To expand their business, people export their products and make contacts overseas. Finding buyers overseas not only doubles the turnover but it also increase the worth and credibility of the exporting company. However, there are few drawbacks in this type of transaction. Sometimes, buyers do not pay promptly and the seller has to suffer but the business world has developed few methods to ensure fair dealing.
Letter of credit and documentary credit are the prime examples of today’s methods to guarantee the payment. There is a fine line between these methods. That’s why. Most of the people they are same and they are often referred as interchangeable.
Though, the basic function of both methods is same but there are few small technical differences that make a distinction. A letter of credit makes the buyer’s bank a party and that bank pledges to pay for the goods whereas documentary credit involves buyer’s bank just as facilitator. Bank has no responsibility in the latter method.
A letter of credit is a trustworthy method and that is why most of the sellers prefer this method of payment. On the other hand, documentary credit is not a reliable method because the bank is not responsible for the payment if the buyer backs out. However, the documentary collection is safe when the seller is sending goods by boat. In this case, the shipping company won’t release the goods unless the bill is paid and buyer will have to pay the draft first to pay the bill.
Moreover, documentary credit or collection takes a lot more time as the seller needs to send the shipping first along with the draft for payment. The bank acts as a middleman and dispatches this draft to the buyer and when the buyer pays the amount then the transaction is complete.
There is another difference in the expenses. A documentary credit is lot cheaper than the letter of credit because the bank charges a significant amount of money in latter method. This is because the bank is guarantor in letter of credit of method.