The letter of credit ? factoring options are two different kinds of trade financing alternatives available to businesses. The former relies on a bank. The latter relies on a financing party that is not a bank. Of the two, the latter is easier to obtain during difficult economic times than the former.
Suppliers typically use this instrument for both foreign and domestic trade. This is a document banks provide to guarantee that sellers will be paid. If the party which secures the facility from a bank fails to pay, the bank then pays the sum owed. This may be the full payment or only that part left unpaid by the buyer.
This device is a form of protection for both buyers and sellers. Such protection allows suppliers to receive what is owed in exchange for which buyers gain possession of goods. This device is offered in varying structural arrangements. Irrevocable and revocable devices are well known. Qualifying, standby and transferable devices are amongst other alternative forms.
In the revocable formulation, the issuer is allowed to alter, adjust or terminate. Suppliers do not like it because they then have a greater risk. When it is irrevocable, it does not allow modifications, amendments, or cancellations without prior agreement. As this is a form of disbursement guarantee, suppliers have a preference for this type.
There is a guarantee of compensation, if there is a standby. But, on its own it is not a form of payment. In the transferable form, both irrevocable and revocable types are optional. When there is an option to transfer, transference of the benefit can be made to another party.
Qualifying for this form of liquidity is not a matter of course. It requires the business owner to take one of two options. One would require the deposit of the full amount in cash with the issuing bank or financial institution. The alternative would require obtaining a line of credit from the bank for use as collateral. This requires the business qualify for bank financing; but it is the preferred alternative as it does not tie up cash. For this reason, the more appealing method is the line of credit option.
As this method is not easy to obtain, factoring is a popular alternative. The factoring market share has been on the rise in the United States. By 2000, domestically factoring had financed over 87 billion USD as indicated by the Commercial Finance Association. This means the method has become the single largest way credit sales are financed.
In this mechanism is the optimal path for businesses that cannot rely on credit lines. For the funding, a funding company furnishes suppliers with their security with the purchase order serving as the collateral. A commission is taken by the factor for this service. The commission is a portion of the invoiced value. This is essentially a purchase of the receivables. In each transaction, three parties participate. While banks consider the risk of lending to the borrower, the factor values the receivables. No cumbersome application is required. There is an absence of conditions and no need for a lasting commitment. In the process, cash flows get evened out. Businesses not paid for months benefit as they receive most of the amount due in advance. The factor determines whether the customers are creditworthy. Funding may be provided in one day. Letter of credit factoring assist trade by removing or lowering the transactional risks involved.
Unique financing products including letter of credit and accounts receivable factoring are solutions that can be customized to your needs. Contact Accutrac Capital Solutions today to get started!
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