Trade Finance Introduction | 2021 Trade Finance Guide

An Introduction to Trade Finance

Trade Finance Global / Trade Finance Introduction | 2021 Trade Finance Guide

Trade Finance & International Trade

Welcome to the TFG Trade Finance and International Trade hub. Find out how we can help you access trade finance to increase your imports and exports, or find the latest research, information and insights on trade finance here.

What is trade finance?

Trade Finance is the financing of goods or services in a trade or transaction, from a supplier through to the end buyer. It accounts for 3% of global trade, worth some $3tn annually. ‘Trade Finance’ is an umbrella term, which includes a variety of financial instruments that can be used by an importer or exporter.

These include:

  • Purchase Order Finance
  • Stock Finance
  • Structured Commodity Finance
  • Invoice Finance (Discounting & Factoring)
  • Supply Chain Finance
  • Letters of Credit (LCs) and;
  • Bonds & Guarantees

The terms Import Finance and Export Finance are used interchangeably with Trade Finance.

In order to address some of the common issues and misunderstandings around Trade Finance, we have put together this short guide.

How can trade finance benefit my business?

Trade finance facilitates the growth of a business by securing funds required to purchase goods and stock. Managing cash and working capital is critical to the success of any business. Trade finance is a tool which is used to unlock capital from a company’s existing stock or receivables or add further finance facilities based on a company’s trade cycles.

Why does this help? A trade finance facility may allow you to offer more competitive terms to both suppliers and customers, by reducing payment gaps in your trade cycle. It is beneficial for supply chain relationships and growth.

Other benefits of trade finance

  • Short to medium-term working capital, using the underlying products or services being imported/exported as security/collateral. It increases the revenue potential of a company, and earlier payments may allow for higher margins.
  • Trade finance allows companies to request higher volumes of stock or place larger orders with suppliers, leading to economies of scale and bulk discounts. 
  • Trade finance can also help strengthen the relationship between buyers and sellers, increasing profit margins. It allows a company to be more competitive.
  • Managing the supply chain is critical for any business. Trade and supply chain finance helps ease out cash constraints or liquidity gaps – for suppliers, customers, third parties, employees or providers. Earlier payments also mitigate risk for suppliers.

It is important to note that trade finance focuses more on the trade than the underlying borrower, i.e. it is not balance sheet led. Therefore, small businesses with weaker balance sheets can use trade finance to trade significantly larger volumes of goods or services and work with stronger end customers.

Due to the embedded risk mitigants that surround trade finance lending and instruments, it leads to the potential of a diversity of supplier base for trading companies. A more diverse supplier network increases competition and efficiency in markets and supply chains.

Companies can also mitigate business risks by using appropriate trade finance structures. Late payments from debtors, bad debts, excess stock and demanding creditors can have detrimental effects on a business. External financing or revolving credit facilities can ease this pressure by effectively financing trade flows.

How can we help?

The TFG team works with the key decision-makers at 270+ banks, funds and alternative lenders globally, assisting companies in accessing trade & receivables finance.

Our international team are here to help you scale up to take advantage of trade opportunities. We have product specialists, from machinery experts to soybean gurus.

Often the financing solution that is required can be complicated, and our job is to help you find the appropriate trade finance solutions for your business.

Read more about Trade Finance Global and our global team.

Our Client Case Studies

MW Beers & Co.

Base Oil Trader

Clothing Company

Machinery Trader

Browse Case Studies

.

Want to learn more about Trade Finance?

Look no further. We’ve put together our feature trade finance insights, research and articles, and you can catch the latest thought leadership from the TFG, listen to podcasts and digest the latest in international trade right here.

From the Editor – Trade Finance Insights

Trade digitalization milestones: a series of fortunate events If you blinked and put your feet up this bank holiday weekend, you probably missed out on a few important milestones for digitalizing trade.
VIDEO: Industry Leader Perspective: The Currency and Cross-border Payments (R)evolution Kenneth Wong, Director, Global Transaction Banking, TD Securities, talks about the changing payments landscape, cross-border payments and digital currencies.
Podcast: The LIBOR transition and trade finance By the end of 2021, it’s anticipated that LIBOR rates will be discontinued, transitioning to the SONIA or SOFR. But what does this mean for trade finance? ITFA explains

Videos – Trade Finance

Trade Finance Podcasts





Trade Finance Frequently Asked Questions

How is trade finance governed and what is the UCP 600?

The UCP 600 (“Uniform Customs & Practice for Documentary Credits”) is the official publication which is issued by the ICC (International Chamber of Commerce). It is a body of rules on the issuance and use of a letter of credit and applies to 175 countries. The aim has been to standardise a set of rules aimed to benefit all parties during a trade finance transaction – for that reason, it is designed by industry experts rather than through legislation. The UCP was created in 1933 and has been revised by the ICC up to the point of the UCP600. The UCP600 came into force on 1 July 2007. Read more →

What is the difference between trade and export finance?

Trade and export finance are sometimes used interchangeably. However, it is important to explain the distinction and how the terms are used.

