What is Trade Finance?
Trade finance is a trade transaction that can be used for both international and domestic trading transactions; but more usually international trade; both requiring a seller of goods and services as well as a buyer. The lender pays for the goods purchased which are security for the advance.
Financial institutions can facilitate these transactions by acting as a third party to remove the payment risk and supply risk while providing the seller with faster payments and the buyer with extended credit.
Trade financing is different to conventional financing or credit issuance. General financing is used to manage solvency or liquidity, but trade financing may not necessarily indicate a buyer's lack of funds or liquidity. Instead, trade finance may be used to protect against international trade's unique inherent risks, such as currency fluctuations, political instability, issues of non-payment, or the creditworthiness of one of the parties involved.
How Trade Finance works
A trade financier will want to see confirmed orders for the goods. Many financiers will fund goods which have a ready market for resale in the event of a buyer defaulting or refusing collection. So bespoke or branded goods are usually exempt. Goods with a short shelf life are also not acceptable.
The financier will arrange payment for the goods – preferably by letter of credit – although domestic transactions can be on open account. The goods are security for the advance and the shipping documents relating to them will be in the name of the financier. Once the goods are delivered to the end buyer, the seller raises an invoice which is copied to the financier who discounts it (advances money against the invoice/s). The financier uses the advance against the invoice to repay the trade loan and pays some of the remainder to the seller to use as cashflow. The seller gets the rest of the invoice value (less charges) when the buyer pays the invoice.
Is Trade Finance right for me?
Yes if your business has the opportunity to buy goods from overseas (or within the UK) at a good price where you can make a profit, and have confirmed orders for these goods.
If you have these opportunities, but you do not have the funds available to pay for the goods upfront, then trade finance enables you to trade and earn the profit and retain more customers.
Without trade financing, a company might fall behind on payments and lose a key customer or supplier that could have long-term ramifications for the company.
In addition, some trade financiers can arrange shipping and assist with advice, documentation and protect against currency fluctuations.