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Trade loans – What are they and how can businesses use them?
Trade loans are short-term facilities involving a borrower and a lender that importers, exporters, and domestic traders use to acquire financing.
Each loan will be for a specific transaction and companies usually use them for purchasing products.
Trade loans assist with funding trade transactions at important points throughout the trading cycle of a company – this is advantageous as it improves the cash flows of a company.
The facility may be used for traders where there are open account transactions, documentary credits, or collections.
Lenders set limits on trade loans by looking at a wide array of factors, which can vary based on the specific nature of each transaction.
They do not necessarily just look at the method of trade.
Trade loans process
Trade loans are considered to be fully revolving credit facilities that traders use to provide financing in the gap between the purchase of a product and repayment from the end buyer.
Lenders will set out a series of documents, such as a purchase order and carriage documents, that the borrower must provide before the two parties can reach an agreement on the facility.
The level of security will determine whether the lender has the right to exercise control over transportation.
Trade loans – where to find it
We usually see trade loans when manufacturers and wholesalers need to make large purchases to fill their demand needs.
As with other facilities, lenders charge interest on the amount that the borrower owes.
Trade finance fees
As with most financial instruments, most of the interest and other charges that lenders administer during trade finance will be derived from the level of risk associated with the underlying transaction.
The riskier, the higher the fees.
Lenders also charge arrangement fees to set the line up as funds are set aside. However, these will all be set on the basis of many possible elements such as security offered, jurisdictions, and insurance cover.
This is because the complexity and structure of the transaction will naturally impact the amount of time a lender needs to set it up, which will usually be up to 4 weeks.
Often, traders will use other facilities in conjunction with trade loans.
Trade loans are advantageous for many reasons. This is because they smooth the transaction cycles allowing the supplier to be paid on time and the borrower to receive effective credit terms.
This can also help buyers negotiate supply-side discounts since they are able to make payments to the supplier sooner, which tends to boost a firm’s reputation as a trustworthy counterpart.
Many firms use this facility to fill seasonal demand or address specific trading cycles.
However, since this type of facility caters to shorter-term trades, they do tend to have higher interest charges. These higher charges increase the probability of default.
As with any loan, defaulting on a trade loan will negatively impact a borrower’s credit score and may impede their ability to secure financing again in the future.