Trade finance is a term universally used for financing both imports and exports. In many mediums this will encapsulate invoice finance, purchase order finance, off balance sheet lending, letters of credit and similar funding instruments. Trade finance is usually spoken about in reference to cross border trade. However, it may also be domestic trade. It is commented on by many as being seen as a financing mechanism which is not well known in the market, but by having purchase orders and suppliers – there is a way of financing a trade through the use of a lender’s funds. Read more →

What does trade finance include?

Trade finance includes the following:

What are the methods of payment for trade finance?

Cash Advances

As the least risky product for the seller, a cash advance requires payment to the exporter or seller before the goods or services have been shipped. Cash advances are very common with lower value orders, and helps provide exporters / sellers with up front cash to ship the goods, and no risk of late or no payment.

Letters of Credit (LCs)

Letters of credit (LCs), also known as documentary credits are financial, legally binding instruments, issued by banks or specialist trade finance institutions, which pay the exporter on behalf of the buyer, if the terms specified in the LC are fulfilled.

An LC requires an importer and an exporter, with an issuing bank and a confirming (or advising) bank respectively. The financiers and their creditworthiness are crucial for this type of trade finance: it is called credit enhancement – the issuing and confirming bank replace the guarantee of payment from the importer and exporter. In this section, and in most cases, we may consider the importer as the buyer and the exporter as the seller.

See a worked example here of how trade finance can be used to finance the purchasing of Frozen Fish from a supplier, to be sold on to end customers:

Documentary collection

Documentary collections differ from a Letter of Credit (read our blog post on the differences between DCs and LCs).

In the case of DC, the exporter will request payment by presenting its shipping and collection documents to their remitting bank. The remitting bank then forwards these documents on to the bank of the importer. The importers bank will then pay the exporters bank, which will credit those funds to the exporter.

Open Accounts

An open account is a transaction where the importer pays the exporter 30 – 90 days after the goods have arrived from the exporter. This is obviously advantageous to the importer and carries substantial risk for the exporter – it often occurs if the relationship and trust between the two parties is strong.

Open accounts help increase competitiveness in export markets, and buyers often push for exporters and sellers to trade on open account terms. As a result, exporters may seek export finance to fund working capital whilst waiting for the payment.

Who are the providers of trade and export finance?

Retail and commercial banks

Some commercial banks have specialised trade finance divisions, which offer facilities to businesses. Commercial banks represent the majority share of financial institutions globally, although they range in size from small and niche banks to large multinational banks.

Alternative Finance and Non-Bank Funders

There are many types of financial institutions that do not use public deposits as a funding resource. Funding sources include crowd-funded (pooled) investment, private investment and public market sourced capital.

Read more here.

What is the process for applying for trade finance?

1. Application

The initial ‘credit’ application drives the process when applying for credit.

Lenders will often ask for information on current assets or collateral that the business owns, including debt and overdrafts, assets that the company or directors own (property, equipment, invoices).

2. Evaluating the Application

The evaluation process will normally involve some kind of credit scoring process, taking into account any vulnerabilities such as the market the business is entering, probability of default and even the integrity and quality of management.

3. Negotiation

Eligible SMEs applying for trade finance can negotiate terms with lenders. An SME’s aim with a lender is to secure finance on the most favourable terms and price. Some of the terms that can be negotiated can include fees and fixed charges, as well as interest rates.

4. The Approval Process and Documentation of a Loan

Typically, the account officer who initially deals with the applicant and collects all of the documentation will do an initial credit and risk analysis. This then goes to a specific committee or the next level of credit authority for approval. If the loan is agreed (on a preliminary basis) it goes to the legal team to ensure that collateral can be secured/ protected and to mitigate any risks in the case of default.

Read our full ‘trade finance application process’ here.

What are the challenges for SMEs in accessing trade or export finance?

From the banks perspective, as the regulation burden (i.e., Basel III) has become heavier, SMEs often don’t fulfil certain criteria for banks to justify lending to. As lending money has an associated transaction cost, it is more costly to assess and monitor loans to a smaller, riskier company where profit is less certain, relative to a larger, more profitable and stable business.

Banks will often ask for the following from any company when filling out an application for any type of business finance:

  • Audited financial statements
  • Full business plans
  • Financial forecasts
  • Credit reports
  • Details and references of the directors
  • Information on assets and liabilities

As well as the cost of lending to SMEs being less profitable for banks, there is a much higher default risk and chance of bankruptcies with SMEs in comparison to larger firms. The other challenge banks have in lending to SMEs is the lack of security and collateral an SME can provide.

SMEs also face challenges in accessing finance from banks. In a recent survey by the British Business Bank, 46 percent of SMEs were looking to grow in the next 6 months, yet awareness of types of finance available and finding sources of finance (especially after being rejected from a bank) are major concerns amongst SMEs. The perceived high cost of borrowing, lengthy procedures for securing a loan and also the amount of paperwork and documentation required is often off-putting and cumbersome to SMEs.

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