Letters of credit are agreements between a beneficiary, usually a person or company, and an issuer, usually a bank. These agreements formally indicate the existence of a beneficiary’s line of credit with the bank. One might wonder: Why are Letters of Credit important and when are they used? The answer to the question is simple: Letters of Credit prove the existence of a line of credit, and thus assure a seller of goods that the buyer will be able to pay for goods ordered. They are used in all sorts of commercial transactions, especially international transactions.

For example, lets say Widget Brokers, Inc. want to buy 1000 widgets from Widget Manufacturing, Inc. at a price of $10 per widget. The total price for this order is $10,000.00. Let’s say Widget Manufacturing has never conducted business with Widget Brokers before. If this is the case, Widget Manufacturing may want to see the terms of Widget Broker’s line of credit with LOC Bank. These terms will be formalized in an agreement between Widget Brokers and LOC Bank in a “Letter of Credit” agreement. If Widget Manufacturing sees that Widget Broker’s line of credit is over $10,000.00, they should rest assured that Widget Broker will be able to pay for the order.

Therefore, if you are a buyer of goods without a solid reputation, and you are looking to make a large purchase of supplies, you may want to open a line of credit with a bank and from them secure a Letter of Credit to assure the seller that you will pay for the goods as promised.

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