Letter of Credit vs Open Account: How SMEs Get Paid Safely in International Trade

The letter of credit vs open account choice decides whether an SME gets paid or gets burned in international trade. An exporter ships goods to a new buyer on trust, then waits six months for payment that never feels certain. An importer ties up working capital in a letter of credit, then watches cash flow tighten.

This decision sits at the heart of every cross-border trade — especially for SMEs shipping across the Singapore–Malaysia–Indonesia corridor. Choose the wrong payment term and you either risk non-payment or freeze your own working capital. This guide compares all five international trade payment methods, explains the UCP 600 rules that govern letters of credit, and shows you exactly how to choose. Get the term right, and you protect both your sale and your business survival.

Key Takeaway

• A letter of credit is a conditional payment guarantee from the buyer's bank, secured before shipment

• An open account ships first and bills later — favouring the buyer's cash flow but exposing the seller

• The five trade payment methods run from cash in advance to consignment, trading security against competitiveness

• The most secure method for the exporter is always the least secure for the importer

• Under ICC UCP 600 rules, a letter of credit pays on compliant documents — not on the goods themselves

Why Payment Terms Decide Whether You Survive

Most SME owners negotiate hard on price, then accept payment terms without a second thought. Yet the payment term decides who carries the risk if the deal goes wrong. A single bad term can sink a profitable shipment, on either side of the trade. Therefore, the payment method matters as much as the price itself.

Trust is the core barrier in international trade between parties who barely know each other. The exporter wants payment before releasing goods; the importer wants goods before releasing payment. This standoff is exactly what payment instruments exist to resolve. The right term bridges the trust gap without crushing either party's cash flow.

Here is the pattern that repeats across ASEAN trade, from Singapore's port to Batam's industrial zones to Johor's manufacturing hubs. A new exporter ships on open account to win a buyer, then waits months for payment. Meanwhile, a cautious importer over-secures every deal and starves its own working capital. Instead of guessing, you must match the payment term to the specific risk in front of you.

What Is a Letter of Credit? Definition and How It Works

A letter of credit (LC) is a formal written undertaking issued by a bank — on behalf of the importer — guaranteeing payment to the exporter once specific document conditions are met. It is governed globally by the UCP 600 rules published by the International Chamber of Commerce (ICC), applied across approximately 175 countries. The LC shifts payment risk from the buyer's creditworthiness to the bank's financial standing.

Under UCP 600, every letter of credit is irrevocable once issued — meaning neither party can change the terms unilaterally without mutual consent. Payment depends entirely on compliant documents: the commercial invoice, bill of lading, packing list, certificate of origin, and any other documents the LC specifies. Even a minor discrepancy — a wrong date, an inconsistent product description, a mismatched port name — can trigger a refusal. Therefore, document accuracy under an LC is not a formality; it is the payment itself.

How a letter of credit works, step by step:

1. Buyer and seller agree on LC as the payment term in the sales contract

2. Buyer applies to their bank (issuing bank) to open the LC

3. Issuing bank sends the LC to the seller's bank (advising or confirming bank)

4. Seller ships the goods and compiles all required documents

5. Seller presents compliant documents to their bank within the LC validity period

6. Banks examine documents against UCP 600 strict compliance standard

7. Issuing bank releases payment to the seller's bank on confirmation of compliant documents

8. Buyer receives the shipping documents and claims their goods

What Is an Open Account? Definition and How It Works

An open account is a payment arrangement where the exporter ships the goods and then invoices the buyer to pay at an agreed later date — typically 30, 60, or 90 days after shipment. It is the simplest and most common payment method in established trade relationships across Singapore, Malaysia, and Indonesia. No bank guarantee exists; the seller relies entirely on the buyer's willingness and ability to pay.

Open account strongly favours the importer because it frees their cash flow and reduces transaction costs. However, it transfers all payment risk to the exporter for the full credit period. Shipping on open account to an unverified buyer is one of the most common — and costliest — mistakes SME exporters make in their first year of international trade. Reserve open account for buyers who have proven their reliability over multiple transactions.

