Protect your business: Use letters of credit effectively

Imagine this: you've just closed a massive international deal. Your buyer is across the globe, excited, ready, and seemingly trustworthy. You ship the goods, celebrate the successful transaction... and then radio silence. No payment. No updates. Just stress.

This is the risk many exporters face when stepping into global markets. But there’s a tool specifically designed to protect you from these nightmare scenarios—letters of credit. When used correctly, they’re a rock-solid way to ensure you get paid and your trade partner gets what they ordered.

In this post, we’ll dig into what a letter of credit means, how it fits into export transactions, the full letter of credit process, and some pro-level advice on how to use it without falling into common traps. Let’s get into it.

What is a letter of credit and why does it matter?

At its core, a letter of credit (LC) is a written commitment from a bank. It says: “If the seller follows these specific rules and delivers the right documents, we’ll pay them—even if the buyer doesn’t.” This transforms the bank into a middleman that ensures no one loses out.

So, why does this matter in international trade? Because international deals often lack trust. Different legal systems, languages, and financial norms can make even a simple contract feel like a gamble. A letter of credit eliminates that uncertainty. It’s not just about money—it's about building trust in situations where face-to-face reassurance isn’t possible.

Let’s paint a quick picture: You’re an Indian exporter, shipping LED displays to a client in the U.S. You don’t know them well, and you're naturally skeptical about sending goods worth thousands of dollars. Instead of just hoping for the best, you ask for a letter of credit. The buyer agrees, and their bank issues an LC that guarantees payment once you ship the displays and submit the agreed documents. You fulfill the terms, present the paperwork, and receive your payment on time. That’s the power of an LC.

How letters of credit protect your business

Letters of credit aren’t just nice-to-haves—they’re must-haves when the stakes are high. They provide a structured framework that benefits both sides of a deal. And let’s face it: peace of mind is priceless in business.

For exporters, the most obvious benefit is payment security. Once you meet the LC’s conditions, the bank is on the hook to pay you—regardless of whether the buyer goes bust, disappears, or disputes the shipment. That’s a level of security that can keep your cash flow healthy and your production lines running smoothly.

But it’s not just about exporters. Importers benefit too. An LC shows your supplier that you mean business. It reassures them that you’re financially stable and ready to pay—once they do their part. That trust can help you negotiate better prices or more favorable delivery terms. Plus, you only part with your money once the seller has proven they met your conditions. That keeps the quality and delivery expectations in check.

The letter of credit process: step by step

Understanding the LC process can make the difference between a smooth transaction and a paperwork nightmare. Here's how it flows:

1. Agreement – Both parties agree on using a letter of credit and define all transaction terms—like amount, shipping date, and required documents.
2. Application – The buyer requests the LC from their bank, which drafts the terms based on the agreement.
3. Issuance – The bank issues the LC and sends it to the seller’s (exporter’s) bank.
4. Advising – The seller’s bank reviews the LC for accuracy and notifies the seller.
5. Shipment – The seller ships the goods as agreed in the contract.
6. Presentation – After shipping, the seller submits all required documents (like invoice, bill of lading, certificate of origin) to their bank.
7. Verification – The bank checks the documents to ensure they comply with the LC terms. Even small discrepancies (like a misspelled product name) can delay payment.
8. Payment – If everything checks out, the bank releases the funds to the seller.

This might sound complicated—and to be honest, it is a bit. But with the right bank and a bit of experience, it becomes a reliable, repeatable system that removes much of the unpredictability in international sales.

Types of letters of credit (and when to use them)

Different business scenarios call for different types of letters of credit. Understanding which one fits your transaction is key:

• Revocable letter of credit: This type can be changed or canceled by the issuing bank without prior notice to the seller. It’s rarely used because it offers minimal security for the seller.
• Irrevocable letter of credit: This is the most common and preferred type. Once issued, it cannot be amended or canceled without the consent of all involved parties. It provides assurance that the terms won’t change unexpectedly.
• Confirmed letter of credit: In this version, a second bank—typically in the seller’s country—adds its own guarantee to the LC. This is a smart move when the seller isn’t confident in the issuing bank’s credit rating or the political stability of the buyer’s country.
• Sight letter of credit: Payment is made as soon as the bank verifies that all documents match the LC terms. It’s ideal when the seller needs immediate payment.
• Usance (or deferred payment) letter of credit: Payment is delayed for a specific number of days after document verification, giving the buyer extra time to arrange funds or sell the goods.

