Get the Facts on Trade Finance
Unfortunately, small businesses have limited access to loans/interim financing to pay for the goods they plan to buy/sell. Even with a confirmed order, most banks won’t offer a loan or overdraft protection for these transactions. Trade finance makes it possible for businesses- both small and large- to engage in import and export transactions.
Business owners, whether the company is small or large, don’t want to have their funds tied up in an order that could take several weeks to arrive and companies that are exporting these goods don’t want to wait until the product arrives to be paid. Some statistics are showing that more than 80% of global trade relies on trade finances. This keeps goods moving even when the companies don’t have the cash flow to finance these transactions.
How Does it Work?
Trading intermediaries, typically financial institutions, oversee/facilitate various financial transactions between importers and exporters. These financial institutions finance the business transactions between buyers and sellers. Transactions can take place internationally or domestically.
Trade finance covers a variety of activities including factoring, issuing letters of credit, forfaiting, export credit/financing, and lending. There are several entities involved in trade finance: buyer & seller, export credit agencies, insurers, and trade financiers.
5 Facts Related to Trade Finance
Below, we’ll explore 5 facts related to trade finance.
Reduces Risk of Non-Payment
When international trade first came about, exporters were not sure when or if the importer would pay for their products. Over time, exporters looked for ways to reduce this risk of non-payment. That being said, importers were concerned with pre-paying for goods since there was no guarantee the seller would ship them.
Trade finance addresses these risks by accelerating payment to exporters and assuring importers that the goods have been shipped. The importer’s bank provides the exporter’s bank with a letter of credit once shipping documents are presented.
As an alternative, the exporter’s bank may give them a business loan while processing the importer’s payment to keep the supply active instead of the exporter having to wait on the importer’s payment. This loan is recovered by the trade financier when the exporter’s bank receives the payment.
Reduces Pressure on Importers & Exporters
Trade finance has facilitated economic growth around the world by bridging the financial gap between exporters and importers. An exporter doesn’t have to worry about whether or not the importer will pay. And the importer doesn’t have to worry about whether or not the exporter will ship.
Types of Trade Finance Products/Services
There is a variety of products/services offered by trade financiers based on the needs of the companies and transactions. They are as follows:
Letter of Credit
This is a promise by the importer’s bank to the exporter that once the shipping documents have been presented, payment will be released.
The bank is the guarantor in case the importer or exporter fails to fulfill their end of the contract. The bank pays the beneficiary.
These two products have several variations to accommodate the various circumstances and transaction types.
Factoring in Trade Finance
Factoring is commonly used by exporters to accelerate cash flow. The exporter sells their open invoices to the trade financier at a discount. The financier will be paid by the importer. Which helps prevent the exporter from undertaking the risk of bad debts and gives them the working capital to continue trading. The financier makes a profit when the importer pays the agreed-upon price for the goods.
This is an agreement in which the exporter sells their accounts receivable to a forfaiter in exchange for cash at a discount. This process transfers the debt owed by the exporter to the forfaiter. The receivables purchased by the forfaiter must come with a guarantee from the importer’s bank. This is because the importer has taken the goods on credit and will sell them before making any payments to the forfaiter.
Trade credit is a great financial solution to protect importers from the exporter not shipping the goods and protects exporters from importers not paying. This is a mutually beneficial financial product. If you are interested in learning more about trade credit for your business, contact Toluca Lake Capital.