Updated on 19th June 2023

Planning the importation of a first consignment of goods can prove to be more difficult than you realised.

That’s why it’s important that you understand what trade finance is, how it can help your business and how it works?

What is trade finance?

Trade finance makes it easier for businesses to buy and sell goods as it bridges gaps in cash flow and allows a business to capitalise on opportunities at home and abroad.

Did you know that 90% of world trade depends on some form of trade finance? (Source: World Trade Organization)

Trade Finance Definition

Trade finance is an umbrella term that covers a range of financial products. All trade finance facilities are designed to help facilitate seamless and reliable trade between two different businesses. It allows companies to access the necessary funding to buy goods and sell goods, it helps to mitigate risks involved in trade transactions, and it provides a reputable third party to act as an intermediary for financial transactions. 

Trade Finance: How it works

Understanding how it works is important in our understanding of what trade financing is. The purpose of these financial facilities is to ensure an increase in liquidity (the ‘movability’ of money) in a business. 

Trade finance introduces a third party into the interaction between a buyer and a seller. Both of these parties can utilise this third party to fund their side of the trade. 

The Seller

The seller benefits by maintaining working capital through invoice financing and enjoys a guarantee that they will receive payment for the goods or services provided. 

The Buyer

The buyer can fund their purchase of the goods or services and can rest assured that payment will only be released once the goods are shipped.

Trade finance vs business loans

Trade finance is distinct from traditional business loans or overdrafts in a few ways. For one, the red tape in the application process is significantly less. For another, there is generally no need to use a property or home as collateral.

While trade finance can be used to fill in gaps in a company’s cash flow, it is generally used by companies to manage the risks involved with domestic and international trade.

Types of Trade Finance

There are a few different types of trade finance under the larger umbrella term. Each mechanism and product provides businesses with the support they need to carry out trade.

1. Letters of Credit

Letters of credit are used to mitigate the risks for both parties. The third party financier guarantees payment as per the letter of credit as long as the specific conditions set out for payment are met. The buyer benefits by knowing that the goods have been manufactured and sent before payment is provided.

2. Payment in Advance

Payment-in-advance is a common requirement in international trade. The seller will often request a down payment before the ordered goods are manufactured. A third party financier will provide a revolving line of credit to pay the supplier, with the facility lasting up to 120 days, allowing businesses to purchase and sell those goods before being required to settle the payments. 

3. Payments Against Documents

For payments against documents, a financier (and importer) may require documents to be provided proving that the goods have been shipped before payment is made. Suppliers may supply a bill lading or some other document to the third party, and only then is payment transferred. 

4. Import/Export Finance

Import Finance

Important finance is a trade finance solution that businesses can access to purchase finished goods from suppliers, either overseas or locally, without requiring access to the funds independently. The funding, linked to an invoice finance facility, provides a line of credit of up to 180 days. 

The importer, using the amount owed in outstanding customer invoices, can fund the purchase of the goods and also repay the amount borrowed. 

Export Finance

Export finance is designed to help the other part in an international transaction, the exporter. It allows exporters to access working capital and maintain cash flow throughout the sale cycle. Using the accounts receivable as collateral, the exporter can access a line of credit to fund the production of the goods. 

This allows them to take on new orders without waiting for those overseas customers’ payments to clear and transfer.

For a more detailed breakdown of how these trade finance solutions work and how they encourage more commerce and business, see our guide “How Trade Finance Works”.

Do you need trade finance?

Whether you’re a buyer or seller, trade finance offers a variety of benefits.

On the demand side of the equation, an investment in goods can create a gap in a business’s working capital. This can be a considerable issue for businesses needing to maintain operations but also expand and grow. Trade finance allows buyers to fund their purchase and continue to generate revenue without suffering the inhibitive gaps in their working cash flow. 

On the supply side, suppliers working with a large client to provide an extensive amount of goods may offer extended payment terms. This can result in a loss of working capital during the delay between manufacturing and shipping, and the end delivery. Trade finance allows suppliers to access the locked up capital in their manufactured and shipped goods without requiring the buyer to already have taken possession of the goods. 

Mitigating Risk

Trade finance also works to mitigate risk by ensuring a sufficient supply of liquid cash flow. When it comes to international (and even some forms of domestic) commerce, mitigating risk can be hugely important. 

How it works to reduce risk

In trade, there are conflicting needs. The buyer wants to receive goods before paying, and the supplier wants to receive goods before shipping. Neither party wants to risk being out of pocket without receiving what was promised. Trade finance helps to mitigate this risk by accommodating the conflicting needs of each party. 

Through trade finance, risk can be reduced on both sides. For example, a letter of credit can reassure a buyer that the payment held by the third party will only be released once the goods are made and sent. This also works vice versa. 

Due to the varying needs of businesses, trade finance comes in a range of products and solutions but should be customised, when it comes to terms etc., for the specific needs of the businesses in question. Moreover, multiple different financial products can and and should be utilised to promote as seamless and productive trade as possible. 

Trade Finance: The Benefits.

1. Risk Mitigation

As outlined above, trade finance allows businesses to engage in trade with one another, even across countries, with reduced risk and greater peace of mind.

2. Cash Flow

Funding facilities can also be hugely important to a business needing more liquidity. If there is a cash flow gap or more working capital needs to be accessed for growth, trade finance can provide the solution required. With a finance facility set up, you can operate your business with greater confidence.

3. Grow

Growing can be difficult for SMEs, but trade finance is one way to help empower businesses to grow. To ensure that a company has the capital required to increase turnover, secure good new deals and meet revenue targets, trade finance could be the key.

ScotPac: Your trade finance partner!

Almost 50% of SME applications for trade finance proposals are rejected in the Asia-Pacific region.

That’s why ScotPac works hard to provide our clients, no matter how small they are, with the opportunity to access flexible, customsied trade finance solutions to help their businesses grow and thrive.

If you’re looking for a financially savvy way to stay ahead, make sure to speak to our team of local trade finance specialists. With offices throughout Australia and New Zealand, we’re bound to have an office near you. Speak to our team today to find out what sort of trade finance package best suits you and your business’s needs.