What Is a Fully Funded Documentary Letter of Credit (FFDLC)?
A fully funded documentary letter of credit (FFDLC) is a documented letter of credit that serves as a written promise of payment provided by a buyer to a seller. With a fully funded letter of credit, the buyer’s funds for the required payment are held in a separate account for use when needed, similar to the process for escrow. The seller receives payment when all of the terms of the agreement are fulfilled.
Letters of credit are commonly used in commercial, international transactions. They allow a buyer to manage risks of international business dealings while also obtaining support through the promise of borrowed funds. A letter of credit is documented by a bank who serves as a third party in the transaction. A seller may have certain requirements for the financial institutions for which it will accept letters of credit from. A letter of credit serves as a binding and legal document that the seller can accept and legally contest if payment is not made according to the detailed terms.
Letters of credit can be funded or unfunded.
A fully funded documentary letter of credit is a letter of credit in which the funds necessary are held in a separate account which serves as a type of escrow account. Buyers using an FFDLC may deposit some of their own funds and require funding from a financial institution for the remainder of the funds. Typically in an FFDLC, the buyer will need to begin paying interest on the borrowed funds as soon as they are placed in the separate account.
Buyers and sellers will usually work with third parties to fully complete transactions involving all types of letters of credit and specifically FFDLC. The seller may hold documentary letters of credit with their own bank who then acts as their agent. The seller’s agent bank can manage the documentary collection process when appropriate and can help the seller to more easily receive payment into its account.
Other operational procedures may also be included in the documentary collection. Some documentary letters of credit may include an at sight provision which requires that the buyer initiate the transaction as soon as they receive the specified goods and accompanying paperwork.
Overall an FFDLC provides assurance to the seller that the buyer has the necessary funds for the transaction, as it proves the buyer has transferred cash to a separate account. With an FFDLC the buyer does not have to risk sending payment to the seller without knowing whether or not the goods have actually been shipped. Fully funded documentary letters of credit include comprehensive provisions detailing all of the necessary business and operational provisions. Such terms may include clauses for proof of shipment, such as a bill of lading stamped by customs. The conditions under which funds may revert to the buyer, such as the seller's failure to provide a bill of lading within a set time, are also outlined in the FFDLC.
Funded vs. Unfunded
Letters of credit can be funded or unfunded. A fully funded documentary letter of credit will provide assurance that cash for the value necessary in payment has been moved to a separate account for payment when required. Unfunded letters of credit do not set aside funds specifically through a separate, escrow type of account. In an unfunded letter of credit, the bank backing the letter of credit promises to pay if the buyer is unable to at the time payment is required. In an unfunded letter of credit, the bank may pay the full amount or a partial amount depending on the funds the buyer has available. If a bank must issue funds for an unfunded letter of credit then interest on the funds being borrowed from the bank would usually not begin until transferred.
- An FFDLC is a letter of credit backed by funds in escrow.
- Businesses can use an FFDLC to obtain some or all of the funds moved to an escrow account for final payment.
- Letters of credit can come in many different variations and may be either funded or unfunded.
Types of Letters of Credit
There can be numerous types of letters of credit. Each may or may not be funded. Some of the most common types of letters of credit include the following:
- Commercial/documentary letter of credit
- Standby letter of credit
- Secured letter of credit
- Revocable letter of credit
- Irrevocable letter of credit
- Revolving letter of credit
- Red clause letter of credit
- Green clause letter of credit
Financial Accounting for Letters of Credit
Companies may also need to make special considerations for accounting for letters of credit. These considerations can depend on whether the letter of credit is funded or unfunded. Letters of credit serve as access to borrowed funds. Therefore letters of credit must be recorded as liabilities on the balance sheet. In general, a funded letter of credit would need to be reported on the balance sheet as a liability immediately since funds are transferred to a separate account and begin accumulating interest. An unfunded letter of credit would not necessarily need to be reported as a liability on the balance sheet until the letter of credit has been utilized in exchange for borrowed funds.