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Trade Finance | A comprehensive guide

Updated: Jan 10, 2022

Trade finance products can boost your cash flow and help your business grow fast. In this article, we will dissect exactly how it facilitates up to 90% of international trade and how you can utilise this funding within your business.

Within global finance, Trade Finance is often associated with import revolving trade credit lines. Although we will touch on these throughout this article there are a lot more products that fall under the Trade Finance umbrella.

Let's dive in:

The comprehensive guide on Trade Finance

Freight ship carrying cargo with overlay of text saying what is trade finance

What is trade finance?

Trade finance in simple terms is funding your businesses purchases from abroad. When purchasing domestically or from overseas you can be left with a cash flow gap where you don’t have the funds to pay for the goods and services, but will once you receive payment from your clients.

This is where trade finance comes in, financial institutions and banks alike can either fund your purchases upfront through a variety of products which can allow you to negotiate discounts with your suppliers due to early payment. Likewise, they can issue a letter of credit that promises payment to your supplier upon receipt of shipping documents (bill of lading).

It used to be the case that letters of credit were the only product that could help facilitate these transactions but now a whole industry with a vast amount of different products has risen to service different businesses needs.

Whilst not all trade finance is used for conducting business internationally, a vast amount of it is. Dealing internationally can come with a multitude of risks including non-receipt of products and quality of products. Trade finances aim is to limit that risk by granting higher protection to the customer which we will look at later in this guide.

Trade Finance Products

There are many different types of products that can fund your purchases. We go in-depth into each type of product on our blog so if you want to find out more about a given product click on the subheadings below.

1. Revolving Trade credit line (known in the industry as Trade Finance)

This is the most common option we help our clients get access to when undertaking trade finance. Used by a vast number of companies, a financier will give you a certain amount of borrowing you can use to pay suppliers abroad.

When you are paid by your customer for the goods you are supplying you pay back the financier plus any interest rates and fees that occurred. Once paid back the funds are then reusable. From our experience, this product is harder to access for small businesses with financiers looking for normally minimum net assets of £300,000.

Financiers will take into account a lot of aspects about your business when coming up with a figure of what level of funding to grant you, we go in-depth into Revolving trade credit lines here.

2. Letter of credit

This is where your suppliers will be issued a guarantee by your financiers that they will receive payment once goods have been shipped and paperwork has been received (bill of lading). Essentially giving your supplier confidence that they are going to be paid so they start the work.

Exporters on the other side of the transaction can take this letter of credit to their international bank which can grant credit to the exporter to help fulfil the customer purchase.

There is a lot of moving parts with letters of credit and we go in-depth on the product here.

3. Invoice finance

Similar to supply chain finance, you have orders from your customers but don’t have the cash flow to fulfil purchasing the goods needed, that’s where invoice finance works well. Funding a percentage of your invoices owed to your company (usually 70-95%) upfront which you can then use to purchase the necessary products to fulfil your order.

Within invoice finance, there are a number of different products offering a range of uses. We go into detail on the subject here.

4. Purchase Order Finance

A purchase order is a legally binding document between a supplier and a customer. The customer will detail out the products they are requesting to buy and the terms they would like to buy them under. Once the supplier accepts then it is legally binding. Financial institutions will finance purchase orders due to the legally binding nature of the contract, with lots of different options available check out our comprehensive article here.

How does trade finance work?

According to the World Trade Organization 80-90% of business is conducted using trade financing. Often or not suppliers abroad (unless you have a long trusting relationship with them) will shy away from issuing you credit terms, trade finance then becomes very useful.

Trade finance works by making capital available to your business so it can fund payments to suppliers. Instead of there only being two parties in a transaction you are adding a third party which would be the financier.

Financiers would fund the goods that you are acquiring through a range of different products above. They would then take a percentage of the given amount they are funding normally through a 30-day interest rate or a fixed fee (not uncommon to see both charges).

multiple containers at a dock with overlay of text saying difference between trade and export finance

Difference between trade and export financing

Trade Finance is funding for the importation or purchase of products and services from a supplier. Trade finance can be loosely associated with all finance both import and export but it is most commonly used in the industry purely for the import side of the equation.

