How Trade Finance Products Work

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Many small businesses rely on trade finance products to facilitate their global shipments. Understanding how these products work can help you make smarter financial decisions for your business. For example, a clothing company in Canada might want to buy from an Indian supplier but would rather mitigate their payment risk by financing the shipment through a letter of credit (LoC). The bank will then take on all the other risks.

Trade Finance

As the global trade ecosystem expands, businesses need tools to facilitate it. These include a range of different finance products that help mitigate risks involved in international commerce, such as letters of credit, supply chain financing, and receivables financing. A letter of credit is a type of guarantee that allows sellers to offer their buyers payment terms like 30, 60, or 90 days from shipment. These guarantees protect sellers from failure-to-pay on the buyer’s side and help them compete with foreign competitors.

Other trade finance products are bill collection and discounting which is a major service provided by banks. Banks facilitate the movement of documents, makes necessary checks and then processes payments to the exporter against these bills. This is a great tool for small businesses that are new to international trading. It helps them to compete against their foreign counterparts and win sales. It also reduces their cash outflows.

Export Finance

A specialist type of finance designed to help businesses export to international markets. Similar to invoice factoring, it advances money against foreign accounts receivable, bridging the cash-flow gap between shipment and payment. It also helps companies qualify for preferential credit terms from their buyers, enhancing their competitiveness in global markets. Once a sales agreement is in place between the buyer and seller, and after the importer passes credit assessment, the finance provider will make funds available for the transaction to proceed. These funds are used to cover the purchase order value, bridge the payment gap between the seller and the buyer, and reduce supply chain and shipping risks.

In addition, trade insurance products – such as export credit guarantee and export risk management – complement these financing products by offering a level of credit enhancement. This allows banks to offer more favourable lending terms for foreign accounts receivable, further improving a business’s profitability and cash flow.

Import Finance

Many different forms of digital payments solution help traders mitigate a variety of risks associated with international trading and bolster their supply chains. These can include letters of credit (LC), purchase order finance, supply chain finance, forfeiting, and asset-backed financing. LCs are financial guarantees issued by banks on behalf of importers, promising to pay the exporter upon fulfillment of the terms and conditions of a specific sale. These are common way to mitigate payment and delivery risk for both buyers and sellers in high-risk transactions.

Documentary collection is a method of import finance in which commercial documents are exchanged between the buyer and seller, verifying the shipment before payment is made. This eliminates the need for a full advance payment and helps businesses manage their cash flow needs while ensuring suppliers get paid promptly. It also reduces the need for additional capital investment from angel or private equity investors. In this way, it’s a vital component of any international business plan.

AR Financing

Accounts receivable financing is a type of working capital funding that uses a business’s outstanding invoices as collateral. This is an alternative to factoring, and it has less stringent requirements on things like customer credit and time in business. It’s also generally faster and cheaper than a traditional bank loan. It also takes the pressure off of chasing debtors for payment, freeing up resources that can be put toward growth and resiliency.

For example, a clothing manufacturer with a $50,000 purchase order from a retailer could qualify for AR financing by transferring the unpaid balance of that invoice to a financer in exchange for a cash advance. They’ll likely pay 2-3% of the total invoice value in fees for this service, but they’ll be getting cash that would otherwise be tied up waiting for their customer to pay. This is an excellent way for a high-growth company to make the most of their current assets.

Conclusion

Trade finance products are the linchpin of international commerce, providing the financial infrastructure for businesses to thrive on a global scale. From letters of credit to trade credit insurance, these tools mitigate risk and facilitate cross-border transactions, fostering economic growth and strengthening global trade relationships.

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