Revolving Letter of Credit

Meaning

A revolving letter of credit is a single letter of credit that covers multiple transactions over a long period of time. It is very specific in a way that it is used for regular shipments of the same commodity between the same buyer (importer) and the seller (exporter). This letter of credit is issued only once for a certain period of time or a certain number of transactions.  It avoids the need for repetitive arrangements to open a new letter of credit for every transaction.

Types of Revolving Letter of Credit

The revolving letter of credit can be further divided into two subcategories. One is based on time, the other is based on value. Let’s understand each in detail. Following are the two types of revolving letter of credit:

Revolving Letter of Credit Based on Time

In the revolving letter of credit that is based on time, a specific amount (payment) is allowed to be drawn within a defined period of time. Let’s understand with an example.

Example – Mr. Cho from China is a manufacturer of ball pens and is a regular supplier to Mr. Will who is based in the UK. They decide to have a transaction with a revolving letter of credit. On January 1, 2018, Mr. Will obtains a revolving letter of credit of USD 60,000.00 to be drawn each month by USD 10,000.00 for the next 6 months in the name of Mr. Cho.

Following is the line of transactions –

Month Transactions on the part of Mr. Cho Payment through revolving letter of credit
January 2018 Goods worth USD 10,000.00 manufactured and shipped Payment received USD 10,000.00
February 2018 Goods worth USD 3,000.00 manufactured and shipped Payment received USD 3,000.00
March 2018 Goods worth USD 4,000.00 manufactured and shipped Payment received USD 4,000.00
April 2018 Goods worth USD 12,000.00 manufactured but shipping of only USD 10,000.00 allowed. So goods of USD 10,000.00 shipped and remaining goods kept in stock Payment received USD 10,000.00
May 2018 Goods worth USD 8,000.00 manufactured and goods worth USD 10,000.00 shipped (USD 8000.00 of May + USD 2000.00 of April) Payment received USD 10,000.00
June 2018 Goods worth USD 10,000.00 manufactured and shipped Payment received USD 10,000.00
End of June 2018 Revolving letter of credit expired

Further, a revolving letter of credit based on time can be of two types as follows –

Cumulative

In a revolving LC based on time, if it is the cumulative type, the previous unused L/C limits can be used in future months. In the previous example, if Mr. Cho doesn’t ship any good in the month of May 2018, then he can ship goods worth USD 20,000.00 in the month of June 2018.

Non-Cumulative

In a revolving letter of credit based on time, if it is the non-cumulative type, then the previous unused L/C limits cannot be used in future months. In the previous example, if Mr. Cho doesn’t ship any good in the month of May 2018, still he is allowed to ship only goods worth USD 10,000.00 in the month of June 2018. The USD 10,000.00 unused limit of May 2018 becomes void.

Revolving Letter of Credit Based on Value

The second type of revolving letter of credit is based on value. In this, an amount and a validity for the letter of credit is set, and the seller has to work on these criteria.

Let’s extend our previous example and make it revolving letter of credit in relation to value. Other things same on January 1, 2018, Mr. Will obtains a revolving letter of credit of USD 60,000.00 to be drawn each month by USD 10,000.00 for the next 6 months in the name of Mr. Cho.

Revolving Letter of Credit

Here even though the letter of credit looks same, the line of transactions will be different as follows:

Month Transactions on the part of Mr. Cho Payment through revolving letter of credit
January 2018 Goods worth USD 10,000.00 manufactured and shipped Payment received USD 10,000.00
February 2018 Goods worth USD 3,000.00 manufactured, but can’t ship as the value of transaction must be USD 10,000.00 No payment
March 2018 Goods worth USD 4,000.00 manufactured, but can’t ship as the value of transaction must be USD 10,000.00 No payment
April 2018 Goods worth USD 12,000.00 manufactured but shipping of only USD 10,000.00 allowed. So goods of USD 10,000.00 shipped and remaining goods kept in stock Payment received USD 10,000.00
May 2018 Goods worth USD 8,000.00 manufactured and goods worth USD 10,000.00 (USD 8000.00 of May + USD 2000.00 of previous months) shipped Payment received USD 10,000.00
June 2018 Goods worth USD 10,000.00 manufactured and shipped Payment received USD 10,000.00

Thus we can say that the revolving letter of credit is a good payment instrument when the transactions are long-term in nature. It helps in avoiding the procedural hassle and cost of issuing a regular letter of credit for every transaction.

Benefits

The prime benefit of the revolving letter of credit is saving a lot of time and energy of all the three parties i.e. Bank, Importer as well as Exporter. Just that the arrangement should be clear and long-term between the buyer and the seller.

Disadvantages

In case, there is any dispute between the buyer and seller before completion of the whole transaction, the time, energy, and cost involved in acquiring the LC could be lost.

Last updated on : September 5th, 2018

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3 Comments

  1. Joel Masiwe
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