Export Factoring vs Letter of Credit: Which Should an Exporter Use?
A letter of credit (LC) is a bank's undertaking to pay you if you present documents that comply with its terms, while export factoring can turn an invoice you have already issued on open-account terms into an advance before the buyer's due date, subject to credit approval and the facility terms. They answer different questions: an LC reduces the risk that a buyer will not pay, and factoring shortens the wait for money. Many exporters use each with different buyers.
Key facts
- An LC moves your payment risk from "will the buyer pay?" to "are my documents compliant?".
- Factoring works on open-account terms. No LC is needed, and the buyer pays the invoice at maturity.
- An LC does not by itself shorten the wait: unless the LC receivable is discounted, you may still wait for the LC's own payment date.
- Whether factoring on a given invoice is with or without recourse is decided case by case. Non-recourse is not a blanket feature of any facility.
- Any advance against an invoice is set after credit review and under the facility terms; this site publishes no percentage or rate.
What problem does each one solve?
A letter of credit is a payment-assurance instrument. The buyer's bank commits to pay when you present documents that match the LC's terms. Export factoring is post-shipment receivables finance: once the invoice exists, it is converted into an advance. Packing credit, a third tool, funds production before shipment (see export factoring vs packing credit). Three tools, three points in the order cycle.
How does a letter of credit work, and what does it not solve?
The buyer's bank opens the LC in your favour. You ship, then present the specified documents. If they comply with the LC's terms, you are paid. A discrepancy, even a small one, can delay or defeat payment even if the shipment itself was correct. An LC is strong against buyer-trust risk but weak against two things: it adds documentary work to every shipment, and it does not shorten the wait unless the LC-backed receivable is also discounted.
How does factoring differ from an LC in what it protects against?
Factoring works on open account, where no LC is needed. Where an LC shifts the risk to a bank's documentary commitment, factoring on an eligible invoice can, if the facility is structured without recourse, move part of the buyer's credit risk to the finance provider. That is decided per buyer and per invoice and described in the facility terms. It never covers a genuine commercial dispute over the goods or services delivered. For the mechanics see export factoring in India and the glossary.
Can you use both?
Yes, and it is common for an exporter's buyer mix to include both. An LC suits a new buyer, an unknown credit or a higher-risk market, where the bank's commitment is worth the paperwork. Factoring suits an established buyer who expects open-account terms. They are usually applied buyer by buyer, not stacked on the same shipment.
Which buyers push exporters from LC to open account?
Whether a buyer will open an LC depends on that buyer's own policy and on your relationship, so the right mix differs buyer by buyer. A new buyer, a buyer whose credit you cannot assess or a market you regard as higher risk are common reasons to prefer an LC. Where you are comfortable trading on open account, getting paid faster on open-account exports becomes the practical question.
How much paperwork does each add per shipment?
An LC is the heaviest: documents must match the LC's text, and a misdated bill of lading or a differently worded goods description can hold up payment. Factoring needs supporting documents for each invoice but does not require matching against a pre-agreed LC text. See documents needed for export factoring.
A quick decision guide
| Situation | Often considered |
|---|---|
| New buyer, unknown credit, higher-risk market | Letter of credit |
| Established repeat buyer who expects open account | Export factoring |
| Need cash before you can ship | Packing credit (pre-shipment finance) |
| Several buyers at different stages of trust | A mix, matched buyer by buyer |
Frequently asked questions
Is export factoring cheaper than a letter of credit?
There is no general answer. The costs are different in kind: LC charges are fees to banks per transaction, and factoring cost depends on the buyer, the tenor and the structure. Compare the full cost breakdown for a specific shipment rather than a headline figure.
Can I factor an invoice that is covered by a letter of credit?
That is a question for the specific facility terms. Factoring is designed mainly for open-account invoices, and an LC-backed receivable is usually handled through LC discounting by a bank.
Does factoring remove the need for a bank?
No. Many exporters keep their bank for packing credit and other facilities and use factoring for the post-shipment gap.
Does an LC guarantee that I get paid on time?
Not by itself. Payment depends on presenting compliant documents, and the LC's own payment date may still be some time away.
Sources
- RBI, Master Circular on Rupee/Foreign Currency Export Credit and Customer Service to Exporters, 1 July 2015 (pre-shipment and post-shipment credit): rbi.org.in. The instructions have since been consolidated into later RBI Directions; this page has not checked the current consolidated text.
Selling on open account and want to be paid sooner? Tell us about your buyers and invoices.
Check eligibility → Takes 60 seconds · no obligationGeneral information for exporters, not legal, tax or financial advice. Regulations change: check the current text with your Authorised Dealer bank or adviser. Any advance is set after credit review and under the facility terms.