Export finance is the flip side of the coin, you are raising financing for the sale of goods that you will export to a different country or market. This allows you to receive the funds before completing the goods or services which can help cash flow. We look at export finance in depth here.

Foreign currencies effect on Trade Finance

The bulk of businesses using trade finance to import from abroad due to the increased protection that it can provide whilst you conduct business outside of the UK. When conducting business abroad you can be left at the mercy of the foreign exchange market which is prone to fluctuations.

Regular payment terms with trade finance providers are 90-150 days, which means for that period of time you are either hoping that the currency pair you are trading in moves in your favour or stays the same.

Unfortunately, it can move in the opposite direction which can easily eat into your profit margins and increase the amount you will have to pay back to your financier.

Quite a few trade financiers will have it written in your financing agreement that you will have to do your foreign exchange business through them, ultimately taking charges on the finance and the foreign transaction. This can amount to be costly but there are ways to combat this which we go over in our article here.

Increased protection of trade finance

Dealing domestically makes working with suppliers a lot easier but when you venture into international trade there can be stumbling blocks. Trade finance looks to decrease that risk by providing a level of protection when purchasing goods or services from abroad.

Let's take a few products as examples:

Trade revolving credit facility

Financial services companies and banks alike will run due diligence on your suppliers to make sure that they are creditworthy, who they say they are and that none of the parties associated with the company is on any red or black lists.

Likewise, they will look at the financial stability of the provider.

If the financier feels that it is too risky for them to fund a transaction with a certain supplier that can be a good indication of whether the supplier is a good partner for your business.

Letter of Credit

Whilst a bank will guarantee the funds to a supplier for the purchase of goods or services the money will only be released under certain conditions. This is normally released under the issuance of a bill of lading which will detail ‘Evidence of contract of carriage’ which shows what the goods are that are being loaded onto the ship, amounts and other specifics.

Releasing the funds at the point where the goods are being loaded onto a ship gives the buyer confidence that they are receiving what they purchased. If any of the specifics of the letter of credit are not met then the funds will not be released.

Using other forms of trade finance can come with more risk, for example funding your supplier purchases through invoice finance grants you no protection against the funds used to pay suppliers but does give you access to bad debt protection against non-receipt of customer payment.

For this reason, it is common for finance companies to bundle both a trade revolving credit facility with an invoice finance facility. This way they see both sides of the transaction and limit their exposure if anything were to go wrong.

What businesses are eligible?

There are a lot of different variables when it comes to eligibility for financing products. Funders take into consideration (but not limited to):

  • The product you are purchasing

  • The country you are importing from

  • Debtors

  • Creditors

  • Management Accounts

  • Last 2 years filed accounts

  • Cash in the bank

  • Credit history

  • Assets and Net Assets

  • Level of Debt in the business

From our experience getting access to a trade credit line can be harder than getting invoice finance, for example, normally businesses look for a high turnover and profitability to be able to support their funding of purchases with this product.

Likewise, there are unsecured (no security) trade credit line facilities out there that have even higher barriers to entry.

Our team knows the market and understands the likelihood of you being accepted with certain facilities at different financiers. Contact us today here.

Paperwork on a table with a pen and paperclips with overlay of costs of trade finance

Costs of trade finance

Costs of different products within trade finance depend on a number of factors, the size of the lending, the risk that the financier is taking on and likewise the ultimate receiver of the funding.

We go further in-depth on pricing with the individual products in our articles below:

  • Purchase Order Finance

  • Invoice finance

  • Letter of credit

  • Revolving trade finance credit line

Best Trade Finance providers

On offer is a wide range of trade finance solutions with a vast choice of companies available, so how do you know which is the right fit for your business?

At the end of the day it comes down to your business and its needs, with a lot of these products it's not one size fits all and there will be cases where one is better than the other.

There are leading products on the market that are very cost-effective and efficient but have certain barriers to entry.

There will be an ideal fit for you in the market for your business whatever stage it might be at. We would suggest exploring the options that are out there to ultimately find the right financing partner.

To conclude:

Trade finance can be a very useful tool within your business allowing you to utilise extra liquidity with increased protection. Whilst not all products will be right for your business there will be some that fit in just nicely and help you grow at a fast pace than you would have without them.

Our team are always happy to help, get in touch with us here.

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