The Five Payment Methods: From Safest to Riskiest for Exporters

International trade uses five primary payment methods, each placing a different balance of risk between the exporter and importer. Understanding all five lets you select the right tool for each buyer relationship and market — whether you are exporting from Singapore to Jakarta, shipping from Johor Bahru to Manila, or trading across the broader ASEAN Economic Community.

Cash in Advance — Maximum Security for the Seller

Cash in advance means the buyer pays before the seller ships the goods. This gives the exporter total security and zero payment risk. However, it places all the risk on the importer, who pays before seeing or inspecting anything.

Cash in advance suits first orders with unknown buyers, very high-risk markets, or custom-made goods with no resale value. Many buyers refuse prepayment because it strains their cash flow and signals distrust. Consequently, demanding cash in advance can protect you on one deal while costing you the next. Use it selectively — for unknown counterparties, high-value goods, or politically unstable destinations.

Letter of Credit (LC) — Bank-Backed Security

A letter of credit is a conditional payment guarantee issued by the importer's bank. The bank commits to pay the exporter once compliant shipping documents are presented. This replaces reliance on the buyer's promise with the bank's financial obligation — making it the preferred instrument for new trade relationships across the Singapore–Malaysia–Indonesia corridor.

An LC suits new buyer relationships and moderate-to-high-risk markets across ASEAN and beyond. The trade-off is cost — bank issuance fees, amendment fees, and documentary compliance work. A discrepancy in the bill of lading can delay payment even when the cargo is perfect. Therefore, invest time in getting your LC documents right before you present them.

Documentary Collection — Bank-Facilitated, Not Bank-Guaranteed

A documentary collection uses banks to exchange shipping documents for payment, but without a bank guarantee. The exporter's bank forwards documents to the importer's bank, which releases them on payment (Documents against Payment, D/P) or on acceptance of a time draft (Documents against Acceptance, D/A). The ICC governs this method under URC 522 rules.

Documentary collection costs less than a letter of credit but offers weaker protection. The bank moves the documents but does not guarantee the underlying payment. It suits established relationships where trust has grown but some structure still adds comfort. Therefore, it sits between the bank guarantee of an LC and the open risk of an open account.

Open Account — Maximum Flexibility for the Buyer

Open account means the exporter ships and invoices, and the buyer pays later on agreed credit terms. This method strongly favours the importer's cash flow and makes the exporter more competitive. However, it exposes the exporter to the full risk of late payment or non-payment for the entire credit period.

Trade credit insurance — available through insurers operating in Singapore and Malaysia such as Euler Hermes (Allianz Trade) and Atradius — can offset some of that risk for SME exporters. Treat open account as something a buyer earns through a proven payment history, not a default concession you offer to win a first deal.

Consignment — Highest Risk, Highest Market Access

Consignment is a form of open account where the exporter is paid only after the goods are sold onward by the buyer. The buyer holds the goods but does not own them until a final downstream sale occurs. This carries the highest payment risk of all five methods for the exporter.

Consignment ties the exporter's payment to the buyer's ability to sell, meaning the seller finances the inventory and absorbs all risk until the final sale closes. It can win market share in highly competitive segments where buyers resist any upfront commitment. Reserve consignment exclusively for proven, long-term partners with transparent and auditable sales reporting.

Payment Method Risk Comparison Table

Letter of Credit vs Open Account: The SME Decision Framework

Most ASEAN SME trades — particularly across the Singapore, Johor, Batam, Jakarta, and Surabaya trade lanes — ultimately come down to a choice between a letter of credit and an open account. The LC protects the seller; open account protects the buyer's cash flow and competitiveness. Your position in the deal, the buyer's track record, and the market's risk level decide which fits.

The core difference:

• A letter of credit shifts payment risk to a bank, protecting the exporter before goods ship

• An open account keeps the risk with the exporter but gives the importer time to pay after delivery

• The letter of credit favours the seller's security; open account favours the buyer's cash flow

• Your choice depends on who holds the leverage and how much you trust the counterparty

When a Letter of Credit Protects You

Choose a letter of credit when selling to a new buyer, entering a new market, or shipping high-value goods. The LC replaces your reliance on the buyer's promise with a bank-backed commitment. It keeps you competitive — the buyer avoids full prepayment — while eliminating your non-payment risk.

