Trade finance provides funds for paying suppliers. However, what is trade finance and who can use it? Let's explore the details of this financial service.
Many global merchants struggle to gain access to finance. This is especially true for SMEs — 8 out of 10 are deemed ‘unbankable' by big financial institutions. So if you’re a new business with a short operating history or weak financials, what do you do?
It’s enough to break a business — lack of access to capital negatively impacts cash flow and damages a business’s ability to expand globally. And when you have a global economy full of broken, seemingly ‘unbankable' SMEs, global monopolies entrench themselves and innovation is stifled.
International merchants need access to finance quickly. The question is, where can they turn?
The answer: Trade finance.
This article at a glance:
Trade finance is a great way for new SMEs to expand their business globally, and alleviate the burdens of limited cash flow brought on by late payments.
Trade finance in the UK refers to financial products and services that facilitate international trade transactions between businesses based in the UK and their trading partners abroad. These financial products and services may include financing, insurance, and other forms of support to help businesses win contracts, fulfill orders, and get paid when exporting goods and services.
Trade finance itself refers to the range of financial tools and products that businesses use to facilitate international trade and commerce. These financial instruments make it possible for importers and exporters to conduct business efficiently and with ease. Trade finance encompasses a wide variety of financial products which banks and companies employ to make transactions involved in trade more practical.
Trade finance serves the purpose of mitigating the risk of payment and supply by involving a third-party in transactions. It guarantees the exporter payment according to the agreement while the importer may be offered credit to fulfill the trade order.
The parties involved in trade finance include:
Unlike conventional financing, trade finance is not solely used for liquidity or solvency management, but rather to safeguard against inherent risks in international trade. Various financial instruments such as lending lines of credit, letters of credit, factoring, export credit, working capital, and insurance are used in trade finance. The widespread adoption of trade finance has contributed to the growth of international trade.
Trade finance is really about establishing a healthy cash flow — it keeps the global supply chain ticking along nicely. But let’s take a closer look.
1. Reduces risk
Trade finance reduces risk by lending payments to exporters while guaranteeing that goods are shipped out to importers. If your trade financing company provides non-recourse financing, they will still pay the exporter even if the buyer defaults.
2. Increases revenue
Trade finance allows companies to request larger orders from suppliers. They can then take advantage of economies of scale and enjoy access to discounts offered by suppliers for large bulk orders.
3. Improves operational efficiency
Trade finance reduces delays to payments and shipments. Payment to the exporter and shipment to the importer are largely guaranteed, reducing the risk of non-payment and non-receipt of goods.
4. Promotes business growth
Trade finance allows previously ‘unbankable' companies to follow through with certain deals that couldn’t have been completed without a large amount of capital at their disposal.
Trade finance wears a lot of different hats. The choice of hat is yours — what works for one business might not work for another. Ultimately, it all depends on how much transactional risk you’re willing to take, and what kind of resources you have at your disposal.
Let’s explore your options.
There are two main cash flow gaps in the international trade cycle: when you pay upfront and when you’re waiting for a payment from your customer.
Trade finance and invoice finance address these cash flow gaps respectively.
Let’s say your cash flow is a bit too tight to pay upfront for a large number of goods. That’s when you turn to trade finance.
Instead of committing to a large sum of money — and not knowing the exact time you’ll be able to get paid for your products or services — lenders will pay the money on your behalf.
Timmy is a Vietnam-based exporter of phone cases that he sells to a UK-based distributor. As it will take more than three months before he can get the money back from the distributor, he opts for trade financing. The lender will take on the initial cash burden of buying the cases from Timmy’s manufacturer so that Timmy can reduce the time his business is out of pocket.
Invoice finance comes into play when you’re waiting for your customer to pay you.
There’s invoice factoring, which allows you to raise money quickly by selling unpaid invoices to a factoring company at a discounted price. In return, the factoring company lends against the customer’s invoices.
Invoice discounting allows you to get a percentage of the total unpaid invoice from the lender, giving you a temporary cash-flow boost.
If you’d like a greater percentage of the advance payment, selective invoice finance is a solid choice. It allows you to choose which unpaid invoices you’d like to be advanced.
There are plenty of trade finance solutions to choose from. As we’ve already discussed, it all depends on what kind of export business you’re running, your resources, and how much risk you’re willing to take.
