Meaning
Documentary credits allow a buyer to take possession of goods immediately while deferring payment to a specific future date. Importers prefer usance letters of credit because they provide a period of trade credit that helps with working capital management. The seller receives a guarantee of payment on the maturity date rather than at the time of shipment.
Credit Period
Length of the deferral is usually expressed as a set number of days after the bill of lading date or the date of acceptance. Under the terms of usance letters of credit, the buyer has time to process or sell the imported goods before the invoice must be settled. This timeline is a critical part of the commercial negotiation between the parties.
Discounting Option
Conversion of the future payment into immediate cash is possible if the exporter needs liquidity. Banks can discount usance letters of credit by paying the seller the face value minus a fee and interest for the remaining period. This allows the exporter to get paid early while the bank takes on the role of waiting for the buyer’s payment.
Cash Management
Improvement in the cash conversion cycle is the primary advantage for the purchasing company. By utilizing usance letters of credit, a business can align its outgoing payments with the incoming revenue from the sale of the goods. This reduces the need for expensive short term bank loans to fund inventory.
The financial strength of the issuing bank is the most important factor in the marketability of the credit to third party investors.