A letter of credit suits the first three to five transactions with any new counterparty, regardless of market. For Singapore and Malaysia SME exporters shipping into new ASEAN markets — including Vietnam, Thailand, the Philippines, or Indonesia's outer islands — the LC fee is a small price for the protection it delivers. Weigh the bank charges against the full value of the shipment and your total exposure if payment fails.

When Open Account Makes Commercial Sense

Choose open account when a buyer has demonstrated reliability over multiple completed transactions with zero payment incidents. Open account reduces friction, wins larger repeat orders, and signals mutual trust. It works best in stable markets — Singapore, peninsular Malaysia, major Indonesian cities — where you have clear legal recourse if a dispute arises.

If you offer open account in competitive markets, consider trade credit insurance to limit exposure. Price the credit period into your quote — 90 days of tied-up capital carries a real financing cost that erodes your margin if you ignore it. Never grant open account to a buyer simply to win the first deal; earn it through the second and third transaction.

UCP 600: The Rules Behind Every Letter of Credit

UCP 600 — Uniform Customs and Practice for Documentary Credits — is the International Chamber of Commerce rulebook that governs letters of credit globally. It contains 39 articles and applies across approximately 175 countries. Every bank that issues an LC incorporates UCP 600 by reference, giving all parties a consistent, enforceable framework regardless of whether the trade originates in Singapore, Kuala Lumpur, Jakarta, or anywhere else in the world.

Three UCP 600 principles every SME exporter must understand before presenting documents:

• Irrevocability: All LCs under UCP 600 are irrevocable by default — neither party can amend or cancel without the other's written consent

• Independence principle: The LC is entirely separate from the underlying sale contract; banks deal in documents only, not in goods, services, or disputes between buyer and seller

• Strict compliance: Banks examine documents against the LC terms character by character — even a misspelled word, inconsistent port description, or mismatched date gives the bank grounds to refuse payment

The Cash Flow Trap SME Exporters Miss

A letter of credit secures your payment, but it does not always pay you quickly. A deferred-payment LC can lock your cash for 30, 60, 90, or even 180 days after shipment. Which means a "safe" LC can still strangle the working capital you need to fund your next production run or pay your freight forwarder. Payment security and payment speed are two entirely different problems — and both matter equally for SME survival.

Many SME exporters celebrate winning an LC, then struggle while the cash sits in limbo for months. Trade receivables finance — also called LC discounting or post-shipment financing — can unlock that cash before the LC payment date matures. Consult your bank about available facilities in Singapore or Malaysia before you agree to any deferred-payment term. Plan your working capital around when you actually receive funds, not when payment is due on paper.

This trap is exactly why payment terms belong inside your pricing conversation, not after it. A 120-day payment term carries a real annualised financing cost — typically 3–6% depending on your bank and market — that must be factored into your quoted price. The smartest ASEAN SME traders negotiate terms and price together, always, and never separately.

How to Choose the Right Payment Term: A 5-Step Method

1. Assess counterparty risk — How well do you know this buyer or seller? How stable is their market, banking system, and legal framework? A new buyer in an unfamiliar ASEAN market warrants stronger security than a 10-year partner in Singapore

2. Determine your position — Are you the exporter needing payment security, or the importer protecting cash flow? Each side has a different optimal starting point in the negotiation

3. Match the method to the risk — New or unknown counterparty → LC or cash in advance; established, trusted buyer with payment history → documentary collection or open account

4. Price the payment term — Calculate the financing cost of any deferred period and build it into your quote; bank charges, credit insurance premiums, and tied-up working capital all carry a real cost

5. Confirm governing rules in the contract — Reference UCP 600 explicitly for letters of credit and URC 522 for documentary collections; written confirmation prevents jurisdiction disputes

For more on the costs that compound when payment delays cause shipment holds, see our guide to hidden shipping costs that drain SME profit. For help structuring your freight documentation to support a clean LC presentation, explore IFG Shipping's freight forwarding and trade documentation services.

Not Sure Which Payment Term Protects Your Next Shipment?

For 25 years, IFG Shipping has helped ASEAN SME traders navigate this exact decision across the Singapore–Malaysia–Indonesia corridor and beyond. We prepare clean LC-compliant shipping documents, help you weigh letter of credit against open account, and flag the cash-flow traps that catch first-time exporters before they cost you.

