Understanding Letter of Credit Discounting

Every business needs a fund for running its operations, be it for starting a company, expanding a company, purchasing machinery or working capital need. The major requirement of finances for many businesses is for working capital. Traditionally, most of the working capital financial instruments were secured, where one must have some kind of mortgage on the property. But, now there are unsecured working capital instruments which avail loans even without collateral.

LC Discounting

The letter of credit is the financial document issued by a banker where a guarantee is given by the bank to pay to the seller for the buyer’s obligation, in case a buyer fails to make the payment. LC discounting takes away the risk and gives assurance to the seller for the funds. Such an instrument is used in international trade mainly where the buyer and seller are unknown and have to risk in a transaction between each other. There is involvement of majorly 4 parties in such a transaction namely: Exporter, Exporter’s Bank, Importer and Importer’s bank. The request for LC can be done by both a buyer and seller and the term and conditions are decided mutually between them.

Features

1. LC Discounting speeds up the cash flow of the business organization and assist in working capital management effectively.
2. The risk of transaction is resolved by such an instrument and hence gives assurance to both the parties involved.
3. The following are the benefits to the parties.

• The seller gets immediate cash flow for his business
• The buyer gets a credit period for making payments
• The bank receives interest for the said services

1. LC is discounted only after checking the authenticity of the payment from the buyer, which proves that the instrument is safe and secure in funding.
2. LC discounting can be availed by both domestic and international customers, but it is majorly used in international transactions.
3. The relationship between the exporter and importer is developed well and there is smooth working of the entire procedure.

Process of LC Discounting

1. In the case of a manufacturing or trading company, the sellers may require fund immediately and cannot wait for the due date. In such a case, LC Discounting plays a major role in assistance to the eligible sellers.
2. Buyers on-demand from the seller request Letter of credit (LC) from the respective banks before shipment of goods and send the same towards the seller/exporter bank.
3. The exporter bank checks the authenticity of the document and communicates the acceptance to the seller.
4. The exporter receives the Letter of Credit and requests it for discounting.
5. Hence. The bank discounts the LC after deducting the charges or discounting fees. The exporter gets the money and uses the same for his business expenses.

Example

Let us suppose that “ABC Private Ltd” is a company engaged in manufacturing situated in India. The company receives an order of goods from a foreign country “XYZ Private Ltd” which is asking for a credit period of 60 days for the payments of goods. Being unknown to each other, “ABC Pvt Ltd” demands a Letter of Credit from “XYZ Pvt Ltd” and sends it for confirmation towards “ABC Pvt Ltd” who checks the letter and accepts it and can discount the same. By discounting the LC, the seller will get the immediate cash flow and do not have to wait till the ending of the credit period.

FAQs

When is the requirement of LC?

The main requirement of LC is when the parties are unknown and have to risk in transacting with each other. It is used mostly in international transactions.

Who can avail LC Discounting facility?

All the eligible businesses who are engaged in manufacturing or service industries can apply for such a facility. It can include selling or shipping of goods, trading businesses or other related businesses.

How much is the interest charged for discounting?

The interest/fees depends upon the amount of the transaction, the Credit score of the buyer, history of the debtor, etc. and vary according to the clients.

What are the documents required for discounting LC?

The documents include shipment and insurance bills and original LC issued by the buyer’s bank.

How Terkar Capital help you?

Terkar Capital is one such financial consultant that arranges both conventional and non-conventional debt products for their clients. We have a team of experts who constantly help the borrower in all the steps, right from the first meeting till the repayment of funds. Our timely and efficient services make us different from others. So whenever it is raising funds, Terkar capital is ready to serve you at best!