Each type serves a strategic purpose. Picking the right one helps you balance between risk, trust, and cash flow.

Benefits of using letters of credit

So why should a business bother with letters of credit instead of just sending an invoice and waiting for a wire transfer? Because LCs do more than just “ensure payment.”

• Minimized risk: They virtually eliminate the risk of non-payment for exporters and reduce the risk of receiving the wrong goods for importers.
• Improved relationships: Buyers and sellers can focus on the business, not on worrying whether the other party will follow through.
• Professional structure: LCs enforce deadlines, documentation standards, and conditions that keep everyone accountable.
• Stronger negotiating power: A buyer offering an LC is seen as more trustworthy. A seller accepting one is seen as more flexible and professional.
• Financing opportunities: Exporters can sometimes get advances from their bank before the buyer even pays, using the LC as collateral.

In short, letters of credit aren’t just about money—they’re about building systems that support international growth.

Common pitfalls to avoid

As useful as they are, letters of credit aren’t foolproof. If you’re not careful, you can still lose time or money. Here’s what to watch for:

Strict compliance

Banks are picky. Every term in the LC must be met exactly. A typo, missing stamp, or mismatched document date can delay or derail your payment. It’s all or nothing.

Unexpected costs

Between issuance, advising, confirmation, and negotiation fees, LCs can get expensive. Make sure you know who’s covering what in advance.

Delays

If your documents aren’t perfect—or if your bank moves slowly—expect delays. Build in extra time for document preparation and corrections.

Fraud

It’s rare, but it happens. Fraudsters might submit fake documents or impersonate real businesses. Always vet your trade partners and use reputable banks.

Tips for using letters of credit effectively

• Know your terms inside and out: Don’t sign off on an LC unless you understand every requirement. If it’s unclear, ask your bank to walk you through it.
• Choose reliable banking partners: Banks with global trade experience are your best allies here. They’ll help you navigate the LC process without drama.
• Keep your paperwork tight: Accurate, complete documentation is your ticket to fast payment. Don’t leave room for error.
• Stay in touch with all parties: Good communication between buyer, seller, and banks ensures fewer surprises.
• Match the LC to the deal: Choose the LC type that aligns with your risk appetite, product timelines, and cash flow needs.

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A well-structured letter of credit is like a trade insurance policy. It’s not flashy, but it works quietly in the background to protect your time, money, and reputation. Whether you're an ambitious exporter entering new markets or a seasoned importer handling big orders, understanding how to use LCs effectively is a crucial skill.

So the next time you hear the term "LC," don’t let it intimidate you. Think of it as your business bodyguard—making sure that what’s promised is what’s delivered, and that everyone gets paid fairly.

Frequently asked questions about letters of credit

1) What is a letter of credit in export transactions?

It’s a payment guarantee issued by a bank, ensuring that the exporter will get paid once specific shipment and documentation terms are fulfilled.

2) How is the letter of credit process managed?

The buyer initiates the LC, the bank issues and advises it, the seller fulfills terms, and the bank pays upon successful document verification.

3) Who pays the letter of credit fees?

It depends on the contract. Typically, the buyer pays issuance fees, and the seller covers advising or confirmation fees.

4) Can a letter of credit be cancelled?

Only a revocable LCs can be cancelled without notice. Most modern LCs are irrevocable for added protection.

Disclaimer: The information provided in this blog is for general informational purposes only. Always consult with a financial expert before making any business decisions.

Contributed by Denila Lobo

Denila is a content writer at Winvesta. She crafts clear, concise content on international payments, helping freelancers and businesses easily navigate global financial solutions.