Trade Finance is usually used in international commerce in order to pay trading partner when doing overseas business. It is usually used on its own or coupled with invoice finance to cover the gap between payment and receipt of funds.
In short, trade finance improves cash flow and relationships with trading partners, expand imports, allows access to facilities when there are few historical records, creates flexibility in relation to security offered, and allows management to concentrate on other areas of the business.
International trade is increasing year on year and has grown to $9 Trillion dollars annually in global business. Many of the large banking organisations moved away from trade finance in the 1980s and smaller more innovative players were developed to fill this void; offering new and innovative solutions that are suited to meet the needs of many different types of companies. When looking at countries such as the US and Britain, where imports have outpaced exports since the 1980s, the policy has focused on increasing exports and opening new markets abroad for foreign products. Terms can be drafted to appropriately address risk, to fairly lie with the importer, exporter and financier.
The most common terms of purchase are as follows:
- Consignment Purchase
- Cash-in-Advance (Pre-Payment)
- Down Payment
- Open Account
- Documentary Collections (“DC”)
- Letters of Credit (“LC”)
The two main trade finance tools are letters of credit and documentary collections. LCs are used mostly for exports to countries with intermediate degrees of contract enforcement. This is compared to DCs; they are used for riskier destinations. LCs are employed relatively more than DCs for export markets where contract enforcement is weaker. Regulatory changes have affected the business and several financial institutions lately reduced their trade finance activities or exited the business altogether, but this has led to more alternative financiers entering the market. Risk is the basis for decisions of what trade finance mechanism to use. For the riskiest destination countries, bank fees are so high that exporters prefer cash-in-advance. In that case, the importer pays before the exporter produces, and payment risk is eliminated. Similarly, LCs are not used for low-risk destinations; for those transactions, the exporter can save on bank fees by bearing the risk itself.
At Trade Finance Global, our finance experts and global network can help your business get access to capital to import stock immediately. Find out more here.