Most commonly, the term trade finance is used to refer to a range of different financial products, solutions and instruments used by companies engaging in international commerce and trade.
Trade finance allows for transactions between parties to be quicker, easier and more practical, and allows trade to happen with confidence.
Trade finance – what is it?
With trade finance a third party forms an integral part of the transaction or trade. This party, also the financier, is the one who supplies the money/finance to the supplier and receives the repaid amount from the buyer according to the terms of their agreement.
For the supplier of the trade this ensures full payment at the point of supply. For the buyer it ensures access to working capital, assets, equipment or inventory, and for the financing company it provides incentive in the form of processing fees and agreed interest or repayment rates.
Trade finance as a line of credit
Why use trade finance?
In many ways, trade finance operates in the same way as a line of credit facility. It allows access to funds to ensure a company can operate, grow and scale. Without a financing company, it can be difficult for a business to buy goods from a supplier either domestically or from overseas and continue opertionas while waiting for delivery or engaging in other aspects of the distribution process.
Instruments used in trade financing
Lending lines of credit
Issued by reputable banks and business finance providers, they can be advantageous to both the buyer/importer and seller/exporter.
Letter of credit
A letter of credit allows for a bank or business finance provider to offer up a guarantee for payment and thus significantly lower the risks associated with trade.
Invoice factoring
This financial solution allows businesses to access capital based on a percentage of their issued but still outstanding invoices.
Insurance
Insurance for shipping, delivery and transport of goods can be included or used in conjunction with trade finance arrangements to help reduce risk even more.
Trade Financing: the pros and cons
What are the advantages of trade financing?
1. Control and access to working capital
The most obvious benefit of trade finance is greater control of and access to working capital, even without the necessary asset security demanded by more traditional forms of financing. A financing company will provide trade finance based on the risks associated with your specific trade, your balance sheet and the other values that are not tied specifically to assets. This gives more businesses and growing businesses greater flexibility and opportunity.
Of course, the specific term period, interest terms and deposit required will be impacted by the financing company’s assessment of the risk of your trade.
2. Greater flexibility with trade
Whether or not the trade is of an international nature, transactions can be complicated. By working with a third party financier the process can be streamlined and timeline sped up. It can be easier to come to agreements and pay with other suppliers with the backing of a trade finance company.
3. Opportunities for discounts
If your supplier provides incentives or discounts for early invoice settlement, being able to access capital quickly through a trade finance facility allows you to realise these savings. Not every supplier will provide such terms, but should this be the case, it can certainly be financially beneficial.
4. Minimise the risk of trading
Trading comes with risks and international trading comes with great risks. This applies to both parties–seller and buyer–in a transaction.
Trade finance provides a way for both parties in the transaction to enjoy reduced risk through the assurance of capital for purchasing (for the buyer) and settlement of the full invoice amount (for the seller).
What are the disadvantages of trade financing?
1. Receiving approval for trade finance
Not every business will be able to access trade finance. Financing companies will have specific requirements as part of their risk assessment that they will take into account. From the size of the business, to the nature of the industry and the specific parties or arrangements involved, there are many factors that can make receiving approval for trade finance more or less difficult.
2. It can be more expensive
Trade finance is a great way to help ensure businesses have access to necessary working capital, but this access does not come without a cost. Fees, interest repayments and other terms for the agreement will differ so it’s vital that you take into consideration your specific profit margins, expenses and other factors before applying.
3. One size may not suit all
There is no single financial solution or product that will be right for every business in every circumstance, and trade finance is no different. In fact, considering some of the other disadvantages it might not be suitable for your situation at all.
For example, the team here at ScotPac consult individually with every client to ensure we understand the unique factors of their situation. We’ll then be able to provide customised advice as to which financial solution is best suited to one’s needs.
4. Terms and obligations
While this may not be a disadvantage specific to trade finance, it is certainly something to take into consideration. Trade financing agreements will come with specific terms and obligations for you to abide by and fulfill. The nature of these contractual terms can be more or less suitable to your needs as a business.
Again, this is why it is always recommended that you seek professional and tailored financial advice.
Need a hand? Contact ScotPac today!
Whether you’re still wondering why trade finance or you’re interested in exploring how trade financing can help you grow your business, our friendly staff are ready and waiting to help.
With stellar client review ratings and as the biggest provider of non-bank lender solutions in Australia, ScotPac is best positioned to help you and your business realise your true trading potential. Contact us today to learn more.