In today’s quick-paced global economy, exporters want immediate access to their international sale proceeds, and continue to prefer the security of using letters of credit for their transactions. On the other hand, importers often hope to delay payment as long as possible, and don’t want to borrow funds at high interest rates to pay for the goods.
Can both exporters and importers get what they want? Yes!
By discounting a time draft under a letter of credit (LC), a very simple solution, both exporters and importers can be satisfied. And, it gets better. The costs to achieve this are relatively low, and can be built into the price agreed to between the buyer and seller.
Through the use of a discounted time draft under an LC, exporters can collect cash immediately, while offering importers very attractive payment terms.
This allows the exporter to obtain cash for the goods as if a “sight” LC (payment due immediately after the negotiating bank reviews and approves the documents) were used, instead of the maturity date expressed in the time draft. In turn, the exporter can grant the importer liberal payment terms of, say, 180 days, but not have to wait 180 days for payment.
By taking advantage of this solution, and extending attractive payment terms to the importer, you can significantly increase your level of international competitiveness.
Importantly, the importer doesn’t have to obtain a loan to pay for the goods. This is very good news for foreign buyers, since loan rates offered overseas often are much higher than U.S. rates, due to limited access to U.S. dollars. Plus, your buyers will have more time to meet their financial obligations. In fact, this extended time period may even be enough for the importer to sell the goods.
Upon approving the documents, the negotiating bank accepts the time draft under the LC, thus agreeing to pay the beneficiary (exporter) on the maturity date of the draft.
In our example, assume you and your buyer agree on terms of 180 days for the sale of goods valued at $500,000. Under these LC terms, typically, you would not receive payment until the maturity of the draft, 180 days later. If, however, you desire access to your funds sooner, you can request that your bank discount your draft. Since your bank already has accepted it, the draft immediately will be discounted and the proceeds remitted to you, less fees and discount charges.
Assuming an all-in rate (acceptance fee plus discount interest) of 8% (annual) and a tenor of 180 days, you would receive the discounted proceeds of $480,000 as follows: $500,000 x 8% x 180/360 = $20,000 discount; this $20,000 subtracted from $500,000 = $480,000.
Rather than bear all the financing cost of discounting the draft yourself, you can shift it to your buyers by building it into the original sales contract price. Or, if you and your buyers agree, you can add it to the invoice price as financing costs. And, by doing so, you’ll actually save your foreign customers money.
Should you utilize a sight draft (funds due immediately), your buyers would probably want or need to finance the purchase. Yet, to do so, the loan rate of interest they would obtain from their local bank likely would be higher than the 8% noted above.
By offering your customers extended payment terms under a time draft, they would be less likely to need financing, and more likely to save money, by paying the lesser costs involved with the discounting of the draft.
When you have Bank of America discount your time drafts under LCs, you can look forward to a number of benefits that attract buyers and stimulate your international sales, including:
Understand dynamic global markets.
Understand what’s occurred and more accurately assess what’s ahead. Improve your corporate strategic plan, seize the right opportunities, and boost competitiveness and profits.
Informative, analytical and policy-oriented perspectives.
Comprehend the impact of past events and fully grasp and prepare for the challenges ahead.