The Crucial Importance of Trade Finance

What Is TradeFinance?

 

Trade finance depicts financial instruments, services and products which are used by companies for facilitating international trade. Trade finance can make it possible as well as easier for buyers and sellers to transact their business through trade. 

The crucial importance of trade finance is it exists to mitigate or we can say to reduce the risks involved within the trade transactions. These risks can be payment risks or corporate risks. 

There exist two players in a trade transaction: (1) the supplier, who requires payment for the goods being sold, and (2) the buyer/importer who wants to make sure that he pays for the correct quality and quantity of goods.

 

Understanding Trade Finance

The key function of trade finance is introducing third-party towards the trade transactions in order to remove the risk of payment along with supply risk. It provides supplier with receivables and payment as per the agreement whereas the buyer may get extended credit for fulfilling the trade order. 

Basically, following parties are involved in trade finance:

●        Banks

●        Trade finance companies

●        Importers and exporters

●        Insurers

●        Export credit agencies and service providers

Trade finance is commonly used when traders require some kind of financing to carry out various trade related tasks and to facilitate the trade cycle funding gap. In order to provide effective trade finance, the financier or trade finance provider requires:

-          Controlling the usage of funds, controlling the products along with the source of repayment

-          Monitor the trade cycle via trade transaction

-          Security over the commodities and receivables

TYPES OF TRADE FINANCE PRODUCTS

The market of trade finance consists of certain short-term (with a maturity of normally less than a year) medium term as well as long-term trade finance products. These can be distinguished on the basis of their tenors. Short term trade finance has tenor of less than a year whereas long term can have tenor of 5 to 20 years.

Commonly used trade finance products are:

●      Letter of credit

●      Supply chain finance

●      Structured trade and commodity finance

●      Export and agency finance

●      Trade credit and political risk insurance

To bring down the payment risk and the supply risks during international trade, trade finance introduces third party to business transactions. Through trade finance, exporters get receivables or payments, as per the agreement and the importers receive credits to fulfil the trade order.

The key parties involved in trade finance are the banks, companies, exporters, importers, insurers, credit agencies and service providers.

While general financing usually indicates financial necessity in cases where buyers lack funds or liquidity, trade finance is mostly used to provide protection against the unique inherent international trade risks – like currency fluctuation, political instability, non-payment issues, credit-worthiness of any party involved in the trade and others.

WHAT ARE THE RISKS?

As global trade takes place across borders and usually the buyers and supplier are not familiar with each other and as a result there exists various risks to deal with. These risks include:

Payment risk: Will the seller get paid on full or partial basis on time? Will the buyer get the commodities he expected?

Country risk: This kind of risk can be seen in a number of situations such as exchange rate risk, political risk and sovereign risk.

Corporate risk: The risks which are associated with the company or importer and exporter. For instance, what credit rating is provided by them? Do they have any history of non-payment?

In order to reduce such risks, banks along with other finance providers have stepped in to facilitate traders with trade finance products.

 

Guide for Export Finance

Export finance

The Guide for Export Finance has been developed for the traders to facilitate them with the required information regarding international trade.  It enlists number of financial measures in order to promote exports. You would come to know about the various modes of payment within global trading along with a number of products and services which are available for you within trade finance especially for exporting. It also represents various shipping documents and finance related legal documentation. 

What is export finance?

Export Finance can be described as a specialist range of finance which specifically focuses on the export market. The main aim of export financing is to support businesses to reach and expand within the international market along with the crucial aim to maintain positive cash-flow cycle when the goods are in transit. 

Methods of payment

Typically, there are three standard ways for making payments within the export import trade in the international trade market:

1.   Clean Payment

2.   Collection of Bills

3.   Letters of Credit (L/c)

1. Clean Payments

When you choose clean payment as a mode of payment all shipping documents are supposed to be submitted directly between the trading partners and their role of banks gets limited just to clear amounts as per the requirement. required. Such method provides traders with a relatively cheap as well as uncomplicated method of payment. 

