Do you have a big order on the books that needs funding? Do you purchase in products for confirmed orders? If you answer yes to either of these questions, then trade finance could be the perfect short-term solution to your funding requirements.
To help you decide if trade finance is the right funding solution for your business goals, we have put together this short explainer covering the main points of trade finance:
- What is trade finance?
- Is right for your business?
- How does trade finance work?
- What are the benefits of trade finance?
- What is stock finance?
What is trade finance?
Trade finance is sometimes referred to as supply chain finance, import finance and export finance. It can be linked to invoice discounting, which then enables you to pay the trade finance by using the invoices that you raise.
Put simply, trade finance is a way of financing your purchases to help you meet your sales orders. It closes the funding gap at the beginning of your sales cycle. If you have purchase orders and suppliers in place, then you can finance the transactions using funds from an external lender.
Trade finance makes it easier for importers and exporters to transact business. It’s an umbrella term that has grown to covers finance products from a range of sources such as banks or specialist trade finance companies.
The beauty of trade finance is that it can help you to fund your growth by reconciling the differing needs of your supply chain and customer, whether at home or overseas.
Is trade finance right for your business?
First, ask yourself a couple of questions: have you received a purchase order that you need to fund? Are you planning to import or export goods for resale? If you answer yes to one or both of these then it’s safe to say that trade finance is the funding solution for you.
According to the World Trade Organisation, 80-90% of world trade relies on trade finance. Its function is to introduce a third-party to transactions to remove the payment risk and the supply risk. Trade finance provides the exporter with receivables or payment according to the agreement while the importer might be extended credit to fulfil the trade order. But it applies as much to funding of your supply chain and is also referred to as supply chain finance.
Trade financing is different from conventional financing or credit. General financing is used to manage solvency or liquidity. Trade financing doesn’t necessarily indicate that you lack funds or liquidity. Instead, it may be used to hedge against risks that are inherent in international trade such as currency fluctuations, political instability, issues of non-payment, or the creditworthiness of one of the parties involved.
Download our white paper to find out more
How does trade finance work?
Once you have a confirmed order in place, you can access trade finance to allow you to purchase the materials or stock that you need to fulfil the order; you can ship the goods without using your own working capital while you’re waiting to invoice your customer.
Alternatively, if you are importing, trade finance closes the funding gap between an order you’ve received from a UK customer and the payment required by your overseas supplier.
There are 8 steps:
- Customer places order with UK trading company
- The trading company sources a supplier to fulfill the order
- The trading company secures trade finance to pay supplier
- Trade finance house either provides a loan to the trading company or makes payment to the supplier or provides guarantees such as a letter of credit
- The supplier delivers the goods
- The customer pays the trading company for the goods. Payment may be after delivery if invoice discounting or factoring is also used
- The trading company fulfils the order
- The trading company settles the trade finance facility/the guarantee expires
Trade finance works to build trust between the buyer and the seller at the same time as mitigating the exposure for both.
An exporter requires an importer to prepay for goods shipped. The importer wants to reduce its risk by asking the exporter to document that the goods have been shipped. The importer’s bank assists by providing a letter of credit to the exporter (or the exporter’s bank) providing for payment upon presentation of certain documents, such as a bill of lading.
The exporter’s bank may make a loan to the exporter on the basis of the export contract. The type of document used in the process depends on the nature of the transaction and how evidence of performance can be shown (i.e. bill of lading to show shipment). It is useful to note that banks only deal with documents and not the actual goods, services or performance to which the documents may be relating to.
What are the benefits of trade finance?
You can support your growth plans, take on a big one off sales order, improve your profit margins, increase operational efficiency and productivity and mitigate against financial risks including bankruptcy.
A letter of credit might help you as an importer or an exporter to enter a trade transaction and reduce the risk of non-payment or non-receipt of goods. As a result, cash flow is improved since the buyer’s bank guarantees payment, and the importer knows the goods will be shipped.
Trade finance ensures fewer delays in payments and in shipments allowing supplier, importers or exporters to run their businesses and plan their cash flow more efficiently. Think of trade finance as using the shipment or trade of goods as collateral for financing your company’s growth.
You can increase your revenue and earnings by using trade finance arrangements. You might, for example, land a sale with a company overseas but may not have the ability to produce the goods needed for the order. Through export financing or help from private or governmental trade finance agencies you can complete the order. As a result, you get new business that you might not have had without the creative financial solutions that trade finance provides.
Finally, you can use trade finance to reduce the risk of financial hardship. You can avoid falling behind on any payments or avoid losing customers by taking advantage of trade finance options such as revolving credit facilities and accounts receivables factoring to help you transact internationally and maintain liquidity.
What is stock finance?
Stock finance is not based on a single buyer and seller relationship, but on the basis of purchasing and storing stock to fulfil projected sales. It is great for international trade because a business accesses a lender’s funds to purchase products to sell, whether it be finished goods or raw materials.
Stock finance is about the movement, purchase and sale of goods and these all impact the level of funding available. The lender will have security over the stock, which is likely to be held in a third-party warehouse, for a given period of usually 90-120 days. This revolving facility then enables a business to access cash as and when it needs it.
You can also release value from existing stock to improve your cashflow to allow you to realise new opportunities, support expansion or acquisition opportunities. Stock Finance can help fund against different stock categories that you own in a revolving facility while you retain ownership of the stock. However it is one of the types of finance to arrange and deemed one of the riskiest.
For more information on trade finance options call one of our experts today on 0203 327 0567.