Currency fluctuations, issues on non-payment, creditworthiness, or instability are some of the commonly seen inherent risks in international trade. To evade this, trade finance involves various modes of payment in international trade, including consignment, open account, documentary collections, cash-in-advance, and letters of credit.
A letter of credit is a guarantee issued by the bank to another bank (usually from another country) for the payments made by a company to its international clients under specific conditions. Therefore, companies that opt for a letter of credit as their best payment option for their international sale must ensure that not only the letter of credit but also the entire process is done correctly. Here are some common mistakes exporters must avoid while creating letters of credit.
1)Â Â Not considering all the methods of payment before making a decision.
As mentioned above, each mode of payment serves a purpose when it comes to international trade. And a company might be making an expensive mistake if it does not consider all the payment methods before selecting the one that best suits their needs. Creating letters of credit can be a complex process. Therefore, it is recommended that they research all the options available for them because there might be another one that is better suited to their needs.
2)Â Â Choosing the letter of credit payment method not understanding its real purpose
Issues come up in any form of documentation and payment when one does not have a clear idea about what it is and its real purpose. This could lead to more complications and the exporter might not know if they are meeting all the requirements or if they are following the right procedure to develop the letter of credit. They must take the time to understand what it is, what it does, and how it works before beginning the process.
3)Â Â Failing to negotiate the terms when the contract is being made
International trade finance involves strict contracts that both parties must legally adhere to. Not stating the terms of one’s letter of credit in their contract could lead to serious legal issues that might not end well for the exporter. This is especially an issue if the sales team does not work in cohesion with the legal and the accounting team to get the payment process right. The company can ensure a smooth transaction by clearly discussing all the terms with their international client or partner from the outset.
4)Â Â Not verifying if the proforma invoice is in line with the agreed contract
Conflicting documentation is one of the major reasons for payment relation complications when it comes to international trade. Each country and each company have their own laws on documentation that are all well thought out and legally bound If the exporter is unaware of the terms and regulations they have agreed upon, then it could inadvertently lead to issues in payment. The solution is as simple as being informed thoroughly about all the negotiating terms to avoid such errors.
5)Â Â Having an inexperienced employee create the letter of credit
Most of these financial errors occur due to incompetency among the professionals in the financial and legal department when it comes to international trade. Therefore, the company must hire someone who is experienced with trade finance and has all the background information required to create the letter of credit the right way.
Adhering to all the international standards of accuracy and completing the export documentation with the right financial consultants ensures a smooth transaction when it comes to international trade.