Letters of Credit vs TT: Choosing Payment Terms with Indian Suppliers

Payment terms are one of the most important decisions in international sourcing. They affect cash flow, risk exposure, supplier commitment and the overall stability of a trading relationship. When buying from Indian suppliers, importers typically evaluate a range of options, from telegraphic transfer (TT) and letters of credit (LCs) to escrow arrangements and, eventually, open account terms.

There is no single payment method that suits every transaction. The right choice depends on factors such as order value, product complexity, supplier track record, production lead times and the level of trust between both parties. Understanding the strengths and limitations of each approach helps buyers protect their interests while remaining commercially attractive to suppliers.

Understanding the Main Payment Methods

Most international sourcing transactions fall into four broad categories:

• Telegraphic Transfer (TT): Direct bank-to-bank payment, often structured as an advance payment followed by a balance payment.
• Letter of Credit (LC): A banking instrument that releases payment when specified documentary conditions are met.
• Escrow: A third party holds funds until agreed conditions are satisfied.
• Open Account: The supplier ships goods before receiving payment, with settlement occurring later according to agreed terms.

Each method allocates risk differently between buyer and supplier. The key sourcing challenge is finding a structure that both sides consider reasonable.

Telegraphic Transfer (TT): The Most Common Approach

TT payments are widely used in international trade because they are relatively straightforward. Rather than involving extensive banking documentation, the buyer transfers funds directly to the supplier's bank account.

A common structure involves splitting payments between an advance and a balance payment. The advance gives the supplier confidence to purchase materials, allocate production capacity and begin manufacturing. The balance is then paid according to the agreed commercial terms, often tied to production completion or shipping milestones.

Advantages of TT

• Simple process with limited administrative burden.
• Faster execution compared with more document-heavy payment methods.
• Lower banking complexity.
• Flexible structures can be negotiated based on the transaction.

Risks of TT

• Buyers assume risk when making advance payments.
• Disputes can be difficult if expectations were not clearly documented.
• Protection depends heavily on supplier reliability and communication.

For first-time orders, buyers often use smaller trial orders before committing to larger volumes under TT arrangements. Supplier verification, sample approvals and clear purchase documentation become particularly important when advance payments are involved.

Letters of Credit: More Structure, More Control

Letters of credit are designed to reduce payment risk by introducing banks into the transaction. Under an LC, payment is generally linked to the presentation of documents that meet the terms specified in the credit.

This structure can provide greater confidence to both parties. Buyers gain assurance that documentary requirements must be met before payment is released, while suppliers receive comfort that payment is supported by the banking system when compliant documents are presented.

Advantages of Letters of Credit

• Greater procedural control over the transaction.
• Clear documentary framework.
• Useful for larger orders or higher-risk situations.
• Can help establish confidence when parties have limited trading history.

Challenges of Letters of Credit

• More documentation and administration.
• Potential for delays if documents contain discrepancies.
• Additional banking involvement and related costs.
• Requires careful drafting and review of LC conditions.

Importers sometimes assume an LC eliminates all risk. In practice, an LC primarily addresses documentary compliance rather than product quality, performance or commercial disputes. Buyers should still maintain robust quality-control procedures and clear specifications.

When Escrow Makes Sense

Escrow arrangements sit between direct payment and more formal banking instruments. A neutral third party holds funds until agreed conditions are met.

Escrow can be useful when:

• The buyer and supplier are working together for the first time.
• The transaction value is significant enough to justify additional safeguards.
• Both parties want protection without the complexity of a letter of credit.

For buyers, escrow can reduce concerns about transferring funds directly before performance milestones are achieved. For suppliers, it demonstrates that funds have been committed and are available once conditions are satisfied.

The effectiveness of escrow depends heavily on clearly defined release conditions. Ambiguous terms can create disputes and delays.

Open Account: The Trust-Based Model

Open account terms generally place more risk on the supplier because goods are shipped before payment is received. As a result, open account arrangements are usually associated with mature business relationships rather than initial sourcing engagements.

Suppliers may consider open account terms when:

• A long history of successful transactions exists.
• The buyer has demonstrated reliable payment behaviour.
• Order volumes have become predictable.
• The commercial relationship has strategic importance.

From the buyer's perspective, open account terms can improve working capital management and reduce cash tied up in inventory. However, suppliers must be confident that payment will arrive as agreed.

Many sourcing relationships never begin on open account terms. Instead, they evolve toward them after repeated successful transactions.

How Trust Develops Over Time

Payment terms are often a reflection of trust rather than purely financial mechanics. Strong supplier relationships typically progress through stages.

At the beginning of a relationship, both sides are managing uncertainty. The buyer may have concerns about production capability, quality consistency and delivery performance. The supplier may have concerns about payment reliability and future business commitment.

As orders are completed successfully, confidence grows through observable performance:

• Consistent product quality.
• Accurate documentation.
• Reliable delivery schedules.
• Responsive communication.
• Timely payments.
• Professional handling of issues when they arise.

Over time, this operating history often creates opportunities to renegotiate payment structures. Suppliers may become more comfortable reducing advance payment requirements. Buyers may gain confidence using simpler payment mechanisms. Eventually, some relationships progress toward credit-based arrangements.

Trust is built through repeated execution, not negotiation alone.

Choosing the Right Payment Method for Different Situations

First-Time Supplier Engagement

For a new supplier relationship, buyers generally focus on balancing risk and practicality. Escrow or carefully structured TT arrangements are often considered, particularly when the order value is manageable and supplier verification has been completed.

Large or Complex Orders

Where order values are substantial or products require long production cycles, additional controls may be appropriate. Letters of credit can provide a more structured framework, particularly when both parties want stronger procedural safeguards.

Established Supplier Relationships

Once suppliers have demonstrated reliability across multiple transactions, buyers may find that TT arrangements become more efficient. The administrative simplicity can benefit both sides.

Strategic Long-Term Partnerships

In mature relationships with strong commercial history, suppliers may consider more flexible arrangements, including forms of open account trading. Such terms are typically earned through consistent performance over time.

Practical Questions Buyers Should Ask

Before finalising payment terms with an Indian supplier, sourcing managers should evaluate several practical questions:

• Is this a first transaction or an established relationship?
• How critical is the order to the business?
• What is the supplier's track record?
• How complex is the product and production process?
• What level of working capital flexibility is required?
• How much administrative effort can the organisation support?
• What happens if production delays occur?
• How will disputes be handled?

The answers often reveal whether a simpler TT structure is sufficient or whether additional safeguards should be considered.

Payment Terms Should Support the Relationship

Importers sometimes focus exclusively on reducing their own risk. Suppliers do the same from their side. The most effective payment arrangements recognise the commercial realities facing both parties.

A supplier asked to accept excessive risk may increase prices, decline the opportunity or prioritise other customers. Likewise, buyers who assume unnecessary risk may expose themselves to avoidable problems.

The goal is not to find the toughest payment terms. The goal is to establish terms that support a reliable, sustainable sourcing relationship while matching the risk profile of the transaction.

As you evaluate suppliers and sourcing options, combining payment-term planning with supplier due diligence and market intelligence can improve decision-making. Explore market intelligence, learn how the sourcing process works, or review available supplier categories through products before structuring your next purchasing agreement.