Updated on 17th September 2024
Planning your first importation of a consignment of goods can prove to be more difficult than you anticipated.
That’s why Trade Finance can help. But before you consider whether it is right for you, it is 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. It serves to bridge gaps in cash flow and allows a business to capitalise on opportunities at home and abroad by maintaining access to necessary working capital.
Did you know that up to 90% of world trade depends on some form of Trade Finance? (Source: World Trade Organization)
Trade Finance is an umbrella term that covers a range of financial products. All Trade Finance facilities are designed to help ensure seamless and reliable trade between two different businesses in separate countries.
It does this by allowing companies to access the necessary funding to buy goods and sell goods. It also helps to mitigate risks involved in trade transactions and provides a reputable third party to act as an intermediary for financial transactions.
How Trade Finance Works
It is critical to understand how Trade Finance works to better understand what it is. The purpose of these financial facilities is to ensure an increase in liquidity (i.e., 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
How does Trade Finance differ from more traditional Business Loans?
Trade Finance is distinct from loans and 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.
What are the Different Types of Trade Finance
There are a few different forms of Trade Finance under the wider term. Each mechanism and product provides businesses with specialised support to carry out international 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 of lading or some other document to the third party, and only then is payment transferred.
4. Import/Export Finance
Import Finance
Import Finance is a trade finance solution that businesses can access to purchase finished goods from suppliers, whether 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 then fund the purchase of the goods and also repay the amount borrowed.
Export Finance
Export Finance is designed to help the other party 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 on “How Trade Finance Works”.
Should You Apply for 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.
The Advantage of Mitigating Risk
Trade Finance also works to mitigate risk by ensuring a sufficient supply of liquid cash flow. When it comes to international commerce (and even some forms of domestic trade), mitigating risk can be hugely important.
How does Trade Finance reduce risk?
In trade, there are conflicting needs. The buyer wants to receive goods before paying, and the supplier wants to receive payment before shipping goods. Neither party wants to risk being out of pocket without receiving what was promised.
Trade Finance helps to mitigate this risk of the business transaction falling through 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 the 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 should be utilised to promote as seamless and productive trade as possible.
Trade Finance: The Benefits
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.
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.
Fund Growth
Growing can be difficult for SMEs, but Trade Finance is one way to help empower businesses to grow. To ensure that your company has the capital required to increase turnover, secure good new deals and meet revenue targets, Trade Finance could be the key.
ScotPac: 35 years of Trade Finance experience
Almost 50% of small and medium sized enterprises’ applications for trade finance proposals are rejected in the Asia-Pacific region. Compare this to only 7% of multinational corporations’ proposals being rejected.
That’s why ScotPac is the partner of choice for SMEs. Our lending specialists work hard to provide our clients with the opportunity to access flexible, customised Trade Finance solutions to help their businesses grow and thrive.
If you’re looking for a financially savvy way to stay ahead, Speak to our team today to find out what sort of Trade Finance package best suits you and your business’s needs. best suits you and your business’s needs.