Publication evofenedex globe magazine for international entrepreneurship, April 2021 – www.evofenedex.nl
In international business, obtaining payment security is of paramount importance. A Letter of Credit or Cash Against Documents can offer a solution. The risks of non-payment can be mitigated in several ways. We speak with Marloes Wittebroek, director of Elceco from Veghel, about the Letter of Credit and Cash Against Documents, two common payment instruments in international trade.
“When you do business internationally, you have to decide with every order how this order will be paid,” Marloes Wittebroek begins. “To minimize the risks in international transactions, many exporters opt for a Letter of Credit (L/C) or Cash Against Documents (CAD).” In the past year, Marloes has seen more companies start working with LCs. “Especially companies that previously did business on the basis of prepayment, but which, due to global unrest, wanted more certainty, turned to an L/C.”
Payment Obligation with a Letter of Credit
The Letter of Credit is an obligation of the buyer’s bank to pay the exporter a certain amount on a certain date or to accept a draft. The essence is that a bank, under certain conditions, undertakes to pay, directly or in the future. The exporter no longer runs a debtor risk, but still runs the bank risk and the economic or political risk. If the exporter also wants to exclude these risks, he can ask the advising bank to confirm the documentary credit. If this bank is willing to do so, the exporter has to deal with a payment obligation from (usually) his own bank.
Letter of Credit as the Most Secure Option
“Various factors influence the chosen payment method,” says Marloes. “Issues such as regulations from foreign governments play an important role here. In a number of countries, it is determined by the government that you can only do business above certain amounts on the basis of an L/C. Countries in the Middle East, Africa and the Far East in particular often use LCs.
When you have previously done business with a company in a positive way and there is trust back and forth, CAD can be a suitable solution. If you are trading with a party for the first time, the use of an L/C is more obvious. An L/C is the most secure option for both buyer and seller. The buyer only has to pay once the goods are actually on their way to him and the seller has the certainty that the agreed order amount is available to him at the buyer’s bank. CAD has the same document process, but offers slightly less security.” With Cash Against Documents, the importer, at the moment he accepts the documents from his bank, gives approval for payment by his bank to the exporter.
Differences Between an L/C and CAD
Even though both L/C and CAD work with documents, there are several differences between the two payment instruments. Marloes: “When using an L/C, the correct preparation of documents is very precise. You must follow the L/C’s instructions exactly to be able to receive a payment. On the other hand, with CAD, the prescribed documents do not have to comply with strict regulations. The most important starting point here is that the documents must not contradict each other in content. This makes the CAD process very simple compared to an L/C.
Another difference is that with an L/C, the order amount is fixed at the opening foreign bank, and upon presentation of correct documents under the L/C, payment by this bank is mandatory. This is not the case with CAD; the order amount is not fixed at the opening bank. If problems arise in the latter situation, as a result of which the potential buyer no longer has the money, you as a seller no longer have control over the money.”
According to Marloes, entrepreneurs often underestimate that with the choice of an L/C, the necessary effort is expected in its follow-up and implementation. “Drawing up documents (in a timely manner), instructing third parties and the continuous follow-up of this can be quite challenging for exporters.”
