia was due on the 14th June 2006. The payment eventually arrived on the 21st August 2006, over two months late. The delay in payment cost the Exporter USD 1700 as it resulted in his account being overdrawn by this amount for 68 days at 9% per annum.
So are Letters of Credit too Expensive ?
The Irish Exporter could have insisted on receiving a confirmed Letter of Credit (see glossary) through Allied Irish Banks plc.
The following costs would have applied at that time:
|Acceptance Commission (@ 1.5% pa for 60 days)||USD||$250|
|Negotiation / Payment Fee||USD||$150|
|Out of Pocket Expenses (estimate)||USD||$60|
|Total Letter of Credit Cost||USD||$710|
|Interest Cost as a result of late payment||USD||($1700)|
|Benefit of using Letter of Credit||USD||$990|
The Letter of Credit looks expensive because the costs are very visible and are linked to each transaction. The benefits, on the other hand, are intangible.
What benefit would the confirmed Letter of Credit have provided to the Exporter?
A Guarantee of payment on the due date from Allied Irish Banks. (Provided the terms and conditions of the Letter of Credit were complied with).
No risk of non-payment as a result of problems with the buyer or the Asian economy.
A definitive date for the receipt of funds, particularly important for devising proper currency hedging strategies.
The opportunity to receive the payment in advance of the due date through non-recourse discounting of the receivable.
Please note that this case has not accounted for the costs the Irish Exporter incurred in chasing the debt with the Asian buyer. In addition if the Exporter had sold his foreign currency receivable on a forward basis to his bank for the original due date, they may have incurred a further cost in cancelling or rearranging the forward contract.
Letters of Credit although appearing expensive do provide real and tangible benefits to companies. In this case the Irish exporter only lost US$ 1700. Of course if the Asian buyer had not paid at all they would have lost the whole US$ 100,000.
Case Study – Letters of Credit 2 – Benefits of Outsourced Service : Exporter Story
Outsourced Letter of Credit Service makes International trade go faster
International trade offers a number of advantages and opportunities for growing businesses. The rewards can be great; but you should be aware of the risks and how to minimize them. A pause in cash flow can disrupt almost any aspect of the business – from manufacturing to research to operations – making it absolutely critical for payments from international shipments to process as soon as possible. One Irish company learned their lesson the hard way – and solved their problems by implementing Letters of Credit (LC’s).
International business demands fast, accurate documentation to process payments as soon as possible. This Company believed the best way to do this was by generating Letter of Credit (LC) documentation in-house. Expediting and accurately completing documents linked to international letters of credit is a considerable challenge for the majority of the freight forwarders. Significant number of medium and enterprise companies still rely on manual processes and spreadsheets to manage export transactions.
Nevertheless, this methodology created problems upon problems, including:
- Inaccurate documentation
- Increased expenses and wasted money
- Cash flow problems
- Underestimated process flow – taking 3 times more time(20+ days) then initially estimated by project team
- Additional cost spent towards training the personnel
- Exhausted, unhappy employees
- Delayed delivery and potential penalties due to the same
After accumulating unnecessary expenses and wasted time as well as getting unsatisfied clients and hurting company morale, the Company sought to do it the right way. The Company searched for the most reliable and respected LC documentation company available and they found their partner in Export Edge professional outsourced service .
Export Edge was effective at turning around the Company’s cash flow and efficiency when exporting goods. With Export Edge technical platform for effective letters of credit management and professional staff behind it many benefits were achieved:
- A significant reduction in man-hours spent on documentation with utilization of technical platform for LC management ( up to 7 days for processing)
- Consistent cash flow with payments made much quicker than before
- More money due to fewer expenses wasted on documentation penalties and labor cost
- Saved time and money associated with learning to do something that was outside of their staff’s member’s normal scope of responsibility
- Eliminate the possibility of discrepancies and errors that come with inexperienced LC preparation
Case Study facts retrieved from Allied Irish Bank p.l.c. AIB Tradefinance Source:www.aibtradefinance.com/tf/CaseStudy_1.asp