From the smallest start-up company importing its first products from overseas, to multi-national corporations importing or exporting their gargantuan inventory across the globe, trade finance makes these kinds of transactions possible for every business.
If you’re in the business of buying and selling goods, chances are you will need to rely on trade finance to help. Typically, when a supplier is not giving a business credit and they are required to pay for goods up front, this is when trade finance comes in handy.
It is estimated that over 80% of global trade is dependent on trade financing. It helps keep goods moving even when companies do not have the cash flow to finance the transactions themselves. Here’s a look at how trade finance works and its benefits and drawbacks.
How Does Trade Finance Work?
Trade finance is a type of commercial finance whereby a lender, a trade finance company, essentially pays the supplier or manufacturer for the goods on the buyer’s behalf. For the seller, it gives them the reassurance that they will be paid upon releasing the goods. For the buyer, it protects their cash flow, as they are not required to pay up front before receiving the delivery, eliminating the risk of the supplier taking payment and not shipping the goods.
Essentially, trade finance provides a safety net for both the buyer and seller, protecting both of their interests. It removes the risk between companies wishing to trade with each other. The seller might be concerned that they aren’t going to get paid by the buyer, particularly if it’s a new, unheard of company or if they are based in another country. Whereas the buyer might not have the cash available to pay for the order upfront, especially if they’ve made multiple orders. Trade finance is a well-known method of obtaining funds to bridge the gap between shipping and payment.
Trade finance acts as a third party to remove the payment and supply risk by bringing a lender into the equation. The seller gets paid per the terms of the contract, and the buyer gets an extended credit. The arrangements are usually transactional, to cover the individual deals.
Trade finance can be broken down further into import finance, purchase order finance and supplier finance. Whichever way you look at it, the whole point of trade finance is to remove the risk from these transactions, particularly at the start of a buyer/seller relationship, when the parties involved have no idea about the people they’re dealing with.
Letter of Credit
One of the most prominent ways to eliminate risk is for the third party to draw up a letter of credit. This legal document, sourced from a trusted institution such as a bank, acts as a guarantee which states that, once proof that the goods have been shipped and are on their way to the buyer (importer), then it will release the money to the seller (exporter). Letters of credit provide a secure method of payment under the sales contract between the buyer and seller.
Pros and Cons of Trade Finance
- A tailored option for businesses that need to offer letters of credit or deposits to secure their orders with suppliers locally and internationally.
- Funding can cover up to 100% of eligible purchase orders.
- It is a relatively easy way to arrange short-term finance.
- It can be expensive.
- Letters of credit have an expiration date.
Here’s a good time for a word about Brexit and the UK moving away from the single European market. Whatever happens with politicians, it’s important to remember that people, companies and countries, will always do business with each other. What changes is the political arena in which you must operate. So, business goes on; it’s just the rules that change.
That’s not to underplay the importance of Brexit, but those in business know that they have to work within the regulatory framework in which they operate. If there is a hard Brexit, margins will take a battering because trade tariffs could be imposed. Even a soft Brexit, in which we reach an understanding with our European neighbours, still means that some tariffs and custom control costs will have to be factored into the equation.
Trade Finance from Ping Finance
At Ping Finance, we can put you in contact with lenders to fund your business ventures, including importing goods from all over the world. You can avoid missed business opportunities by being able to pay your suppliers up front with a trade finance loan.
If you can demonstrate that there is demand for your product, or produce a purchase order from your customer, you could be able to benefit from trade finance. There are many trade finance solutions, and which one suits your business best will depend on the terms agreed upon with your supplier. Lenders will pay for the goods on your behalf, you make the sale and then repay them from the proceeds.
Trade finance services are generally charged as an interest rate per month, so the longer a transaction is open the more it will cost. Interest rates vary but can be anywhere between 1%, 3% and 4% per 30 days, as the lender will want to make sure there’s a sufficient profit margin in the transaction to cover their fees.
To find out if you’re eligible for trade finance, here are some of the key things lenders will look at:
- Who is the supplier?
- What’s your trading history with them like?
- Who is the customer and are they creditworthy?
- What profit margin is in the deal?
- What are the goods and who’s in possession of them during transition?
With one, simple application form, Ping Finance can give you access to hundreds of loans and lenders across the UK. Register today – free of charge and with no obligation – to get the ball rolling to see if your business is eligible for trade finance services.