Business transactions of buying and selling from around the world are expected. The trust factor lies in the payment methods the buyer and seller opt for.
Different methods exist to collect the payment from the customer and deliver the item. Other payment methods are available across the globe when international business is happening.
Key Takeaways
- A letter of credit is a financial instrument issued by a bank, guaranteeing payment to a seller on behalf of a buyer, provided certain conditions are met.
- A bill of exchange is a written order in which one party directs another party to pay a specified sum of money to a third party at a future date.
- Letters of credit are used to facilitate international trade by reducing risk for both parties, while bills of exchange are negotiable instruments used for short-term financing and credit transactions.
Letter of Credit vs Bills of Exchange
The difference between a letter of credit and a bill of exchangeย is that a Letter of credit focus on the payment mechanism, and a bill of sale are nothing other than a payment instrument.
Comparison Table
| Parameter of Comparison | Letter of credit | Bills of Exchange |
|---|---|---|
| Risk Factor | There is less risk of the importerโs bank having payment as default as once the letter of credit is issued; it cannot be withdrawn. | There is a risk because it depends on the importer making the payment or backing out of the process. |
| Holding authority | Greater control is in the hands of the importer | Greater control is in the hands of the exporter |
| Mode | Bank pays the money | It is always the individual who pays the money |
| Discount factor | There is no discount factor here | The seller can avail of the discount facility |
| Payment factor | It will set the payment rules and doesnโt support the actual payment process. | Actual payment is received here by the seller. |
What is Letter of Credit?
Letter of credit, also known as Documentary credit, is part of Trade finance. There are two parties involved in this, one is the Buyer, and the other one is the Seller.
The seller gets a query regarding the buyerโs requirement and then informs the buyer of the product and the process.
The seller doesnโt agree to the same and insists the buyer make the payment and get the goods delivered. A buyer approaches a bank called an Opening bank/ issuing bank to issue a Letter of credit to purchase the product.
Before the transit is made, the seller documents the Transport, Insurance, and other overhead details to the Advising bank then later, the same goes to the issuing bank, and then it reaches the buyer at last.
What is Bills of Exchange?
Bill of exchange happens between three parties, the Drawer, Drawee and the Payee.
In the first instance, Buyer buys a product and prefers payment through cash. In the second instance, Buyer buys a product but likes 45 daysโ credit to make the payment.
The draft issues are called a bill of exchange, and it is an acknowledgement signed by the Buyer and given back to the Seller.
The third instance involves a certain amount of benefit too, in the form of a Bill of Exchange because cash is not blocked until the credit period.
Main Differences Between Letters of Credit and Bills of Exchange
- Theย main difference between a Letter of credit is a financial documentย is LOC is issued by a bank or a financial institution upon the request of the buyer to the seller. Still, the bill of exchange is an acknowledgement that revolves around the buyer, seller and payee.
- A letter of credit doesnโt have a specific period as credit, but the bill of exchange has this credit policy concerning the days that have been asked for.
- https://papers.ssrn.com/sol3/papers.cfm?abstract_id=151849
- https://cbr.cba.org/index.php/cbr/article/download/2486/2486/
- https://digitalcommons.nyls.edu/cgi/viewcontent.cgi?article=1059&context=journal_of_international_and_comparative_law
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
