Revolving Credit Lines: A Case Study on Standby Letters of Credit (SBLCs)
It is not uncommon for businesses to have long-running obligations or revolving contracts with suppliers, distributors, and customers. In fact, in some industries, like manufacturing, this is likely to be the norm, as companies will like to secure shipments and inputs over some time, typically a year, to hedge against price fluctuations that are typical in the commodities market.
In today’s dynamic business environment, having access to a revolving credit line is critical for both individuals and businesses. It provides the flexibility required to address immediate needs for operations, manage cash flow, and capitalize on growth opportunities. A revolving credit line gives businesses access to credit that can be used and reused continually, as agreed with the lender.
Letters of Credit
Letters of credit are trade instruments that act as a guarantee of payment from a bank on behalf of its customer and are used to reduce risk when trading within and across national borders. The LC is shared as a SWIFT message from the buyer’s bank and is confirmed by the seller’s bank. They are the safest and most secure way to do business.
For sellers, an LC guarantees that they will receive payment for the goods or services they provide, provided they meet the conditions outlined in the LC. This assurance significantly increases the level of trust in the transaction, especially when dealing with new or unfamiliar buyers. With the backing of a reputable bank, the seller can confidently proceed with the transaction, knowing that they will get paid on time.
On the buyer’s side, an LC protects against potential risks, such as non-performance or fraudulent activity by the seller. The buyer can specify the required conditions and quality standards in the LC, ensuring that they only pay for the goods or services if they meet the agreed-upon specifications. This protection minimizes the buyer’s exposure to financial loss and ensures they receive what they ordered before making payment.
One increasingly popular method of obtaining revolving credit for suppliers is through the use of standby letters of credit (SBLCs). Trade Finance Global defines SBLCs as guarantees provided by banks on behalf of clients, ensuring that payment will be made even if the client fails to fulfill their payment obligations. SBLCs act as a safety net, with the bank serving as the supplier’s last-resort payer. Ideally, SBLCs remain unused, serving as a reflection of a company’s creditworthiness and providing the bank’s assurance or guarantee. Having an SBLC in hand allows importers to negotiate favorable payment terms that align with their sales cycle.
To illustrate the practical application of SBLCs, let’s consider the case of a biscuit manufacturer needing a consistent and reliable supply of grain to sustain its production operations and meet market demands. In this scenario, we will explore how an SBLC can be utilized to establish a credit line for the manufacturer, facilitating the continuous import of inputs throughout its sales contract with the exporter.
Assuming a year-long sales contract, the biscuit company will need $36,000,000 to secure 750 metric tons of grain per month for $4000 per metric ton, for a monthly expense of $3,000,000. The manufacturer’s first step is to engage Breeze to broker an SBLC worth $36,000,000 that they can draw from monthly to cover their grain shipment
The verbiage of the SBLC will outline that the manufacturer can draw $3,000,000 worth of grain each month from the exporter, totaling $36,000,000, and the instrument will remain valid for a year. To obtain this facility, the importer pays Breeze a fee of $3,600,000, which amounts to 10% of the issuance fee.
The importer’s trade cycle involves initially receiving the grain cargo, transforming it into biscuits, selling them to off-takers, wholesalers, and other entities in its distribution network, and subsequently paying the exporter for the cargo in order to procure the next batch of shipments.
This monthly transaction is repeated, allowing the importer to secure an annual shipment with only a fraction of the total sales contract as an upfront payment.
Businesses can ensure a consistent supply of goods while effectively managing their cash flow by using SBLCs for revolving transactions. SBLCs give importers the financial flexibility to meet contractual obligations without requiring large upfront payments. Furthermore, these instruments serve as proof of a company’s creditworthiness and provide reassurance to both suppliers and banks involved in the transactions.
Breeze provides uncollateralized letters of credit to African businesses for expanding international trade. Our LCs, which are provided by leading financial institutions, are an efficient way to improve operational capabilities, increase investment returns, and establish strong trust with international business partners.
Visit here to get started.
