A usage letter of credit is a financial instrument that sets out the terms and conditions for paying off a debt at a specific date in the future. Typically, the terms and conditions found in the letter of credit cover details such as the payment method used to settle the debt, the total amount due at the time of settlement, and the name of the beneficiary. It is not uncommon for the letter of credit to be accompanied by supporting documents, such as an invoice for the full amount due for payment and even a draft time for it to be processed on the agreed date.
While a usable letter of credit may have an expiration date of any duration acceptable to interested parties, documents of this type generally include a date that is no later than six months from the date of issue of the letter of credit. This makes the letter of credit a useful financial tool to meet short-term needs, allowing the recipient of the letter to obtain the necessary credit to finance a specific project and, hopefully, generate enough return from that project to pay the amount. due within the stipulated period. As with most types of debt instruments, usury letters can be settled early if the recipient is able to do so, often without any penalty.
There are benefits to using a letter of credit that help differentiate it from other types of debt instruments. In many cases, the amount of interest the beneficiary pays is lower than on short-term commercial loans. At the same time, the benefit of being able to withdraw the line of credit immediately means an inflow of cash that can be used for a specific project, such as a new product launch. If that product starts generating returns within the projected time frame, these funds can be used to pay off the letter of credit, without the need to draw on the assets of other companies to finance the launch or pay off debt.
An example of how a usage letter of credit can be used effectively is with a company that experiences changes in revenue levels during specific seasons. The company may obtain the letter of credit as a means of managing company expenses during a slow season. With the maturity date set to coincide with the return of increased business volume and increased cash flow, the company is able to pay off debt on time without any apparent difficulty.