Letter of Credit and Its Significance in the UAE Corporate Finance Regime
SMEs may often land overseas business projects that warrant big funding. Businesses that carry out international trade transactions often rely upon letters of credit to meet the funding requirements. A letter of credit is an integral component of corporate finance in the UAE, which effectively minimises the risks involved with the payment and delivery of goods.
Ineffective communication between the two parties also adds to the risks involved in international trade. Letters of credit, often regarded as the ‘lifeblood of international commerce’, minimise such risks and smoothen the transactions. In this article, we will explain the significance of letters of credit in the regime of corporate finance in the UAE. Consult with providers of corporate finance services in Dubai to carry out international trade with ease. Read ahead to know further about the importance of letters of credit in Dubai:
What is a Letter of Credit?
A letter of credit or a credit letter is a document issued by a bank that guarantees that the supplier will receive the buyer’s payment on time for the exact amount. The Letter of Credit works like a promise made to the supplier of goods that the bank will cover the full or remaining amount of the purchase in case the buyer fails to pay for the purchase. A Credit Letter is a contract in which the issuing bank agrees to disburse a specific amount of finance at a specific period when the applicant requests it.
The bank provides the finance in the name of the seller of goods, also known as the beneficiary. The use of a Letter of Credit has become common among businesses engaged in frequent overseas trade as international trade involves risks such as distance, differing laws in each jurisdiction, and difficulty in knowing each party personally. Consult with providers of corporate finance services in Dubai to arrange Letters of Credit facilities easily.
How Does a Letter of Credit Work?
The Letter of Credit is a negotiable instrument and hence the issuing bank pays the beneficiary or any bank nominated by the beneficiary. In case the Letter of Credit is transferable, the beneficiary can transfer the right to draw to another entity (e.g. a corporate parent or a third party). A fee will be collected by the bank as a service charge, which will often be a percentage of the size of the letter of credit. Traders can easily obtain letters of credit services through trade finance companies in Dubai.
Key Components of Letter of Credit
A typical Letter of Credit is composed of the following components:
- Issuing Bank (A bank that offers the credit)
- Applicant (The one who arranges for the payment)
- Beneficiary (The one who receives payment from the issuing bank)
- Specified time limit (The specific time limit within which the payment should be made)
- Agreement (An agreement on which the parties agree to the terms & conditions set out in the Letter of Credit)
- Specified place (The specified place where the documents are mandated to be presented)
Significance of Letters of Credit in the UAE
A Letter of Credit guarantees that the seller will receive payment as long as the conditions are met. In case a foreign buyer changes or cancels the order, the seller will still get paid by the buyer’s bank for the shipped goods. A Letter of Credit offers security against non-paying buyers or buyers that go bankrupt.
A Letter of Credit can be used as proof to your supplier that you will meet your payment obligations. This will come in handy when your company needs to make an urgent purchase such as an inventory or equipment. Apart from guaranteeing the payment, a Letter of Credit ensures that the payment will be made on time which helps the SMEs effectively manage the cash flow. Approaching the best corporate finance companies in Dubai is the key to obtaining a Letter of Credit quickly.
Types of Letters of Credit
The types of Letters of Credit vary depending on the need for them. Corporate finance firms in Dubai can help you to decide which one is ideally suited for your business requirement. The following are the major types of Letters of Credit:
- Irrevocable letter of credit
- Confirmed letter of credit
- Import letter of credit
- Export letter of credit
- Revolving letter of credit
Consult with the Best Corporate Finance Companies in Dubai, UAE
A Letter of Credit is critical for businesses to fulfil their international trade requirements but the process may be tougher for SMEs. However, corporate finance companies in Dubai such as Jitendra Chartered Accountants (JCA) can help you easily obtain Letters of Credit facilities from the banks. JCA is a 20-plus-year-old accounting & audit firm offering bespoke corporate finance services in Dubai. Connect with our consultants today to navigate all your corporate finance needs to ensure business growth.