Trade finance is essential for the likes of wholesalers, importers, and distributors, as it can provide the cash needed to pay suppliers.
This helps to close the payment gap at the beginning of your sales cycle, allowing you to fulfil customer orders without being out of pocket for a period of time.
We want to walk you through how trade finance works and why it could be important to your business venture.
What is Trade Finance?
The definition trade finance refers typically to the different instruments and products that allow a business to trade internationally.
Trade Finance is in the same group as the likes of Invoice Finance, Reverse Factoring and Supply Chain Finance and is a form of working capital. Its sole purpose is to provide businesses with cash to purchase inventory or stock from a supplier.
The broad category of trade finance means it covers many different financial products that banks and companies use to make trade transactions feasible.
The activities that are covered are such as issuing letters of credit, as well as lending and forfaiting.
A number of different parties are involved in trade finance circle these include :banks, trade finance companies, importers and exporters, insurers, export credit agencies.
Types of Trade Finance products
The following are all types of trade finance or work within the circle of trade finance products:
- A letter of credit: The importer’s bank issues a letter which makes a promise to the exporter that it will immediately make the payment once the transaction has been completed.
- A bank guarantee: The bank will act as a guarantor in case the importer or exporter fails to fulfil the terms and conditions of the contract. Meaning the bank would pay a sum of money to the beneficiary.
- Factoring: The exporter sells their invoices to a trade financier (the factor) at a discount. The factor will then sell the invoice to the importer, who pays the full price for the product.
- Forfaiting: This is when an exporter sells all of their accounts to a forfaiter at a discount in exchange for cash.
- Insurance: This is used for shipping and the delivery of goods.
- Lending: Lines of credit are a the of lending issued by banks or other providers to help both importers and exporters.
- Export credit: This is where exporters are given credit against overseas clients for the sale of goods.
How does trade finance work?
Trade finance for the most part works on a confirmed order basis. If you have a purchase order from a client, trade finance empowers you to purchase the stock to satisfy that request. It typically implies the products can be delivered as quickly as time permits, and you will never be out of pocket waiting around for your customer to pay.
Since it depends on purchase orders, trade finance is sometimes referred to as purchase order finance or import finance. You might have homegrown clients, or some in the UK and some abroad — if you’re either importing or exporting, trade finance could help.
Many lenders use trade finance as an umbrella term for different finance products intended for organisations that exchange globally, for example, invoice factoring, supply chain finance, import finance and purchase order finance. When we talk about trade finance here at Invoice Funding, we refer to the solution designed to pay suppliers.
Trade finance vs supply chain finance
These two different funding solutions are often confused for one another. The reason why the mistake is made so frequently is because trade finance helps you to fund the start of your supply chain, whereas supply chain finance can be offered to suppliers, though ultimately does not apply in this instance.
If you were to sell clothes in the UK, and after a few months your brand started to develop and grow in popularity, it may be picked up by department stores. This would mean that a particular shop could place an order for 1000 units. You would likely jump at this opportunity as it would clearly be a great chance to achieve business success and further develop your brand recognition.
Amongst all of the excitement, a problem arises. You are only used to selling around 100 unites a month, thus you do not have the required funding to pay the supplier for such an increased amount of product. Both the customer and supplier are well established ventures, so you are able to approach a trade finance lender.
The lender would then investigate your purchase order from the department shop and carry out the due diligence. Once they become satisfied, they’d like to work with you, they order the products from the manufacturer on your behalf.
Now that trade finance is in place, your supplier is paid faster than normal, so the products can be shipped at a speedier rate. The supplier invoices the trade finance company for the shipped goods, then once the department shop pays the trade finance company, you will obtain the profits minus some fees.
Advantages of trade finance
With the example we have given to you, trade finance would remain suitable even if your manufacturer was based overseas and the customer located in the UK. This form of funding is very flexible in that sense.
Another great thing about trade financing is that it can work alongside any other existing finance your business is utilising, such as asset finance and invoice finance.
Trade finance with invoice finance
As we’ve found in the model above, organisations like clothing brands can have two cash flow issues. The first problem is the deferral between paying providers and receiving stock. The other is the postponement between transportation of products to your customers and getting compensated by means of invoice.
Trade finance is intended to settle the first of those two issues — and invoice finance can address the second.
On the off chance that it requires fourteen days for your products to show up from the supplier, fourteen days to get them to the customer, and afterward your client pays you based on 30-day terms, you’ll be out of pocket for quite a long time prior to being paid. Trade finance removes the supplier payment delay from the situation, however you’ll in any case need to stand by to get paid by your client.
With invoice finance set up too, you’ll get the vast majority of the invoice’s worth when you invoice your client — so you can reimburse the trade finance lender prior. You could get trade finance and invoice finance with separate lenders or bundled into one with the same loan specialist for an easier process.
Yet, note that you don’t need to have invoice finance — you can stick with trade finance alone if that is the best fit for your company.
Companies and providers
There are heaps of trade finance suppliers available. By and large, the standard banks, for example, HSBC and Barclays only work with well-established organisations with turnover in the £millions, so they’re impossible for small business owners. Larger lenders will usually only offer trade finance if it is coupled with invoice finance.
Nonetheless, there are many lenders offering trade finance, invoice finance, or a blend of the two, so be on the lookout for them. With these suppliers, you might have the choice to pick whether you’d like invoice finance included, so you can find the correct solution for your venture.
We can help you to find the correct lender today, so don’t be afraid of getting into contact with a member of our expert team as soon as possible.
Do you meet the criteria?
The two main questions we ask in order to discover if trade finance is right for a business are as follows:
- Do you have a purchase order you need to fund?
- Do you intend to import or export products for resale?
If your answer to both of these questions is ‘yes’, then trade finance is likely perfect for your situation. Keep in mind that trade financers are not as concerned with what’s on your balance sheet as mainstream lenders. They’d rather know what the transaction is and how it will help your business to grow.
Trade finance is generally for companies that have good supply chains and end-buyers, but don’t have the working capital to go it alone.
Trade finance rates explained
The interest rates for trade finance are normally somewhere in the range of 1.25% and 3% each 30 days. As a rule, the bigger the order, the lower the rate you’ll pay. The expense of finance will likewise rely upon the provider and purchaser you’re working with, in light of the fact that the two of them influence the odds of something turning out badly.
One more component that influences the cost of finance is credit protection. Credit protection implies the bank will be obligated for the misfortune if your client doesn’t pay, so it adds to the expense in light of the additional danger. Nonetheless, some organisations will believe this additional expense to be worthwhile as it provides them with peace of mind.
Lastly, it merits recalling that having invoice finance alongside trade finance might add to the general expense — so despite the fact that it’s a decent choice for certain businesses, it’s not really the best option for everybody.