A letter of credit is an instrument, issued by a financial company, that promises payment to suppliers if certain conditions are met. Here is an example. Let's say that you need to buy some widgets from a supplier in China. The supplier want immediate payment. However, you don't want to pay until you are certain that the product is delivered according to specifications. The solution: A LOC.
In this case, a financial institution (e.g. bank, purchase order financing company) issues a LOC that promises payment to the supplier if certain conditions are met. With this in hand, the purchaser can buy the product and the supplier can be assured of payment.
Letters of credit are a very important tool that is used in purchase order funding.
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