Prepare letter of credit: how the process runs, step by step

Preparing a letter of credit starts when a purchase contract calls for one. It ends when the issuing bank releases an instrument the seller will accept. Procurement, treasury, accounting, the bank and the supplier each own a part, and most trouble sits in the handoffs between them.

The steps in order

1. Agree the payment terms in the contract. Owner: procurement or the commercial team. The contract should name the letter of credit as the payment method. It should also state the trade term, the latest shipment date and the documents the seller must present. Vague contract wording here causes most of the amendments later.

1. Raise the request to treasury. Owner: the buyer in procurement. The request carries the signed contract or purchase order, the supplier's banking details and a plain description of the goods. Treasury needs all of it before anything can be drafted.

1. Check facility headroom and choose the bank. Owner: treasury. Someone confirms there is room under a trade finance line and decides which relationship bank will issue. If headroom is short, the bank may ask for cash margin, and that changes the funding picture.

1. Draft the application. Owner: a treasury analyst or the trade operations desk. The analyst completes the bank's application, usually through its online portal. Each field has to match the contract: amount and currency, expiry date and place, partial shipment rules, the document list and the goods description. The bank's standard wording applies under the international rules for documentary credits unless the parties agree otherwise.

1. Share the draft with the supplier. Owner: procurement, with treasury on call. The supplier takes the draft to its own bank. They look for terms they cannot meet, such as a document they have no way of obtaining. Catching this before issue is far cheaper than amending afterwards.

1. Approve internally. Owner: authorised signatories under the delegation of authority. Unusual clauses may also go to legal or tax. The approver should see the contract alongside the draft, not the draft alone.

1. Submit to the issuing bank. Owner: treasury. The bank runs its own checks on sanctions, the goods and the parties. It may come back with questions or ask for collateral.

1. Issue and advise. Owner: the issuing bank, then the advising bank. The issuing bank sends the credit over the interbank messaging network to a bank in the seller's country, which passes it to the supplier. Treasury files a copy of the issued text and checks it against the approved draft.

1. Record the commitment. Owner: accounting. The open credit goes into memorandum or off balance sheet accounts so the contingent liability is visible. Issuance fees and any cash margin are posted to the general ledger. Where the bank data does not feed in automatically, a manual journal is prepared and routed for approval.

1. Update the cash forecast. Owner: treasury. The expected payment date and value go into the cash projection. Large settlements are flagged early so funding is lined up.

1. Handle amendments. Owner: treasury, triggered by procurement or the supplier. A change to dates, amounts or documents goes back through approval and the bank. The supplier must accept it before it binds them.

Once the credit is live, the work passes to document examination and settlement, which is a separate process.

Where it tends to go wrong

The goods description in the credit often differs slightly from the invoice the supplier will produce. Banks check documents strictly, so small wording gaps become discrepancies at presentation.

The latest shipment date and the expiry date are often set without asking logistics. When a vessel slips, an amendment follows.

Some teams skip the supplier review in step 5 to save time. The time comes back, with interest, as amendment fees and delay.

Open credits sometimes sit in a bank portal and nowhere else. Accounting then misses the commitment at period end.

Questions to ask the people who run it

The written procedure and daily practice often part ways. These questions surface the gap.

• Who actually fills in the application, and where do they get the terms from: the contract, an email, or memory of the last one?
• Does the supplier see a draft before issue every time, or only for new suppliers?
• What happens when the facility is nearly full? Who decides to post margin?
• Which clauses get changed most often by amendment, and why?
• Does the approver look at the contract, or approve on the analyst's summary?
• How does accounting learn that a credit has been issued, amended or expired?
• Is there a template for each regular supplier, and who keeps it current?
• When the bank rejects or queries an application, who hears about it first?
• Are any credits issued outside the normal route because a deal was urgent?

What auditors and reviewers ask for

Reviewers usually want evidence that each credit was approved by someone with authority and that it matches an underlying contract. They also test whether the open commitments in the ledger agree to the bank's list. A short process memo describing these steps, kept up to date, answers most of their requests. Findings from those reviews should feed back into the template and the approval route.

APQC's Process Classification Framework® (PCF) is an open standard developed by APQC, a nonprofit that promotes benchmarking and best practices worldwide. To download the full PCF or to view definitions and measures, please visit www.apqc.org/pcf.