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Take the Edge Off Risk With Letters of Credit
Talk about using letters of credit, and most people will think you're dealing in international trade. Letters of credit are not commonly used for domestic credit. However, in some industries letters of credit are becoming a simple necessity. One such industry is the meat industry.
"We have a saying in the meat industry," says Marilyn Ehn, CCE. "If we don't sell the product, we smell it." Ehn is the former corporate credit manager and current payroll manager for Monfort Inc. (Greely, Colorado).
"Letters of credit allow us to do business with customers we wouldn't otherwise be able to sell to," she explains. "Because we aren't able to go out and reclaim our product, letters of credit take the edge off the risk of doing business."
She offers some solid recommendations on how to make the most out of letters of credit.
Identify Needs
The first step is to explore your specific needs related to letters of credit, as well as the various types of letters. Consider the following questions:
- What type of letter of credit do you need? There are several types of letters of credit--commercial, standby, etc. "You need to understand what each type provides and then make certain you match the type of letter to your specific needs," Ehn says. "For example, if you're looking for security for a single shipment, you wouldn't want the same type of letter of credit that you would need to cover several shipments over a specific period of time."
- Do you understand the terminology? "There is an assortment of technical terms that may be used in a letter of credit," she says. "You need to understand what the terminology means, what it can do for you, and what you want it to do for you."
- Do you have verification? You'll want to confirm that whoever signed the letter of credit is actually a bank officer. You'll also want to verify that the bank is solvent. "It's a good idea to maintain a list of all banks you have dealt with and check to see that they have been approved within your organization as a qualified agency," Ehn says.
Drawing on Letters of Credit
As a credit manager, Ehn made it a point to employ careful procedures with all letters of credit. "I wanted to make certain that all letters of credit would be handled properly--even if I was out of the office when it came time to draw on a letter of credit. I wanted my staff to be able to administer a letter of credit without my help and without creating a stressful situation or leaving us open for noncompliance."
To that end, Ehn developed a checklist of documents that needed to be prepared and presented to the bank, as well as instructions on how to organize the package prior to mailing.
The coversheet - This would contain the following information:
- The name of the bank.
- The name of the person signing the letter of credit, along with the person's department and title.
- The customer's name.
- The draft number.
- The face amount of the letter of credit.
- An itemized list of what would be contained in the package sent to the bank:
- The original letter of credit and amendments (if called for). "Letters of credit are usually very specific," she explains. "Some letters of credit require only a copy of the letter. In either case, specify the type of document you're sending to show that it complies with the terms of the letter of credit."
- Sight draft.
- Invoices being drawn on.
- Beneficiary statement as demanded within the letter of credit, stating to the effect that Monfort was exercising their rights under the letter of credit.
The explanatory letter - Ehn would also include a letter of explanation delineating why Monfort was drawing on the letter of credit--that the customer had failed to directly pay its obligations within normal terms.
International Credit Today
For more information on international credit issues, check out Credit Today's
International Credit Today
... If you are not extending international credit now, you may be in the next year or two. Learn the ins and outs of doing business in Mexico and South America and the future of business in Asia. We tell you how to collect foreign debts, how to use international credit reports, how to do international collections by telephone, the meaning of the key Incoterms, and the uses of forfaiting and letters of credit.
International Credit Today
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If the letter of credit you're drawing on requires specific language in order to exercise your rights, be sure you copy that language exactly. "I copied the language word for word," she says. "This includes typos, misspellings, and all other mistakes that have been inadvertently made." The letter would also include the following information:
- A statement along the lines of "The drawing of this letter of credit covers amounts due from the company that remain unpaid." Again, this language should be quoted directly from the letter of credit.
- A paragraph explaining that this was in payment of the draft and list the draft number being used.
- Information on where and how to make payment, normally asking that funds be wired and stating the name of the bank, the account number(s), the American Bankers Association routing numbers, and any other special instructions.
- A short note at the bottom of the page requesting that the bank call Ehn if there were any problems in wiring the funds or any other questions.
Maintenance
Renewal of letters of credit varies depending on the type of document. Some are dated to expire after a certain amount of time ranging anywhere from one week to one year. Others are automatically renewed each year.
"We maintained an ongoing log of all letters of credit--both alphabetically and chronologically," Ehn says. "One month prior to an expiration date, we would send a letter to the bank and to the customer explaining that we would need to receive a renewal for the letter of credit two weeks prior to the expiration of the current letter. Without renewal, we warned, we would not be able to maintain the customer's current level of credit with our company." Individual credit reps would also receive copies of this letter. This enabled them to stay current with the credit status of their customers and gave them a tool to prompt a call to the customer if the renewal was not received by the time specified. It also helped management to have an everyday accounting which allowed them to "catch" those customers who might fall through the cracks and receive an order after the letter of credit had expired.
Solid Protection
"Letters of credit served our company well," Ehn says. "I only had one instance in nine years where I was 'home-towned.' In that particular case, the banker--a good friend of the customer--notified the customer that we were exercising our rights under the letter of credit. The bank was able to delay just long enough for the customer's attorney to file with the court and order a stay.
"But this was only one of many situations. Letters of credit allowed our company to grant secured credit quickly to customers and with little conflict or wasted time for either our company or our customers. They provided a means for the sales department to sell to customers that might not be good credit risks under normal circumstances."
Editor's Note: The above article originally appeared in the Credit & Collection Manager's Letter, which Credit Today purchased in 2006.
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Outlook 2012
This month's survey explores...
- What the top problems are facing credit execs currently, and
- What the top improvement initiatives are.
Click here to participate!
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