Which is Better for Me? A Letter of Credit or Cash Against Documents?
Trade Financing Programs from Bankers Factoring
Trade Finance is funding provided by Bankers Factoring that supports the sale of physical goods, either domestic or international, by reducing quality and payment risk for both the buyer and seller.
Tension exists in the settlement of any trade for both the exporter and importer. With the current bottleneck in the supply chain, the Seller ideally would like to receive cash up front, eliminating collection risk and working capital requirements. The Buyer on the other hand wants the assurance that the physical goods are delivered according to agreed-upon specifications, both in terms of quantity and quality before the settlement is made, and prefers payment terms in place in order to better manage their own working capital.
This can be particularly true for both parties for first-time trades or cross-border transactions where settlement and collection risk are viewed as greater than in a well-established relationship built on a record of mutually satisfactory exchanges.
Trade Finance from Bankers Factoring is also known as PO Funding or Import Financing can mitigate both the quality and payment risk for both the US Importer and Foreign Exporter.
Role of Bankers Factoring in Trade Finance
Many commercial finance companies offer Trade Finance as a means of facilitating the sale of goods and services by acting as an intermediary between Buyer and Seller, linking both parties together by reducing risk on both sides of a trade.
Buying products for the first time or from overseas can often present small businesses with opportunities to expand their own customer base or service existing clients at improved margins. New suppliers may not meet specifications, and the only way to find out is to actually do a trade. The added drawback to importing is difficulty in arranging timely payment to the Seller or tying up valuable credit capacity.
Reliable background information is often hard to come by depending on the jurisdiction, and trust is unfortunately not always a recognized currency domestically. At the same time, the Seller needs comfort that they are going to be paid. Collection efforts can be difficult and expensive to pursue if something should go wrong.
By organizing a sale around a “Cash Against Documents” or CAD arrangement (sometimes referred to as “documentary collections or documents against payments”) both Buyer and Seller can gain a meaningful measure of protection. The Buyer gets assurance that it is receiving exactly what was ordered. The Seller maintains title to the goods until they are paid. Conducting business in this fashion, especially at the start, can facilitate trade and help build long-term relationships leading to repeat orders and trade transactions.
Benefits of Trade Financing from Bankers Factoring:
For the Buyer:
- Helps ensure the buyer/importer receives exactly what was ordered before making payment
- Does not tie up minimal working capital
- Another set of eyes on shipping documents
- Easy, low-cost implementation and execution
For the Seller:
- Reduces credit and collection risk
- Easy to put in place compared to other payment methods
- Export financing FOB country of origin
- excelerate cash flow
- Low overall cost
Types of Trade Finance from Bankers Factoring
Open Letters of Credit (supporting domestic or international trade)
A Letter of Credit is a promise from a financial institution to pay the beneficiary an agreed-upon sum upon a certain date on behalf of its client.
How do Letters of Credit Work?
- The Buyer is able to give comfort to the Seller that they will be paid, by having its commercial finance company issue the promise to pay on its behalf.
- The Seller now is no longer shouldering the credit risk of the Buyer. The payment has been backed by the finance company.
- Seller can get added comfort by having its own financial institution add its promise to backstop payment by the finance company (a process called “Confirming”)
- Payment is made by the finance company to the Buyer when the Letter of Credit is presented by the Seller. Simple.
What is the Letter of Credit Process?
- The Buyer works with its commercial finance company to issue a Letter of Credit, naming the Seller as beneficiary.
- The commercial finance company issues the Letter of Credit, which is a binding promise that the finance company will pay the Seller a specified sum.
- The commercial finance company will reserve the amount of the letter of credit from usage under the Buyer’s credit facility. Because the Letter of Credit is a promise to pay, the fees attached to it can be much higher than on borrowed funds, normally around 3-5%.
- Open Letters of Credit typically have many conditions attached to them. They are negotiable after a certain date.
- The Seller presents the Letter of Credit to its financial institution which in turn surrenders it to the commercial finance company for payment.
Letters of Credit Benefits:
- Seller is relieved of collection risk – they are now being paid directly by a well-established finance company.
- Easy, straightforward process.
- While the amount is reserved from available borrowing capacity, the costs can be lower than a loan, if you are bankable.
- Buyer can get attractive payment terms because the Seller has assurance that the paying party is credit worthy.
- Payment date can be extended to the benefit of the Buyer’s working capital cycle.
