What is a letter of credit in fashion sourcing?
A letter of credit (LC) is a bank guarantee that a supplier will be paid once it presents documents proving shipment according to agreed terms.
In short
A letter of credit is a payment instrument in which the buyer's bank commits to pay the supplier once the supplier presents specified documents, such as a bill of lading and commercial invoice, that match the credit's terms. It reduces payment risk in international trade.
How does it work in practice?
The brand applies to its bank to open an LC in favour of the factory, based on the purchase order or pro forma invoice. The typical flow is:
- The buyer's bank issues the LC, often advised through the supplier's bank.
- The supplier produces and ships the goods.
- The supplier presents the required documents to the bank.
- The bank checks the documents and pays if they comply exactly.
Payment may be at sight or deferred, and many factories use the LC to secure financing for fabric purchases.
Why does it matter for fashion businesses?
For suppliers, an LC provides security that they will be paid, which can make them willing to work with a new brand. For brands, it ensures payment only happens against proof of shipment. However, LCs add cost and administration, and banks check documents, not product quality, so inspections remain essential. Many established relationships move to open account terms to simplify cash flow.
How is AI changing it?
Trade finance teams use AI and document recognition to check presented documents against LC terms automatically, flagging discrepancies faster. Digital trade platforms aim to replace paper documents with electronic records, which reduces delays caused by couriered originals.
Common pitfalls
- Minor document discrepancies, such as spelling or dates, delaying payment.
- Unrealistic shipment dates in the LC, requiring costly amendments.
- Assuming an LC guarantees product quality.
Brands should agree draft LC wording with suppliers before issuing it, so document requirements and dates are realistic.
Frequently asked questions
Why do factories ask for a letter of credit?
It gives them assurance of payment from a bank rather than relying only on the buyer's creditworthiness. It can also help them finance materials.
What is the alternative to a letter of credit?
Common alternatives include open account terms, deposits with balance before shipment, and supply chain finance programmes. The choice depends on trust and the parties' financial strength.