Trade finance makes it easier for businesses to buy and sell goods, bridge cash flow gaps, and capitalise on opportunities at home and abroad.
If you’re planning to import your first consignment of goods or you’re looking to expand and take on new clients, it’s important to know how trade finance works and how it can help your business.
Trade Finance Definition
Trade finance is an umbrella term that covers a range of financial products designed to help facilitate trade between businesses. It makes it possible for companies to access funding to buy and sell goods while helping to mitigate the risks involved with trade transactions.
How Does Trade Finance Work?
The purpose of trade finance is to increase liquidity for businesses and to improve the management of risk to facilitate trade. Trade finance introduces a third-party into a transaction between a buyer and a seller.
The seller can maintain working capital through invoice financing and guarantee they will receive payment, and the buyer can fund the purchase of goods and ensure they are shipped before payment is released.
Trade finance is different from a traditional business loan or overdraft. While it can help to plug cash flow gaps, trade finance is often used by companies to manage the risks involved with domestic and international trade.
The Types of Trade Finance
There are several trade finance products and mechanisms used to fulfil the requirements of businesses and facilitate trade transactions. According to the World Trade Organization (WTO), up to 90% of world trade depends on some form of trade finance. These mechanisms can include:
Letters of Credit
A letter of credit helps to mitigate risk for both the buyer and seller. The third-party financier will guarantee payment to the seller as long as conditions of payment are met. For the buyer, it ensures that the goods are manufactured and shipped before payment is released.
Payment-in-advance is a common requirement for international transactions. The seller will typically require a down payment before manufacturing the ordered goods. ScotPac Tradeline is a trade finance solution that enables companies to access a revolving line of credit to pay international and local suppliers. You can arrange a facility that lasts up to 120 days, allowing you to purchase and sell the goods before making a repayment.
Payment Against Documents
Financiers and importers often require payment against documents to ensure the shipment of goods before payment to the supplier is released. Suppliers are usually required to submit a bill of lading to the third-party financier before the payment is transferred. Once the documents are submitted, the payment to the supplier is released.
Export finance is specifically designed to help exporters maintain cash flow and increase the speed of sales cycles. You can use your accounts receivables as collateral to access a line of credit. With access to funding, you can produce or manufacture goods for sale and take on new orders rather than waiting for overseas customer payments to clear.
Import finance is a trade finance solution for businesses that purchase finished goods from overseas or domestic suppliers. The funding is linked to an invoice finance facility to provide a line of credit of up to 180 days. You can fund the purchase of goods and repay the amount owed using outstanding customer invoices.
There are a number of trade finance solutions to help facilitate trade transactions and encourage commerce. For a more detailed breakdown of how these mechanisms work, take a look at our guide “How Trade Finance Works”.
Why Companies Need Trade Finance
Both buyers and sellers can benefit from trade finance.
For buyers, an investment in goods can make a significant dent in working capital. This can be a considerable problem for importers purchasing goods from overseas. Being able to access trade finance allows importers to fund the purchase of goods and generate revenue without suffering cash flow gaps while waiting for goods to arrive.
For suppliers, working with a large client or offering extended payment terms can result in a shortage of working capital. Trade finance enables companies to release the capital tied up in the manufacturing and shipment of goods.
A lack of cash flow is not the only reason companies need trade finance. Many large businesses with sufficient liquidity seek trade finance to mitigate the risk involved with international and domestic commerce.
How Trade Finance Can Reduce Risk
Trade finance helps to mitigate risk by accommodating the conflicting needs of the buyer and seller.
The seller would prefer to receive payment upfront to avoid the risk that a buyer will be unable to pay for goods once they have been shipped.
The buyer would prefer extended payment terms to ensure the goods are shipped and to avoid the risk of paying for goods that are not received.
A trade finance solution can be used to reduce the risk for both parties. For example, a letter of credit can be used to ensure that payment is only released once the supplier has presented the bill of lading to the financier. The letter of credit offers the seller a guarantee that the goods will be paid for once they are shipped.
Trade finance covers a range of financial solutions that can be tailored to the needs of importers and exporters. Multiple financial products can be used together to facilitate trade and ensure a smooth transaction.
The Benefits of Trade Finance
Aside from risk mitigation, trade finance offers many benefits for businesses looking to purchase and sell goods in Australia and around the world.
A funding facility helps to increase liquidity and avoid any cash flow gaps. You can pay your overheads and be confident that you have the financial backing to take on new orders. You may be able to offer extended payment terms to your customers, or secure bulk buying/early payment discounts from your suppliers to increase your margins.
Trade finance empowers SMEs with the capital they need to increase the turnover of goods, secure deals with larger customers, and scale revenues to increase profitability.
To see how trade finance can benefit your business, take a look at our case study showing how the Sydney-based import business Ayonz has used trade finance to fuel growth through difficult economic times during the COVID-19 pandemic.
Trade Finance with ScotPac
Trade finance is vital for business growth. But access to funding is unfortunately skewed towards big companies and corporations. In Asia and the Pacific, 45% of SME trade finance proposals are rejected. This is in contrast to the 83% of trade finance proposals from corporations that are accepted.
Here at ScotPac, we believe every business deserves the opportunity to grow, no matter how big or small. We offer a range of flexible trade finance solutions to help businesses access the funding they need to take on new orders.
You can set up a revolving line of credit to help you compete in global markets and closer to home. We have a team of trade experts to help you negotiate and secure better terms, and we can facilitate letters of credit, documents against payment, and telegraphic transfers.
Speak to one of trade finance advisors today, and we’ll help you put together a trade finance package that meets the needs of your business.