A standard, commercial letter of credit is a document issued mostly by a financial institution on the request of the buyer in favour of supplier of goods which usually provides an irrevocable payment undertaking. It may be Inland LC or Foreign LC. In this case the buyer bank gives guarantee on behalf of its client to supplier for supplying of material or goods subject to that invoices, bill of lading, shipment documents will come directly to the bank. Bank will mark lien on the goods and will stand as lender/creditor in the books of the client (buyer).
The supplier could opt for discounting of LC. In this case he will approach his bankers/agent/factor that will again approach to the buyer client. The buyer bank will make payment (after deducting the margin) on behalf of its client for a fee.
The margin is normally in the range of 10 to 25%, and bank put the money in the form of FDR at prevailing rate till the settlement of the final claim.
LC could be at sight LC or usance LC.
A ‘sight’ LC means that payment is made immediately to the beneficiary/seller/exporter upon presentation of the correct documents in the required time frame. (DP LC or Delivery on Payment)
A ‘usance/time’ LC will specify when payment will be made at a future date and upon presentation of the required documents (DA or Delivery on acceptance)
Point which may be remembered:
-Make the detail of DA or DP LC from copies of LC issued by bank so that distinction can be made to avoid any confusion whether a LC is DA or DP. Suppose company has requested for DA LC and paid the charges but also made payment immediately on receipt of documents under impression that the same is DA LC. It is general mistake in small organizations.
-Check what is requested and what is issued (i.e. DA or DP). The same should requested by authorized officer of the
-Charges paid to bank. Many times there is some discount on the charges which can be checked from sanction letters or any letter received from bank.
-After payment of LC the required docs should be kept in the accounts department which may consists invoices, letter of lading, shipment documents, bank payment advice, proof of receipt of docs at site etc
-Check that the company has not cross the limit as given in Bank sanction letter
-Some time LC’s are opened and issued but forgotten by bank and company. This thing should be checked.
-Check unnecessary charges should not be levied due to delays by other parties
-If terms of LC are revised, check the same should be as per system i.e. request is made and authorized by the signatory in bank.
-One can check the accounting entries in books
-The LC limit should reflect in the Contingencies in Balance Sheet
-It may also happen that docs are lying with bank but nobody requested for payment of same. It may cause unnecessary utilization/blockage of limit and also payment of demurrage charges at port
-Check whether the detail of materials received at site and mentioned in invoice commensurate or not
-Note down the LC’s which are still open due to part payment made but the same should be mentioned in terms of LC