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The Differences Between Trade Finance And Invoice Finance

Updated: Dec 6, 2021

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Treasury management and financial control are vital to the continued success of any business. But maintaining a steady cash flow is a long-term effort, regardless of whether you are spearheading a large company or the owner of a small or medium import enterprise.

differences between trade finance and invoice finance

While self-employment is indubitably a step further toward winning greater freedom, unpaid bills stacking up, payment deadlines drawing near can quickly make it all a strenuous ordeal. Thankfully, to avert overwhelming debts, there exist trade and invoice finance solutions! What are they? What differentiates them? And how can they benefit you? Let us zoom in for a closer look!

An introduction to trade finance

When it comes to trade, be it local or international import-export, the main goal for each of the concerned transacting actors is to ensure that their respective interests prevail. How much they are willing to agree on the terms and subsequent time frame heavily, if not entirely, rely on the inherent risks incurred, however.

While they face specific obstacles and uncertainties, both the purchasing and the selling parties are two sides of the same coin: they equally wish to mitigate hazards and get what they are after. Here is where trade finance and invoice financing come into play.

What is trade finance?

At the root of every single commercial transaction that occurs daily, there are two participants: the seller on the one side, presenting potential buyers with their goods and services; and on the other side, the purchaser, looking to acquire whatever good or service their preferred seller has to offer.

what is trade finance

Ideally, the seller would want the purchaser to foot the bill before the merchandise is on its way. However, it is in the buyer's best interest to lower the risk of the goods getting withheld after payment. To facilitate said proceedings, which will hopefully lead to a fruitful transaction between the two, banking or private institutions, if called on, can help smoothen things up by overseeing the monetary aspect.

3 popular types of trade finance

Before setting everything in stone through contractual means, it is never a bad idea that both sides are attuned to their best interests and assess where to draw the line. The two parties can agree on further detailing clauses to include in the commercial contract, which can specify the nature of supportive documents or clarify the exact terms and conditions of delivery and payment, among which:

Cash in advance

With this method, the seller requires the payment to be undertaken in full before delivery. While the risk of non-payment is slim to none, the buyer is never entirely out of harm's way, should the seller prove unreliable and prone to malpractice tactics.

cash in advance

Open account

As opposed to the previous method, this trade credit or loan puts the buyer into a privileged position. Depending on the agreed-upon contractual terms, the merchandise and attached supportive documents can be sent away up to 90 days before final payment is due.

Letter of credit

Also known as a documentary credit, bankers' commercial credit, or letter of undertaking, a letter of credit is a pledge of security and guarantee involving the assistance of banking intermediaries meant to safeguard payment completion in exchange for fair-and-square compliance with the contract terms.

What is invoice finance?

Unlike trade finance - where a third party ensures payment and supply risks are dampened by sorting payment modalities upon agreement and enabling the purchaser to get extended credit -, invoice finance, otherwise referred to as invoice factoring, is a short-term financing solution. It too relies on go-betweens to help SMEs improve their cash management.

And today, digital providers are aplenty that offer flexible services adapted to the self-employed who wish to transfer their debts for factoring in exchange for a referral fee determined as a percentage of the transferred invoice or a monthly or yearly subscription plan.

what is invoice finance

How do invoice discounting companies work?

It is up to the invoice financing company to evaluate the level of risk associated with the bills submitted and either opt to address or return them. Should they take on the task, they will:

  • Pay the total amount listed on the invoice in the shortest possible time - generally within 24 to 48 hours.

  • Take charge of the entire transactional process and mediate between the two parties.

  • Bear the risk of a dispute regarding the potential default of payment.

Why use invoice finance?

The more widely businesses use credit to pay, the wider the gap separating expenditures and cash flow. Interestingly enough, the most commonly found instability in the account balance of small or medium enterprises is more often than not linked to invoices left unpaid.

Invoice factoring is a speedy recovery solution allowing your business to delegate its overburdening list of late payments while being given access to cash upfront. In turn, that money can be fed back into the cogs of your company, whether to widen your import-export business, open other in-country branches, or cover reinvestment costs.

why use invoice finance

Furthermore, with invoice finance, a company or self-employed individual can:

  • Both protect their finances thanks to shortened terms and avoid discrepancies whenever clients' payments are delayed.

  • Transfer the most pressing invoices (sluggish payers, significant amount, untrustworthy clients) to a factoring provider.

  • Give their clients an image of on-point professionalism.

Trade finance and invoice finance solutions

If you wish to look further into either trade or invoice financing, why not seek the help of a professional team of advisors? We, at Funding Routes, specialize in assisting SMEs and self-employed entrepreneurs in finding the most-suited trade finance and invoice financing solutions through our extensive list of providers and brokers. Feel free to let us know your requirements, and we will be sure to get back to you in a flash!

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