A Basic Problem with a
Letter of Credit
By Michael C. Dennis, MBA, CBF

Several traps to avoid using Letters of Credit

In connection with a request for open account credit terms from a foreign customer, some trade creditors request and will sometimes receive financial statements from these customers. Foreign statements should be reviewed with great care. These statements are normally not prepared or formatted in the same way as U.S. financial statements. For example, assets may be listed in a different order from the way they would appear in financial statements. Financial statements are not prepared based on U.S. Generally Accepted Accounting Principles. In some cases, accounts that would be defined as liabilities under U.S. accounting rules are classified as equity [and vice versa].

There are several other traps to avoid when analyzing foreign financial statements, including these:

• Most creditors have no idea about the standards of training or independence required of auditors in foreign countries.
  
• Many foreign countries do not have the anything approaching the number of accounting and auditing rules as are in effect in the United States. Consequently, credit professionals in many cases cannot accuracy of financial statements presented by a foreign customer even when the statements are audited.
  
• Even when statements have been audited, it is usually difficult to know the scope of the audit, or how rigorous the auditor is required to be
  
• The statements will be denominated in a foreign currency, not in US dollars, necessitating currency conversions.
  
• In many countries, a company will have several sets of books - each for different purposes. Chances are that if a customer has multiple sets of books that they will share with a potential creditor the statements that make the company look the most creditworthy.

For all of these reasons, credit professionals must view foreign financial statements with a certain amount of professional skepticism.

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