Letter of Credit Process From Deal to Payment

A signed sales contract does not guarantee payment when goods are crossing borders. The exporter may be committing inventory, production capacity, and freight costs before receiving funds, while the buyer may be concerned about paying for goods that arrive late or do not meet specifications. A properly structured letter of credit process gives both parties a controlled path between contract, shipment, documents, and payment.

For importers and exporters, a letter of credit is more than a bank instrument. It is a transaction-control tool. It can reduce counterparty exposure, establish clear documentation requirements, and give lenders greater confidence in the underlying trade. But it only works when the commercial agreement, shipping plan, and bank terms match precisely.

What a Letter of Credit Does in International Trade

A letter of credit, often called an LC, is a bank's conditional commitment to pay a seller. The issuing bank acts on behalf of the buyer, known as the applicant. It agrees to pay the seller, or beneficiary, if the seller presents documents that comply with the LC terms.

The word “conditional” carries real weight. Banks examine documents, not the actual goods. If the documents comply, the bank can be required to pay even if the buyer later claims that the goods are defective. Conversely, a seller may have shipped exactly what was ordered but still face delayed payment if the documents contain discrepancies.

This is why the LC should never be treated as an afterthought once the purchase order is signed. The sales contract should establish the currency, amount, Incoterms rule and named place, delivery window, payment timing, required documents, and which party bears bank charges. Those commercial details become the foundation for the LC wording.

The Letter of Credit Process Step by Step

The process involves the buyer, seller, issuing bank, and advising bank at a minimum. A confirming bank or nominated bank may also participate, particularly when the exporter wants added payment protection or local document handling.

1. The buyer and seller agree on the trade terms

Before the buyer applies for an LC, both parties must agree on the commercial framework. The contract should identify the product specifications, quantity, unit price, total value, shipment period, partial-shipment permissions, transshipment terms, and inspection requirements.

The selected Incoterms rule deserves particular attention. For example, a CIF shipment and an FCA shipment require different transport documents and allocate responsibilities differently. A vague contract can produce an LC that asks for documents the seller cannot reasonably obtain.

2. The buyer applies to its bank

The buyer submits an application to its bank requesting issuance of the LC. The bank assesses the buyer's credit standing, collateral, cash margin, and facility limits. Depending on the relationship and the transaction size, the bank may require the buyer to fund the full amount, use an existing trade finance line, or provide security.

The buyer should provide the agreed LC instructions, not simply accept generic bank language. Generic terms can create avoidable conditions, such as unrealistic document deadlines or excessive certification requirements. Finance, procurement, logistics, and legal teams should review the draft before it is issued whenever possible.

3. The issuing bank sends the LC to the seller's bank

Once approved, the issuing bank issues the LC through a secure bank-to-bank channel to an advising bank in the seller's country or region. The advising bank authenticates the message and notifies the seller that the credit is available.

An advising bank does not normally add its own payment commitment. It confirms authenticity and passes on the LC. If the seller is concerned about the issuing bank's creditworthiness, country risk, or payment restrictions, it may request confirmation from a bank it trusts. A confirmed LC adds another bank's independent undertaking to pay, but it also adds cost and may not be available for every issuing bank or market.

4. The seller reviews every LC term before shipping

This is one of the most decisive stages of the letter of credit process. The seller must compare the LC against the sales contract and its actual ability to perform. The review should cover the shipment date, expiration date, presentation period, documentary requirements, port names, product descriptions, insurance wording, and consignee instructions.

A seller should not ship merely because the LC has arrived. If an LC requires an original inspection certificate that cannot be issued in time, or a bill of lading showing a party that the carrier will not name, an amendment is needed before shipment. Shipping first and hoping the bank will overlook a conflict transfers too much risk to the exporter.

5. The seller ships the goods and collects documents

After confirming workable terms, the seller dispatches the goods according to the contract and LC. It then gathers the required documents. These commonly include a commercial invoice, packing list, transport document, certificate of origin, insurance certificate, inspection certificate, and any licenses or declarations specified in the credit.

Document consistency is critical. Names, addresses, dates, quantities, product descriptions, and shipment details must align across the full document set and with the LC. Minor differences can create discrepancies. A spelling variation may be acceptable in some cases, but no company should assume that a bank will waive it.

6. The seller presents documents to the bank

The seller submits the document package to the nominated bank, advising bank, confirming bank, or directly to the issuing bank, depending on the LC instructions. The bank checks the presentation against the credit and applicable documentary credit rules.

If the documents comply, the bank forwards them through the banking chain and payment follows under the credit's terms. A sight LC is payable promptly after compliant presentation, while a usance or deferred-payment LC pays on a defined future date. Deferred payment can support the buyer's cash flow, but the seller must price the financing period and assess whether discounting is needed.

7. The buyer receives documents and takes delivery

The issuing bank releases the documents to the buyer according to the payment arrangement. The buyer uses the relevant transport documents to clear or collect the goods. By this stage, the buyer's focus shifts to customs entry, inland delivery, inspection, and any claims under the sales contract or insurance policy.

The LC does not eliminate the need for strong quality controls, cargo insurance, customs compliance, and contractual remedies. It secures payment against compliant documents. It is not a substitute for supplier due diligence or operational oversight.

Amendments and Discrepancies: Where Cost and Delay Begin

Trade transactions change. Production may take longer than expected, vessels may roll, a port may become unavailable, or the buyer may request a quantity change. When an LC term must change, the buyer requests an amendment through the issuing bank, and the seller must accept it before relying on it.

Amendments can be necessary, but repeated changes signal weak transaction planning and increase bank charges. They can also cause a seller to miss shipment or presentation deadlines while waiting for approval. Build realistic timelines into the original contract and account for documentation lead times, not only cargo transit times.

If the bank finds discrepancies, it may refuse the presentation or send documents to the buyer for a waiver. The buyer can accept the documents despite the discrepancy, but the seller should not depend on a waiver. The buyer may use the discrepancy to renegotiate, delay payment, or reject documents altogether.

Common avoidable discrepancies include late shipment, late presentation, incorrect goods descriptions, inconsistent weights or quantities, missing endorsements, and transport documents that conflict with LC instructions. A pre-presentation review by an experienced trade finance specialist can be far less expensive than resolving a rejected document set after goods are already in transit.

Controls That Protect Both Sides

Successful LC transactions are managed across departments. Sales cannot negotiate terms that logistics cannot execute, and finance cannot approve a structure without understanding the shipment cycle. Assign a single transaction owner who can coordinate the buyer, seller, freight forwarder, insurer, customs broker, and banks.

Companies should also maintain a document checklist tied to each LC, verify the issuing bank and country exposure before accepting payment terms, and review whether confirmation is commercially justified. For higher-value or unfamiliar transactions, legal review of the sales contract and LC terms can prevent a payment dispute from becoming a broader cross-border dispute.

The right structure depends on the deal. An established buyer and seller with a strong payment history may find an LC unnecessarily expensive compared with open-account terms backed by credit insurance. A first transaction involving a new market, large order value, or extended production cycle may justify the added discipline and bank cost.

Golden Biz Consultancy supports importers, exporters, and investors with the commercial, operational, customs, and legal coordination needed to keep cross-border transactions protected. Before goods move, make sure the payment instrument reflects the deal you actually intend to execute.