Why Do Purchase Order Financing Companies Only Prepay Foreign Suppliers With a Letter of Credit?

Most of our purchase order (PO) financing clients are importers who buy goods from another country and sell them to companies in the US or Canada. Some of these importers usually request that we prepay their supplier by wire transfer.

While purchase order financing companies can pay foreign suppliers with a letter of credit, documentary collection, or wire transfer, they will prepay a foreign supplier only with a letter of credit. Why is this?

Payment methods

First, let’s quickly review each payment method. Note that these are broad definitions:

  1. Letter of credit: a bank-issued document that guarantees a payment, provided certain conditions are met
  2. Documentary collection: a bank-intermediated process in which shipping/export documents are exchanged for payment when conditions are met
  3. Wire transfer: a  transfer of funds from one bank to another

Understanding the risks

Let’s start with the obvious: why can’t prepayment to a foreign supplier be made by wire transfer? Simply because there is no guarantee that the product will be delivered. And since the payment has been made, the buyer has little – if any – recourse if things go wrong. From our point of view, prepayment by wire transfer is the same as extending unsecured financing to your supplier. A purchase order financing company offers small business financing to you – not to your suppliers.

In principle, a documentary collection could be used as a form of prepayment. Although it’s safer and more secure than a wire transfer, it still does not offer the protection of a letter of credit, so many PO financing companies don’t use them for prepayment.

The safest way to prepay a supplier is with a properly written letter of credit, which includes appropriate specifications, inspections, and delivery schedules. Although no payment method is 100% safe, a letter of credit offers many protections to the buyer (and their purchase order funding company).

Get more information

We are a leading purchase order funding company and can provide you with competitive terms. For  more information, get an online quote or call us at (877) 300 3258.