Letter Of Credit Financing Explained Without All The Technical Bang On
Welcome to Whiteboard Wednesdays!
Today’s topic is Letter Of Credit financing without all the technical jargon!
Find out what it is, how it works and more importantly what the requirements are.
Click below to find out exactly why you would use a letter of credit.
If you would like an appointment with a Product Specialist, call the office on 1300 652 158.
Watch the video and/or read the transcript below.
Today’s topic is Letter Of Credit financing without all the technical jargon. Find out what it is, how it works and more importantly what the requirements are.
What is it ?
A letter of credit is a letter issued by a bank to another bank (especially one in a different country) to serve as a guarantee for payments made to a specified person under specified conditions.
How does it work ?
When we issue letters of credit, they’re actually Westpac or an Australian big four bank’s letter of credit. All we’re doing is putting up the collateral to finance that letter of credit. So we go to Westpac. We get our money instead of the client, because our client may not have the cash or the security. We go to the bank on their behalf and we give the bank the cash to secure it. So the money leaves our account, goes to Westpac’s account, and we have no further access to it, and it secures that letter of credit. Now when that supplier overseas satisfies that letter of credit, they go to their bank, they cash it, and our bank releases the money to their bank and their bank then pays the supplier.
Why would you use this ?
Whilst it is a slightly painful extra layer of administration it provides security for us and the buyer to make sure that those goods do actually get shipped.
Julia: Hi everyone! Welcome to Whiteboard Wednesdays. Today we’re
going to be talking about letter of credit financing, and I’ve got Daniel
here who’s the expert. So Daniel, let’s talk about letter of credit, but
let’s not get too technical. Let’s just stick with the basics. Let’s start
with telling everybody, what is a letter of credit?
Daniel: Well, let me just start from the beginning. I’m not actually an
expert on letter of credit, but all I can talk about it is that
from our . . .
Julia: But we do it.
Daniel: Yeah, we do letter of credit . . .
Julia: So you know a bit about it.
Daniel: We do letter of credit financing. I know a little bit about it
from our point of view. I guess from a client’s point of view or
someone who’s interested in letter of credit financing, the only
real thing you need to understand is that it operates very
similarly, it’s similar to a bank guarantee, and it’s usually
used for overseas financing or given to suppliers overseas.
Julia: So what is it?
Daniel: It’s basically a bank guarantee. So it’s just a guarantee to
the manufacturer overseas that, should they ship the goods or
fill the conditions listed on the letter of credit, their bank
will pay them.
Julia: Right. Okay.
Daniel: That’s really all it is.
Julia: So that’s basically covering how it works then, as well.
Daniel: Yeah. It’s better than paying by direct deposit or TT, because
it protects the buyer here or the importer in Australia from the
manufacturer overseas getting paid and not shipping the goods.
Daniel: In theory.
Julia: Right. Okay. So what are the requirements to get a letter of
credit financing through us?
Daniel: Yeah, from us, really when we issue letters of credit, they’re
actually Westpac or an Australian big four bank’s letter of
credit. All we’re doing is putting up the collateral to finance
that letter of credit. So we go to Westpac. We get our money
instead of the client, because our client may not have the cash
or the security. We go to the bank on their behalf, or on our
own behalf I should say, and we give the bank the cash to secure
it. So the money leaves our account, goes to Westpac’s account,
and we have no further access to it, and it secures that letter
of credit. Now when that supplier overseas satisfies that letter
of credit, they go to their bank, they cash it, and our bank
releases the money to their bank – I think it’s in that order –
and their bank then pays them. The supplier, that is, overseas.
Daniel: So the requirement, from our point of view, is we generally
these days – and I say generally because there are always
exceptions to the rule – we will finance a letter of credit
provided that our client has a corresponding purchase order from
a reputable customer here in Australia or overseas, because we
finance them. We’ve got some clients that manufacture in China
and then they ship to the U.S., and their orders are based on
U.S. orders or maybe New Zealand or even Europe. But generally,
most of the time our clients are importers at the moment,
because of the way the Aussie dollar is, it’s no surprises
there. But it is usually pre-sold, the goods that we’re
Julia: Yeah. Okay. Then finally, we’re just going to say why you would
use it, but I think you’ve covered that basically.
Daniel: Yeah, that’s right.
Julia: Is there anything else you wanted to add?
Daniel: Look, I’ll just reiterate, it’s just an extra layer of
administration, because they can be a little bit painful to
issue, and a lot of the times, a lot of the smaller suppliers
will struggle to satisfy them. So there are always amendments
that have to be made to them. So it causes a little bit of
administration for our business and also the supplier, but at
the end of the day, in most cases, it is worth it because it
gives the buyer here and us, as the financier, that extra little
bit of protection to make sure that those goods do get shipped.
Now there’s no guarantee that the goods will get shipped. I
mean, how do you know exactly what’s in those boxes? Well, we
use auditors for that, but that’s another segment we should talk
Julia: That’s another Whiteboard Wednesday.
Daniel: Yeah, that’s right.
Julia: Okay. All right. Thanks, Daniel. Thanks for watching guys. If
you’ve got a question, please call the office, and I’ll organise
an appointment for you. Bye.
Daniel: Thanks very much.