A Letter of Credit is an agreement made by the importer’s trade financing institution to the exporter, declaring that they will pay the exporter in a certain amount of time following negotiated terms and conditions.
This is a revenue-based funding solution available only to owners of online shops on platforms like Amazon or Shopify. SMEs can get access to capital quickly, usually in exchange for a chunk of future revenue.
PO financing works well for companies that receive large volumes of orders but don’t have enough working capital to process them. The financing company advances a certain percentage of the purchase order notional amount (usually in the 30-70% ballpark). The advance is used to pay the supplier, giving the beneficiary more time to pay off the invoice.
Supply Chain Financing is a popular option, but it’s not a loan. It’s a set of technology-based business and financing processes that optimise cash flow by allowing businesses to lengthen their payment terms to their suppliers. Arguably, it’s a win-win situation for both buyer and supplier — the buyer can optimise working capital, and the supplier can generate additional cash flow.
Monica is a buyer who purchases goods from Supplier ABC. Usually, Supplier ABC ships the goods and submits an invoice to Monica who approves the payment on standard credit terms of 30 days. However, if Supplier ABC needs cash urgently, it can request immediate payment from Monica at a discount from Monica’s affiliated financial institution. The financial institution then issues the payment to Supplier ABC on Monica’s behalf while extending the payment period for Monica. Monica gets an additional 30 days, totalling a credit term of 60 days.
Accounts Receivable financing or Documentary Collections (DC)
Also known as documentary collections (DC) or factoring, Accounts Receivable financing is an arrangement where a company utilises the receivables — payments owed by customers — as collateral in getting financed. In other words, you turn outstanding invoices into immediate cash.
David has $ 20,000 in accounts receivables and he is accepted for funding by a financial company. The lender funds 70% ($ 14,000), and David uses this to cover several business overheads. The lender charges a fee until his customer pays the invoice. Upon payment, the lender pays back the remaining amount on the invoice.
It’s not difficult to find an international trade finance company. A simple Google search will bring up hundreds of companies — from corporate and commercial banks, finance providers and non-bank lenders to Development Finance institutions and Export Credit Agencies.
Here’s what you normally require for an application:
You may also need:
You should only sign the legal documentation once you’re satisfied with the terms.
At Silverbird, we offer a smart alternative to traditional banking. Hold, transfer and exchange foreign currencies online with an international business account simply by using a single account. Avoid facing low forex rates with multi-currency accounts catered to international merchants like you and convert over 30 currencies within a single account.
There are three main elements of trade finance:
1. Financing — providing financial resources to support trading activities and managing payment risk between the parties involved.
2. Risk mitigation — identifying and managing risks associated with the transaction, including credit risk, political risk, and foreign exchange risk.
3. Documentation — preparing and processing the necessary legal documents to ensure compliance with laws and regulations, as well as to facilitate the smooth flow of goods and payments between buyers and sellers.
There are several types of trade finance that businesses commonly use, including bonds and guarantees, standby letters of credit, import and export letters of credit, documentary collections, and trade loans. These financial instruments enable businesses to mitigate risks associated with international trade and facilitate payments between importers and exporters.
Yes, having a credit line in place is usually a requirement for applying for a trade finance product. The purpose of trade finance is to facilitate international trade by providing financing to traders, and banks typically require clients to have an established credit line before they offer these services. However, the specific requirements may vary depending on the bank and the type of trade finance product.
Trade finance can be considered a high-risk area of finance, as it involves parties in different countries engaging in transactions that are subject to a variety of risks such as political instability, currency fluctuations, and fraud. However, the level of risk associated with trade finance depends on many factors such as the nature of the transactions, the parties involved, and the regulatory environment. Therefore, it is important to evaluate the specific circumstances surrounding each trade finance transaction to assess its risk level.
A trade finance team is responsible for managing the financial aspects of both domestic and international trade transactions. This team is responsible for issuing and managing letters of credit, processing payments between buyers and sellers, and verifying compliance with legal regulations. They work closely with other departments such as sales, operations, compliance, and legal to ensure smooth and efficient transaction operations. Additionally, they assess and reduce risks associated with transactions, monitor credit risk exposure, and develop finance-related policies and procedures.
Get the multi-currency account built for quick and easy international payments, with no limits.