Financial Terms You Should Know

Letters of credit

These mechanisms are used by exporters and importers, and usually provided by the importing company’s bank to the exporter to safeguard the contractual expectations and particularly financial exposure of the exporter of the goods or services. (Also called “export letters of credit”, and “import letters of credit”.) When an exporter agrees to supply a customer in another country, the exporter needs to know that the goods will be paid for.

The common system, which has been in use for many years, is for the customer’s bank to issue a ‘letter of credit’ at the request of the buyer, to the seller.

The letter of credit essentially guarantees that the bank will pay the seller’s invoice (using the customer’s money of course) provided the goods or services are supplied in accordance with the terms stipulated in the letter, which should obviously reflect the agreement between the seller and buyer.

FOB — “free on board”

The FOB (Free On Board) abbreviation is an import/export term relating to the point at which responsibility for goods passes from seller (exporter) to buyer (importer). It’s in this listing because it’s commonly misunderstood and also has potentially significant financial implications. FOB meant originally (and depending on the context stills generally means) that the seller is liable for the goods and is responsible for all costs of transport, insurance, etc, until and including the goods being loaded at the (nominated FOB) port. An importing buyer would typically ask for the FOB price, (which is now often linked to a port name, eg, FOB Hamburg or FOB Vancouver), knowing that this price is ‘free’ or inclusive of all costs and liabilities of getting the goods from the seller to the port and on board the craft or vessel.

Letters of guarantee

There are many types of letters of guarantee. These types of letters of guarantee are concerned with providing safeguards to buyers that suppliers will meet their obligations or vice-versa, and are issued by the supplier’s or customer’s bank depending on which party seeks the guarantee. While a letter of credit essentially guarantees payment to the exporter, a letter of guarantee provides safeguard that other aspects of the supplier’s or customer’s obligations will be met. The supplier’s or customer’s bank is effectively giving a direct guarantee on behalf of the supplier or customer that the supplier’s or customer’s obligations will be met, and in the event of the supplier’s or customer’s failure to meet obligations to the other party then the bank undertakes the responsibility for those obligations.