There are basically two types of clean payments:

●      Advance Payment

●      Open Account

2. Payment Collection of Bills in International Trade

This method of payment of international trade requires the exporter to entrust the bank for handling all necessary commercial as well as financial documents and provide banks the necessary instructions which concerns about the final release of all these documents towards the importer. It is seen as one of the most cost-effective methods to keep the transactions evident for buyers, where trade documents are manipulated by the associated banking system.

There are generally two methods which are opted within collections of bills:

●      Documents Against Payment D/P

●      Documents Against Acceptance D/A

3. Letter of Credit L/c

An LC is a financial document which is provided by a third party i.e. a bank or a financial institution that guarantees the payment for goods and services to the exporter once the exporter submits the required documents. A letter of credit has three important elements – the beneficiary i.e. seller who is the recipient of the LC, the applicant i.e. buyer who buys the goods and services and the issuing bank that issues the LC on the buyer’s request.

Various types of L/Cs are:

●      Revocable & Irrevocable Letter of Credit (L/c)

●      Sight & Time Letter of Credit

●      Confirmed Letter of Credit (L/c)

●      Export finance and documents

International market for trading involves various types of trade documents which has to be produced while making a number of trade transactions.

Below mentioned documents are often used in international trade:

●        Air Waybill

●        Bill of Lading

●        Certificate of Origin

●        Combined Transport Document

●        Draft (or Bill of Exchange)

●        Insurance Policy (or Certificate)

●        Packing List/Specification

●        Inspection Certificate

Invoice discounting

Invoice discounting

What is invoice discounting?

Invoice discounting is one of the simplest forms of invoice financing. With the help of invoice discounting you can sell unpaid invoices to a lender and in return they will provide you with a cash advance which is usually a percentage of the invoice’s value. When your client has to pay for the invoice, the lender is supposed to pay you the remaining balance after the deduction of their fee.

Another way of understanding invoice discounting is that it can be seen as a series of short-term business finance which is availed using invoices as a security. In other words, the lender is known to the fact that you owe the money, so they lend you most of the amount of it before the customer actually pays you.

Invoice discounting is usually kept confidential and thus sometimes called 'confidential invoice discounting' and as a result you can continue to deal with customers yourself as is there is no involved third party, your clients won’t know that you are using a finance provider. 

                   

Invoice discounting example

Bob’s has just begun his business with a discounting facility with The Invoice Company for helping with cash flow, and Bob issues an invoice to his client worth $10,000 for the work that is already completed. Bob’s agreement with The Invoice Company describes that the initial percentage or advance percentage is 75% and this means that Bob is advanced $7,500 by The Invoice Company as soon as he raises the invoice.

Usually, Bob will be uploading the invoice over his online account with the finance provider and then he receives the advance.

Bob’s client settles the invoice within a few weeks, paying $10,000 into a business account which is controlled by the finance provider. With the help of confidential facilities, from the client’s point of view, it will look like they’re paying Bob directly.

Further the Invoice Company pays Bob the remaining $2,500, deducting their fees. The fees are typically around $250-300, so Bob would be receiving between $2,250 and £2,200 in this example.

Key features

●        Invoicediscounting is seen as an alternative solution for traditional types of business finance.

●        It can provide you with instant access towards the cash tied up within the outstanding invoices.

●        It can easily adapt with the changing and growing businesses, making it much more flexible than any other overdraft or loan.  

●        You can have control over the collection of payments, which makes this facility entirely confidential.

Who uses invoice discounting?

Invoice discounting are particularly suited to businesses in areas such as:

●        Construction

●        Recruitment

●        Manufacturing

●        Wholesale

●        Printing and publishing

●        Courier and logistics

But for any business which provides goods and services to other business organizations and facilitate client’s credit terms of 30-120 days (after the task has been completed), invoice discounting can solve the associated problems with slow payment.

Invoice discounting can be seen as a useful option for:

●        Business start-ups — flexible start-up loans are made available to get the new company off the ground

●        Growing businesses — putting your tied cash back to work for your business as soon as it is earned

●        Struggling businesses — It tends to bridge the gap between invoicing the customers and getting paid for the service provided.