Trade finance is a type of financing that helps to facilitate trade between domestic and foreign entities.
Trade finance includes a variety of financial instruments, including letters of credit, export credit insurance, and syndicated loans.
A usance letter of credit is one subset of the many types of letters of credit available to businesses through trade finance.
Below, we’ll detail what a usance letter of credit is and why it can be useful for your business.
What is a Usance Letter of Credit?
A usance letter of credit is a letter of credit that allows the buyer to delay payment for the goods until a later date. A usance letter of credit is also issued by a bank or other financial institution, as opposed to an ordinary documentary draft or cashier’s check.
A usance letter of credit can be used in any scenario where you need delayed payment for goods or services rendered.
For example, if you are selling furniture online and want your customers to pay after they receive their furniture but before shipping it out, then this type of L/C would be useful for both parties:
- For you because now it doesn’t matter if your customer pays late (or doesn’t pay at all);
- And for them because now they know when they will receive their item
Why are Usance Letters of Credit used?
The following are the main reasons for using a usance letter of credit:
- To provide assurance to the seller that payment will be made.
- To provide assurance to the buyer that the goods will be delivered. This is especially important when importing goods from overseas, as there may not always be time for an exchange of letters or emails confirming delivery and payment terms before shipment takes place.
- To provide assurance to the bank that their customer has sufficient funds available in order to make payment on delivery of goods, thus avoiding any risk associated with non-payment by either party.
Benefits of a Usance Letter of Credit to the Buyer, the Seller and the Bank
- To the Buyer: The buyer receives a payment guarantee from their bank. If the seller does not provide the goods that were agreed upon, then the buyer can use their letter of credit to get reimbursed by their bank.
- To the Seller: A seller who is concerned about being paid can request a letter of credit as collateral for a sale. If you are selling to someone who may be unable to pay, you can request that they provide this type of payment assurance before agreeing to do business with them. By using usance letters of credit as collateral, you have better protection against defaulting customers in case they cannot pay when they are supposed to do so.
- To The Bank: Banks make money by charging fees for issuing these types of letters of credit and giving out loans based on them (as long as there is no fraud involved).
A usance letter of credit allows you to negotiate a longer period before you pay for imported goods. This can be beneficial in many situations.
A usance letter of credit allows you to negotiate a longer period before you pay for imported goods. This can be beneficial in many situations.
This allows you to negotiate payment terms with your supplier, based on the buyer’s ability to pay and other factors. For example:
- The buyer may have less cash flow than usual due to an upcoming large purchase from another supplier, so they’re unable to pay as soon as requested by their supplier. In this case, they might ask for an extension on their next order with this supplier until after their big purchase is made and paid for. This would allow them enough time to receive payment from their previous supplier before needing to make payments again (or if the prior sale went through smoothly).
- If there are transportation issues with getting goods from overseas suppliers into your warehouse, then that could delay when it will arrive in time for delivery before expiration date of the letter of credit — thus making it more likely that there will be penalties if payments aren’t made on time or even at all!
As a small business owner, you need to be sure that your goods will be paid for when they arrive.
And as an importer, you need to make sure that your funds are available when needed. Trade finance is a way to accomplish both of these things.
By using trade finance and issuing your own usance letter of credit, you can make sure that the goods being imported will be paid for in a timely manner and also make sure that the customs broker, freight forwarder or other party responsible for receiving payment on behalf of the importer has sufficient funds available at all times.
