Introduction to Trade Finance
Many businesses rely on lending to finance new ventures, reduce their financial exposure or manage their cash flow.
In particular, establishing or expanding international trade flows generates additional costs and risks for firms, from lengthening their supply chains to extending the “finance gap” between firms’ initial investments and realised returns.
As such, specialist trade financiers exist to assess and finance these investments, and help firms manage their inherent risks in a number of ways.
What is the problem?
Many firms avoid developing international business links; the UK government estimates that 400,000 businesses believe they could export, but don’t. Practically, three issues underpin this apprehension.
1) Sourcing or selling products internationally creates clear, tangible risks for firms. International transportation creates uncertainty about when goods will arrive, fear about its effect on their quality, and risks of damage or loss in transit.
A longer value-chain also creates additional potential sources of error during the processing and transportation of internationally-sourced products, and complying with government regulations and bureaucracy can be complex and costly.
2) Lengthened supply chains create an extended “finance gap” for firms. In any business, sellers want prompt payment for the products they manufacture and ship to recoup their investment in components, labour and transportation. In contrast, buyers hope to delay paying sellers for as long as possible, to convert the purchased product into revenue through resale to suppliers and customers which funds the initial purchase.
If the product is being transported across international borders, otherwise profitable investments can be scuppered by a finance gap running into months, as buyers cannot realise return on their products and repay sellers in a reasonable amount of time. Their situation in different countries also creates a risk that either party will not act on their part of the transaction by accepting payment and withholding shipment, or vice versa.
3) Traditional sources of business finance struggle to support international trade ventures. Investments with lengthy finance gaps underpinned by multiple intermittent transactions are perceived by banks as highly risky, making finance correspondingly hard to access. Moreover, firms looking to secure this finance may not want or be able to offer traditional securities (for example, property) to financiers to mitigate this risk.
How does Trade Finance help?
Trade financiers provide or identify sources of capital for firms seeking to invest in international trade and create structures for them to access it. They then operate as a third-party between international buyers and sellers to facilitate the subsequent transaction, reducing the impact of the issues identified above.
Specifically, trade finance specialists’ experience of international trade ventures enables them to better scrutinise firm’s proposed investments and assess the true levels of operational risk to all parties.
This increased awareness means trade financiers can accept more appropriate forms of security from firms seeking trade finance, such as purchase orders, invoices, or even the proposed product purchase itself, and offer extended terms of repayment reflecting buyers’ financing gaps.
Furthermore, trade financiers can reduce risks to buyers and sellers during the following interaction using bespoke trade finance tools. For example, letters of credit can assure sellers of payment once they prove they have shipped a given product, which also mitigate the risk to the buyer that the sellers might accept payment without shipment their goods.
As a third party, trade financiers also take steps to ensure trades are secure and effective by monitoring the physical movement and security of the buyer’s receivable and controlling the receipt of finance by each party.
This increases certainty in supply chains for buyers and sellers, and reduces financing risks for both firms and investors.
Investing in international trade
Supported by trade finance, firms can take advantage of a swathe of opportunities to grow their business and their profits. International trade ventures can unlock new markets by exporting products to new territories. Domestically, importers can service new customers and meet changing customer needs through access to a wider pool of international suppliers.
Through trade finance, these opportunities can be converted into investment, action, and ultimately, profits.
This article is part of an introductory series about trade finance, offering more information about the advantages of trade finance, the ways trade finance can be structured, and the products underpinning import and export transactions.
So stay connected to read more on this interesting and educational series about Trade Finance.
Article by : James Dinsdale, Writer at Trade Finance Global