Letters of Credit Negatives:
- Letters of Credit can be an expensive finance solution if you are not Bankable
- They are not always negotiable by seller
- They are not easily monetized by the seller
- They put on a hold a credit facility or needs to be backed by cash
Cash Against Documents (supporting international trade)
Cash against documents is a means of settling payment for the purchase of goods from an overseas seller. The seller gets paid, and title passes to the buyer once documents supporting the transaction are presented and accepted by an agent acting on behalf of the buyer.
How Does Cash Against Documents Work?
- Cash Against Documents is an internationally recognized, and widely accepted means of settling cross border trade
- The process involves the participation of third-party agents, often banks or financial institutions, acting on behalf of Seller and Buyer
- The package of documents transmitted to the Buyer’s Agent provides full details of the shipment and includes transfer language that allows title to the goods to pass to the Buyer upon payment to the Seller
- Documents to the importer are exchanged between Agents, presented to the Buyer for payment, whereupon title to the goods is released
What is the Cash Against Documents Process?
- Buyer and Seller agree to a commercial sale of goods, including quantities, product specifications, timing, destination, price, and terms of the sale.
- Seller prepares order and organizes shipment of goods
- Seller prepares a package of supporting documents including invoice, copy of the commercial contract, Bill of Lading, insurance details, Bill of Exchange, and other supporting documents required by the country of origin and the country of destination
Of note about Cash Against Documents:
- A commercial invoice is always included, as is a copy of the commercial sales contract outlining the terms and conditions of the trade
- A Bill of Lading is a document serving three main functions: it confirms that the goods have been loaded, provides details of the terms of carriage, and serves as legal title to the shipment
- Insurance documents specify coverage limits during transit, and to the point of title transfer
- Bill of Exchange is the written order that binds the transaction, where Buyer is required to pay a fixed amount to the Seller on a specified date, most commonly upon receipt of the goods
- Seller engages a third-party Agent, often a financial institution or bank, to act on its behalf and transmit the document package to the Buyer’s agent, also often a finance company or bank counterparty
- Once the shipment is received at the port of destination, documents are checked for thoroughness and accuracy by the Buyer’s agent, then presented to the Buyer
- Buyer makes payment through Bankers Factoring, its Agent to the Seller’s Agent
- Title to goods passes to the Buyer once payment has been completed and the original bill of lading has been released.
Cash Against Documents Cost
- Banks and financial institutions typically charge a modest fee for the service of acting as intermediary
- Buyers commonly pay the cost for both parties, although some fee sharing is not unusual
- Overall transaction costs are lower than transactions involving Letters of Credit, where the Buyer’s bank is asked to backstop the creditworthiness of the importer.
- Fastest way for a small US Importer to finance international transactions with PO Funding
Cash Against Document’s Benefit to the Buyer and the Seller
- Owing to its low cost and relative simplicity, cash against documents or CAD is an ideal way in which to conduct business with a first-time overseas Seller. The Seller’s chief protection is that it does not surrender title to the goods until payment is made in full. This does not entirely eliminate risk since the Buyer has the latitude to refuse to delivery of a shipment.
- While the Seller retains lawful (title) but not physical possession, the goods themselves could now be thousands of miles away in some foreign port and it could be costly and/or time consuming to return for sale to other customers. Specialty orders carry the added risk of not being able to be resold. On the other hand, when Seller and Buyer both share a profit motive in completing a transaction, Cash Against Documents represents a well-recognized, readily accepted, and commercially simple, low-cost way of doing business.
- Since the Buyer cannot access the goods without paying, the Seller can have a reasonable expectation of being covered. And since the Buyer does not have to put up a guarantee of any kind, doing business in this fashion does not require using up any of the Buyer’s working capital, making the trade easier to transact with lower overall costs.
- CAD can be FOB the US or FOB the country of origin, reducing costs to our client.
How Do I Qualify for Bankers Trade Financing Using Cash Against Documents?
We have a trade financing spreadsheet where you can download and “score” your import financing transaction.
Qualifications for Bankers Factoring Cash Against Documents include:
- You sell to credit worthy B2B or B2G Customers
- Your minimum gross profit must be at least 20%
- Have experience with similar products and comparable clients
- Transactions per month of no less than $50,000
- Provide qualified purchase orders or letters of credit from your customers
- Payments from your customers come to Bankers Factoring
Contact Bankers Factoring today and see how trade finance can help safely expand your business.