Send us your deal details, and our team will help you choose a term that protects both your sale and your working capital.

Talk to Iman and the IFG Shipping team:

• WhatsApp: +60 14-325 8325

• Email: contact@ifgshipping.com

• Phone (Singapore): +65 6950 5915

• Office: 51 Changi Business Park Central 2, #04-05, Singapore 486066

Get help choosing the right payment term from IFG Shipping →

FAQ: Letter of Credit and Trade Payment Terms

What is the difference between a letter of credit and open account?

A letter of credit is a bank-backed payment guarantee issued before shipment. An open account ships the goods first and bills the buyer to pay later. The LC protects the exporter; open account favours the importer's cash flow. They sit at opposite ends of the international trade payment risk scale.

What are the 5 methods of payment in international trade?

The five methods are: cash in advance, letter of credit, documentary collection, open account, and consignment. They are ranked from most secure for the exporter (cash in advance) to least secure (consignment). The most secure method for the exporter is always the riskiest for the importer. Choosing the right method depends on the buyer relationship, the market, and the deal value.

What is UCP 600 and why does it matter for SMEs?

UCP 600 is the International Chamber of Commerce rulebook governing letters of credit worldwide, containing 39 articles applied across approximately 175 countries. Under UCP 600, all LCs are irrevocable and banks pay on compliant documents — not on the goods. SMEs must understand strict compliance: even a minor document discrepancy can delay or block payment entirely.

Can a small business in Singapore use a letter of credit?

Yes. Any Singapore-registered business can apply for a letter of credit through a local bank such as DBS, OCBC, or UOB. The LC is particularly useful when entering new ASEAN markets or trading with first-time buyers in Indonesia, Vietnam, or the Philippines. The trade-off is bank fees and the need for precise, compliant shipping documents. For most SME exporters, the LC fee is far smaller than the risk of non-payment it prevents.

What is the safest payment method for an exporter?

Cash in advance is the safest method for an exporter — payment arrives before shipment. A letter of credit is the next safest, replacing buyer credit risk with bank credit risk. Open account and consignment carry the highest risk of non-payment for the selling party. The right choice depends on how well you know the buyer and how much payment risk your business can absorb.

What is a documentary collection and how does it differ from an LC?A documentary collection uses banks to exchange documents for payment, but without a bank guarantee. A letter of credit carries the bank's own payment obligation; a documentary collection does not. Documentary collections are governed by ICC URC 522 and cost less than an LC. They suit established relationships where the exporter needs some structure but not a full bank guarantee.

How does a deferred-payment LC affect cash flow?

A deferred-payment LC secures payment but delays it — typically 30, 60, 90, or 180 days post-shipment. The exporter ships the goods and presents compliant documents but waits for the deferred date to receive funds. This ties up working capital for the full deferred period. Trade receivables finance or LC discounting through your Singapore or Malaysian bank can unlock that cash before the maturity date.

Which payment method is most common in ASEAN trade?

Open account is the most commonly used payment method in established ASEAN trade relationships, particularly between Singapore and Malaysia where legal systems are stable and disputes are resolvable. Letters of credit are more common in newer trade lanes — particularly exports into Indonesia's outer regions, Vietnam, Myanmar, and higher-risk ASEAN markets. The right choice always depends on the specific buyer relationship and shipment value.

About the Author

Iman Yusoff founded IFG Shipping Pte Ltd in Singapore and brings 25 years of freight forwarding and trade finance experience across Southeast Asia. His career spans tanker operations at Land-Oil, global forwarding at Panalpina (now DSV) and SDV (now Bolloré), and NVOCC ventures across the Singapore–Malaysia–Indonesia corridor. He serves as Board Member and Secretary of the Singapore Malay Chamber of Commerce and Industry (SMCCI). He teaches ASEAN SME owners to ship smarter, spend less, and stay trade-compliant.

This guide provides general trade information, not financial or legal advice. UCP 600 and URC 522 references are accurate as of June 2026. Bank charges, LC terms, and trade finance options vary by institution and jurisdiction. Consult your bank or a qualified trade finance adviser before agreeing to any payment term.