If the seller and the buyer are involved in a long-term collaboration, they can resort to revolving credits to settle their frequent sale transactions.
Revolving credits are letter of credits that automatically reset the initial value every time payment is made, without the need of opening a new credit.
Since parties collaborating on a long-term basis should carry on business under a high degree of trust, revolving credits are mostly beneficial for the buyer. In fact, this type of letter of credit will provide cash available to the seller without the need for the buyer to raise funds or anticipate cash. The credit scheme will provide prompt payment.
How Revolving Credits Work
Let’s draw a scenario whereby an Italian maker of pasta buys wheat from a Canadian farm. Since pasta is a consumer staple and wheat an essential ingredient to make it, the parties have put in place a long-term collaboration whereby the Canadian farm supplies the Italian food manufacturer with monthly shipments of wheat. Consideration is set at EUR 50,000 per shipment.
The Italian company opens a revolving letter of credit in favor of the Canadian farm for EUR 50,000. Every month, the supplier ships the wheat and, upon presentation of documents, is paid EUR 50,000. Once payment has been made, the value of the credit is automatically reinstated at the initial value of EUR 50,000.
This way, the Italian buyer is sure of receive his monthly supply without the need to anticipate cash, raise funds or negotiate a new credit each time. The Canadian farm, on the seller’ side, is sure to receive payment on a recurrent basis.
Who Should Use Revolving Credits?
As we wrote in the beginning of the article, revolving credits are a useful tool when the seller and the buyer carry on a long-term collaboration. That could be the case if the supply chain is deeply integrated, like in the automotive industry, or where the manufacturer is in a so-called defensive industry and requires a steady flow of raw materials to meet the continuous demand for his products. That could be the case in the food and beverage industry, chemicals and pharmaceuticals, mining and energy.
Globartis Research Center