Complete Baths and Kitchen Inc (CBK) is a large 15 year old company with about 2

Question

Complete Baths and Kitchen Inc (CBK) is a large 15 year old company with about 250 retail stores across Canada the US. CBK purchases finished home décor items from Asia, Latin America and Eastern Europe. CBK uses a standard sight, confirmed Letter of Credit (CL/C), on each transaction, to pay for about 90% of its supplies. CBK has worked hard to create and maintain a reputation for fairness and reliability with their suppliers and customers. However, since CBK sells products that are ‘non-essentials’ for many people, the company has seen sales drop during the past few years. Lower revenues have affected cash-flow and short-term debt.

CBK’s survival since the beginning of the recession has been due to careful management of costs, especially on back-office functions and supply chain operations. Now, CBK’s management needs to solve a trade finance dilemma:

A CL/C is an effective way to pay its suppliers; the suppliers’ confidence that they will be paid is very high and CBK knows some of its suppliers use the Documentary Credit to finance their own operations

A CL/C is also an excellent way to ensure CBK gets the products it wants; this has become particularly important during the recession as some suppliers have attempted to cut corners to reduce their own costs, and have produced sub-standard and/or poorer quality product.

However, the costs of doing business this way is high; bank fees for this kind of Letter of Credit will increase in the near future. Going to another bank is not an option, as all banks charge similar fees.

Management has decided to review CBK’s arrangements; they are willing to consider any other payment options that could be viable.

1.Describe the Letter of Credit payment process. Explain what a standard sight, confirmed Letter of Credit is. (5 marks)

2.Discuss the advantages and disadvantages of using a L/C for each party in the process (5 marks)

3.Identify and discuss the pros and cons of two (2) other payment methods CBK could use that are appropriate to their business and situation. (5 marks)

4. If CBK made the decision to change to a lower cost supplier in another country what are some of the possible risks associated with that decision. Are there any other ways CBK can save money other than changing payment methods? (5 marks).

5. Referring to the payment methods you discussed in question 3 choose the one you think is best suited for CB situation and support your decision with reference to the Case, course materials and discussions we’ve had in class. (10 marks).

Explanation / Answer

1. Letter of credit is a document issued by the bank on the behalf of the buyer to the seller as a guarantee to pay the amount owed by the buyer to the seller in case the buyer defaults on the payment. Payment is made by the buyer in the normal course of operations of the business to the seller after the seller has delivered the required product to the buyer. However, if the same amount is not paid by the buyer then the seller will receive such payment from the bank issuing it on behalf of buyer in full setllement of the amount due. In this manner, the seller is guaranted against the confirm payment on performance of the contract.

Standard sight LOC is the quickest type of LOC in which the payment is made by the bank to the seller immediately on the performance by the seller of his part of obligation of deal and submitting the required documents to the bank. The seller is not required to wait for the payment from the buyer if the party has issued standard sight, confirmed LOC.

2. Advantages to the buyer:

1. Solve buyer problem of short term liquidity as he is not required to pay the party from his cash.

2. If the seller fails to provide the desired quality then LOC can be revoked and buyer will receive his payment from the bank. This way he is fully ensured about the quality of the product.

3. LOC is considered as guarantee and therefore, builds up confidence among the seller that buyer will make the payment.

4. Solve overseas payment problem of the buyer.

Disadvantages to buyer:

1. L/C issuing bank charges interest for the performance of the same. These costs are generally higher.

2. Every seller may not be confident enough to use such medium.

3. L/C is considered as a short term loan taken by the buyer and efffects the financial performance of the company reported on balance sheet. Like high debt equity ratio.

4. The company may not be able to pay the such short term debt if payment is blocked from sale of products, this will adversely effect the liquidity of the company.

Advantages to seller:

1. Seller is confident in selling the product as he is guaranted the payment.

2. This reduces the production risk for the seller in case buyer changes his order.

3. The seller is able to calculate the payment date for the goods.

4. Helps the seller in facilitating the export orders.

Disadvantages to seller:

1. Payment will be stopped if good quality goods are not shipped.

2. Sometimes reviewing the documents submitted to bank takes time and therefore payment may get delayed.

3. Sometimes buyer can change the shipping time or order date.

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