If you are a business owner, you have heard about trade finance. It keeps the trade cycle moving forward and immensely influences local and international economic growth. Trade finance proffers multiple financing options to facilitate commercial trade and eliminate risk at the same time.
This type of finance covers various kinds of activities that include lending, issuing letters of credit, factoring, forfaiting and more. It involves participation from different parties like the seller, buyer, export credit agencies, trade financiers and insurers.
Here are some facts about this type of finance:
1. It Checks Payment-Related Risk
During the initial stage of international trade, several exporters were unsure whether the importer would pay them on receiving the goods or not. On the other hand, importers too used to be anxious about pre-payments and wonder if the seller would even ship the goods. Both parties looked for ways to reduce such risks.
This finance makes sure that while exporters get the payment on time, importers too get the goods within the stipulated time.
Another great feature of this type of finance is that it allows the exporter’s bank (trade financier) to ensure a constant supply of goods. The bank gives a loan to the exporter while processing the importer’s payment so that the exporter does not have to wait for the amount. When the exporter’s bank receives the payment, the trade financier or bank adjusts it with the extended loan.
2. Several Products and Services Are on Offer
Trade financiers provide companies with different offerings such as these to fit their needs:
Bank Guarantee: If the exporter or importer is incapable of fulfilling the contract’s terms and conditions, the bank acts as a guarantor. It takes the responsibility to pay the sum of money to the beneficiary.
Letter of Credit: The importer’s bank promises to pay the exporter’s bank when the exporter shows all the shipping documents as per the purchase agreement of the importer.
Bill collection: Another product of trade finance is bill collection, wherein the bank of the seller collects the payment proceeds from the buyer’s bank. The payment is made for the goods from the seller according to the agreement between the two parties.
3. Forfaiting Is Prevalent
In this agreement, the exporter sells his accounts receivables to a forfaiter at discounted rates by exchanging cash. By doing this, the exporter shifts his debt to the importer to the forfaiter. The importer’s bank must guarantee the receivables purchased by the forfaiter because the importer sells the goods he took on credit before paying the forfaiter.
4. It Involves Factoring
Exporters frequently resort to factoring for speeding up their cash flow. The factor here is a trade financier to whom the exporter sells his open invoices at a discounted rate. The factor or trade financier then waits for the importer to make the payment. As a result, the exporter does not have to worry about bad debts and can continue trading. When the importer pays the total price agreed upon for the goods, the factoring company earns profit as it had bought the account receivables at a discounted rate.
These are some of the important things you know about trade finance. If you consult a financial consultant, they can help you with this type of finance so that your business’ payments run smoothly.