Trade finance is important for businesses to ensure they can fulfil all their orders in today’s competitive market. There is nothing more frustrating for companies than having to turn down business because you don’t have a sufficient cash flow. With trade finance, that problem can be alleviated.
In this post, we will briefly outline what exactly trade finance is, how it works, why it’s important, how it can benefit you to use it and how you can secure trade finance.
What is Trade Finance?
We’ve previously taken a more in-depth look at what trade finance is, but essentially it involves a lender buying the goods you want to purchase on your behalf.
If you don’t get credit terms, you’re going to need enough cash to pay for those orders before they arrive. This may not be possible for a business and they may have to turn down orders that they cannot afford to pay for. However, with trade finance, a third-party is introduced to remove the payment and supply risk. They fill the ‘payment gap’ between purchasing from suppliers and realising profit from sales.
Trade finance provides the seller with payment and gives the buyer credit terms. Aside from providing funds to a company that may not have enough to cover the costs, trade finance can also be used to help protect a business against the risk of international trade, such as currency fluctuations, political instability, issues of non-payment or the creditworthiness of the parties involved.
How Does Trade Finance Work?
Trade finance involves a lender that pays the supplier or manufacturer for the goods on the buyer’s behalf. This gives the seller the reassurance that they will be paid upon releasing the goods, and the buyer gets the security of having their cash flow protected. It provides a safety net to both supplier and buyer, protecting their interests.
One of the ways trade finance can work is with a letter of credit. This is a legal document that acts as a guarantee which states that, once there is proof that the goods have been shipped and are on their way to the buyer, the money will be released to the seller.
Trade finance facilities are generally charged as an interest rate per month. These rates vary because of several factors but can be anywhere between 1% and 4% per 30 days. For this reason, the lender will want to make sure there’s a sufficient profit margin in the transaction to cover their fees. When the lender pays for your goods on your behalf, you make the sale and repay them from the sale proceeds.
Why is Trade Finance Important?
Trade finance is a huge driving force behind economical development, it’s estimated that 80% of global trade is reliant on this kind of finance. SMEs in particular rely on trade finance to support their businesses. It can be frustrating to have a lack of viable working capital options, but trade finance allows businesses to focus on growing sales, relieving the pressure on their cash flow when supplier credit is not readily available.
Trade Finance Reduces Risk
Trade finance reduces the risk for both seller and buyer. In an ideal world, the seller would prefer the buyer to pay upfront for shipments to avoid the risk of the buyer taking the shipment but then refusing to pay for the goods. However, there is then risk on the buyer’s end for paying for goods upfront that then might never be shipped.
The likes of a letter of credit provided to the seller’s bank promises payment once the seller presents documents that prove the shipment occurred, like a bill of landing. A letter of credit guarantees that once the issuing bank receives proof of the shipped goods, the terms of the agreement have been met, and it will issue payment to the seller.
With a letter of credit, the buyer’s lender assumes the responsibility of paying the seller. This relies on the lender ensuring that the buyer is financially viable enough to honour the transaction. Trade finance helps buyers and sellers trading both internationally, and in the UK, to build trust in dealing with one another and thus facilitate trade.
Other Benefits of Trade Finance
Aside from the reduced risk of non-payment or non-receipt of goods, trade finance is an important financial tool for businesses to improve their efficiency and boost their cash flow.
Trade finance ensures fewer delays in payments and shipments, improving the overall cash flow of businesses. As a result, both the buyer and seller can run their businesses and plan their cash flow more efficiently.
International trade opens up a new world of opportunities for a business. An SME might not have the capacity to produce the goods needed to fulfil an order, but with trade finance they are able to take advantage of importing opportunities, allowing them to complete their order. Consequently, that company can generate new business that they may not have been able to access without the solutions that trade finance provides.
Like many forms of lending finance, trade finance can also provide businesses with a safety net during difficult times. Without trade finance, a business may fall behind on payments and end up losing critical customers or suppliers, and this could have long term ramifications for the company. Having the option of trade finance not only helps companies trade internationally but helps them during times of financial difficulty.
Access Trade Finance with Ping
If you’re in the business of buying and selling goods, we offer services for trade finance in Manchester and surrounding areas that could help you. With our extensive contacts including hundreds of lenders across the UK, we can find the right lender for your business to help facilitate your next loan.
Take a look at our enquiry form today to find out more. It takes just a minute or two to fill out a few details, and then one of our friendly advisors will be on hand to answer any of your questions.