Evolving Beyond the Letter of Credit

Letters of credit (LCs) have been serving a valuable purpose for hundreds of years. Although still important today, their use has steadily decreased. Today, they are used primarily as a payment mechanism, as the extremely high discrepancy rate negates much of the perceived value.

LCs were created to facilitate international trade. However, transactional documentation moves faster than ever in today’s complex networks of trading partners. The flow of money, data and products needs to be as close to real time as possible. A significant downside to traditional LCs is that they are paper-based, requiring manual processing. Goods are moving faster than documents, creating problems and expenses, particularly when title documents are not available to clear goods.

More modern solutions are available today that are faster, more flexible and that don’t tie up credit lines. In cases of more complex and strategic supply chain scenarios, an enhancement from the traditional LC is well worth examining.

Open Account Platforms

Currently fewer and fewer companies rely on traditional sourcing and trade financing tools. More buyers and suppliers are becoming aware of alternative supply chain and trade financing tools that exist to eliminate risk and bring financial stability to the supply chain. In today’s credit environment, an open account platform that offers suppliers export financing, payment assurance and invoice discounting – and eliminates LC costs and strains on credit lines – is the next logical step. It’s a step that can generate savings of hundreds of thousands of dollars in the supply chain.

Companies Seek Automation

Global trade is complex – and becoming more so every day. Layers of supply chain partners exist. Creating paper fulfilment documents required for an LC is too time consuming and it leads to errors and costs. Buyers and sellers today seek transaction speed and automation. According to research from PayStream Advisors (January 2010), the adoption of electronic invoicing (e-invoicing) and payments continues to increase even beyond Fortune 1000 companies toward small and medium-sized enterprises (SMEs), and the number of e-invoices traded within the US will overtake paper invoice volume by 2011. E-invoice presentment and payment delivered on an open account platform with online financial services provides not only a significant upgrade from LCs, but it can enhance the whole underlying process behind transactions and remove costs.

To ensure liquidity in their supply chains, as well as to extend payment terms, many buyers today seek to offer attractive invoice discounting programmes to their suppliers. For those that offer self-funded invoice discount programmes, the return can be significantly higher than short-term investments. When all procure-to-pay (P2P) processes and related documents are automated on a platform, an opportunity arises to increase the discount period, as well as offer event-based financing. Event-driven financing can reduce risk while creating more financing opportunities at deeper points in the supply chain.

Technology = Opportunity

Technology solutions available today make it possible for financial institutions to have better visibility into transactional events. As a result, buyers and suppliers can take advantage of innovative trade financing models that leverage a blend of invoice discounting programmes, pre-export financing and post-export financing. This helps assure liquidity in the supply chain at the lowest cost possible, based on the financing cost of the most creditworthy party in the transaction. The financial institution recognises the financial strength of the strongest party in the supply chain. Visibility into this party is leveraged up or down the supply chain to eliminate risk related to the weakest link and ensure financing and payments reach the appropriate party. This not only creates supply chain savings, but also creates a significant opportunity for financial institutions.

Benefits of Shifting from LCs to an Open Account Platform

Improve credit line utilisation

Companies often pay for credit lines regardless if they use them. Therefore, it’s important to maximise credit line utilisation and efficiency. On an open account platform, the supplier elects financial services on a transactional basis without impacting the credit lines of the buyer or supplier. Additionally, electronic processing speeds up the process. Processing begins the moment a document is submitted. Instead of the submission of paper documents and a manual review process that might take 20 days, an automated reconciliation, workflow, review and approval process expedites the credit decision to disperse funds within three to five days.

Reduce risk

Increased security and visibility matter even more in today’s complex supply chains, especially to financial institutions. Reducing risk to lenders improves lending rates and increases loan-to-value rates, the amount banks will loan against the transaction value. Banks may offer close to 60%. With an automated platform approach, the lender’s risk is reduced based on digital time stamps and signatures and third party electronic verification from freight forwarders, inspection companies and others that confirm product quality and delivery. This enables better rates and increased funding ratios. Based on this level of visibility, financial partners can provide close to 100% of the invoice amount. This is a considerable advantage.

Increase credit opportunities

Today’s economic conditions raise the urgency to optimise financing across all supply chain participants. Financial institutions are willing to leverage strong buyers’ credit and lend to the supply chain if there is visibility and limited risk. An open account platform can provide connectivity between parties to make this happen. This network approach enables smaller companies to obtain financing they may not have been able to in the past. Best of all, it does not impact the smaller company’s balance sheet. In addition, low cost capital from a strong buyer can be offered into the supplier’s higher cost of capital country.

Banks often hesitate to do pre-export financing with no receivable yet on the books. But this hesitation is erased and additional credit opportunities arise with an open account platform strategy. Picture the ability to monitor different stages of production: raw materials ordered and delivered, goods being produced and finished, shipments, etc. Imagine a tool that increases visibility and verification, making pre-export financing much safer for the lender and increasing the supplier’s ability to borrow. With this tool, banks have more tangible evidence of product moving through the production cycle, creating more opportunities for suppliers to obtain pre-export financing.

Moving Forward

Traditionally, the financial supply chain has been based on banks using paper and manual processes. Faxes, email attachments and some point-to-point electronic solutions may have helped eliminate snail mail and couriers, but they remain cumbersome and offer minimal workflow automation. Bank products, such as LCs and documentary collections, haven’t kept up with the times. Although banks automated part of these processes, such as the application and advising of LCs, and SWIFT automated the bank-to-bank delivery of them, they still require paper fulfilment documents and manual examination. Processes remain inefficient and error prone.

Customers, and their new dynamic supply chains, demand more. As a result, buyers and sellers have been moving to open account platforms. There is not a particular industry leading the movement. It has been a marketplace shift. Open account platforms from a cross-border supply chain perspective are not simply a buyer extending payment terms to sellers. All too often, the process of invoice examination and approval for payment is a manual process for the buyer. Simple e-invoice presentment does not eliminate the manual approval process. Automating the invoice to purchase order reconciliation, providing on demand financial services as well as automating approval workflows, chargeback and dispute reconciliation processes adds tremendous value to both the buyer and seller.

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