Essential Facts You Need to Know About Trade Finance

 

From multinational corporations to small businesses involved in the export and import of goods, trade finance ensures the transactions possible for all entities. New startups and SMEs have limited financial resources, and often banks won't provide them the financial help in terms of loans or overdrafts to protect their interests during any international trades. Over the years, the trade finance solution covers different activities such as letters of credit, lending, forfaiting, factoring, and others actively used by exporters and importers to reduce the risk involved in trading goods.

This post will discuss some essential facts related to trade finance that you need to know.

 

Reduce payment risk

 

During the early international trade, there were lots of irregularities. Exporters were not sure about whether or when they were going to receive payments from the importer. And on the other hand, importers were worried that even when they made prior payments, there was no guarantee that the seller would ship the goods. With time, both the entities involved in buying and selling goods developed a trade finance solution reducing the payment risk. To accelerate the payment process, the exporter's bank gives a business loan while still keeping the payment made by the importer under processing. On the other hand, the importer bank provides a letter of credit to the exporter bank as payment after the shipment documents are submitted.

 

Reduce financial pressure on both buyer and seller

 

Trade finance is the biggest factor leading to exponential growth in the economies worldwide by bridging the financial gap between the exporter and importer. Both the interests of exporter and importer are safe with financial institutions like banks mediating, thus reducing the financial pressure on buyers and sellers.

 

Different finance products and services

 

With the evolution of international trade over the years, the trade financiers like banks and other financial institutions use different products and services to meet the needs of exporters and importers.

 

Letter of Credit

A letter of credit, also known as a credit letter, is an assurance from the bank to the importer that payment will be credited to the exporter account after presenting the shipping documents as mentioned in the importer's purchase agreement. In the event of failure to submit the same documents, the trade financiers like banks can cover the full or remaining purchase amount.

 

Bank Guarantee

In this financial service, the bank will act as a guarantor if the importer or exporter fails to honor the terms and conditions of the agreement. In this case, the bank takes the initiative to pay money to the beneficiary.

 

These two services are offered by the trade financiers in different variations depending upon circumstances and transactions.

 

Factoring in to accelerate cash flow

 

Factoring in trading finance is a common method used by exporters during international trade to speed up the cash flow process. In this mode of transaction, the exporters sell their invoices to the trade financier at a discount and wait till the importer makes the payment of the goods. This transaction tool ensures that the exporter has working capital to keep the business running, thus reducing any bad debts. When the importer does full payment on the agreed price, the factor makes profit as payment done to the exporter was done at a discounted rate. 

 

Forfaiting

 

In this financial tool, the exporters sell the accounts receivable to a forfaiter at a discounted rate for cash. This allows the exporter to transfer the debt from the importer to the forfaiter. During this process, the forfaiter ensures that the importer's bank must guarantee the receivables. This step is extremely important as the importer takes the goods on credit and sells them to the forfaiter before paying any money.