Letter of Credit vs Open Account: Choosing the Right Payment Terms for International Trade

Every international trade transaction involves a fundamental trust problem: the seller wants payment before shipping, the buyer wants goods before paying. Neither party knows the other well enough to carry the full risk. The payment terms you negotiate determine how that risk is split — and choosing poorly can mean losing everything on a single shipment.

Open Account: The Default, and the Risk

Most B2B international trade today runs on open account terms. The exporter ships the goods, sends the invoice, and waits for payment — 30, 60, or 90 days later. For the buyer, this is ideal. You receive and inspect goods before payment is due. For the seller, it's a significant exposure: you've given away your goods and are now an unsecured creditor in a foreign jurisdiction.

Open account works when you have a long-standing relationship, credit insurance in place, or the transaction value is small relative to the risk of the relationship. Using open account with a new supplier or buyer in a jurisdiction with weak contract enforcement is a different calculation entirely.

Letter of Credit: The Bank as Guarantor

A documentary letter of credit (LC) inserts the banking system between buyer and seller. The buyer's bank issues a guarantee that payment will be made when the seller presents specified documents — typically a bill of lading, commercial invoice, packing list, and certificate of origin — that prove shipment has occurred according to the agreed terms.

The critical point: the LC is independent of the underlying trade contract. Once the seller presents compliant documents, the bank pays — regardless of whether the buyer claims the goods were wrong, late, or damaged. Disputes go to arbitration; the bank pays first.

Types of Letters of Credit

Irrevocable LC

Cannot be cancelled or modified without agreement from all parties. All LCs under UCP 600 rules (the international standard) are irrevocable by default. If someone offers you a revocable LC, decline.

Confirmed LC

An additional guarantee added by the seller's own bank. If the buyer's bank or country carries political/financial risk, confirmation means the seller's local bank also commits to pay — removing country risk from the equation. Essential for trade with banks in politically unstable environments.

Standby LC

Functions like a performance bond — only called if the buyer fails to pay under agreed terms. Common in long-term supplier relationships where the parties want security without the documentation burden of a documentary LC on every shipment.

Documentary Collections: The Middle Ground

Between open account and LC sits the documentary collection. The exporter ships goods and sends documents through their bank to the buyer's bank, with instructions to release them only against payment (Documents Against Payment, D/P) or against acceptance of a draft (Documents Against Acceptance, D/A). There's no bank payment guarantee — just bank handling of documents. Lower cost than an LC, more control than open account.

The Real Cost of Letters of Credit

LCs cost money — typically 0.25–1.5% of the transaction value in bank fees, plus documentation costs and the time required to prepare compliant documents. Discrepancies in presented documents — wrong date format, description that doesn't exactly match the LC wording, missing endorsement — can cause rejection and delay.

Experienced LC users build the cost into their pricing and develop document preparation discipline. First-time LC users are often surprised by both the fees and the precision required.

When to Use Each

Open account: established relationships, credit insurance in place, low transaction value relative to relationship size, buyer in a stable jurisdiction with strong contract enforcement.

Documentary collection: moderate trust, some history, buyer in a reasonable jurisdiction, you need document control but LC cost isn't justified.

Letter of credit: new relationships, high transaction values, buyer in a higher-risk jurisdiction, seller lacks credit insurance, either party carries significant counterparty risk.

The most expensive payment mistake in international trade isn't the banking fees on an LC. It's being paid late — or not at all — because you gave too much credit to someone you didn't know well enough. Payment terms aren't a formality to rush through. They're the risk architecture of every deal you do.