When a business wants to engage in global trade, it can take a lot of working capital. This is because shipping, customs and fulfilment fees can be costly.
This is where trade finance comes in to remove payment and supply risks from international transactions. It offers multiple products and services for buyers, suppliers, banks and insurers.
Letters of Credit
Letters of Credit are highly customisable to the terms of individual trade deals and provide businesses with a reliable payment method for international transactions. This eliminates the credit risks associated with open account transactions and allows suppliers to negotiate favourable payment terms while maintaining their cash flow.
An LC is a document issued by an issuing bank on behalf of the buyer that guarantees payment to the seller once specific conditions in an international trade transaction are met. The issuing bank requires a certain amount of margin (cash or securities) from the exporter as security and charges fees for issuance, amendments, confirmations and negotiation. As a result, this type of trade finance helps to alleviate credit risk for the sellers and gives the buyers confidence that their trade agreements will be honored. This is a key element in building trust and fostering long-term trade relationships. In addition, an LC provides a legal safeguard if the buyer fails to pay as it shifts the financial burden to the issuing bank.
Loans
A trade loan can take the form of a short-term import loan to finance materials before selling them domestically, an export loan to finance contract production costs prior to shipment or a revolving credit facility for ongoing international trading. They can be used as a standalone solution or combined with other products such as letters of credit, documentary collections or cashflow financing/invoice factoring.
The upfront funding that trade finance provides allows buyers to offer more attractive terms and conditions to customers, opening up growth opportunities. It also helps suppliers get paid on time, which can reduce working capital stress and enable them to negotiate supply-side discounts.
If you are interested in exploring how trade finance can benefit your business, we recommend speaking to the team at your bank who will know your business best. Remember that defaulting on repayments can negatively impact your credit score and may lead to fees, charges and the seizure of collateral.
Factoring
Factoring is one of the most flexible trade finance tools and can be used in multiple ways. It involves selling invoices or accounts receivable to a third party (known as a factor) for immediate cash. This process reduces payment terms from months to days or even hours, and can help businesses with poor credit gain access to funds.
Once a company sells its accounts receivable to a factor, the factor typically pays up to 80% of the value of each invoice upfront. The balance — less the factor’s fee — is remitted once the customer has paid.
Factoring can also help companies strengthen their relationships with buyers by outsourcing their collections processes and ensuring that customers receive a professional and seamless payment experience. It can also mitigate credit risks by reducing the likelihood of non-payment, especially when dealing with foreign buyers. Non-recourse factoring can offer a further level of protection against non-payment risk. This is particularly useful for companies that export goods to multiple markets.
Insurance
Trade finance is a set of tools that businesses use to mitigate risks and support global commerce. It includes a variety of instruments, such as letters of credit, loans, factoring, and insurance. These products help companies optimize cash flow and reduce risk while promoting stronger international business relationships.
The main objective of trade finance is to reduce payment risk in international transactions. This risk arises when an overseas buyer does not pay for goods and services, and can be caused by political changes or economic ups and downs. To protect themselves from this risk, many companies turn to trade credit insurance.
This type of insurance offers a safety net, allowing exporters to enter new markets without worrying about unpaid invoices. It can also provide an alternative source of funding to cover working capital needs in international markets. This can be especially helpful for small and medium-sized businesses, which may not have access to traditional forms of financing.
