What are the Types of Trade Finance? | Trade Finance Global 2020 Guide
Types of Trade Finance
‘Trade Finance’ is a catch-all term for the financing of international trade. Below, we have briefly summarised the main trade finance products which are available to businesses.
Usually, the seller of goods or services requires payment by the buyer within 30, 60 or 90 days after the product is shipped (post-shipment). Trade credit is the easiest and cheapest arrangement for the buyer. It is based mostly on trust directly between the buyer and the seller. Insurance cover is usually taken by the seller on the buyer, due to the risk of non-payment.
A cash advance is a payment of funds (unsecured) to the exporting business prior to the shipment of goods. It is often based on trust; a cash advance is usually favourable and sought by the exporters so that they can manufacture or produce goods following an order. However, it is a high-risk financing structure for the buyer, as there may be delays on sending product or non-delivery.
Once a Purchase Order (PO) is received from an end customer, on the strength of such PO, a financier may pay the supplier direct and receive repayment from the buyer or their end customer. This will depend on the structure of the facility, but the aim behind a PO facility is for a lender to finance all the way from a supplier, through to repayment of the trade.
Invoices, post-dated checks or bills of exchange can be immediately sold on the market at a reduced rate, to the invoice value. Receivables are mainly commercial and financial documents, and banks, finance houses and marketplaces allow such documents to be sold at discounted prices in return for immediate payment. The discount rate, which may be relatively high and can be costly for SMEs is calculated based on the risk of default, the creditworthiness of the seller or buyer and whether the transaction is international or domestic. Find out more about invoice discounting and invoice factoring in our guide here.
Longer-term debt (including term loans and overdraft facilities) can be more sustainable sources of funding. They are often backed by security or guarantees. Often in the world of international trade and finance, securing against assets owned by business owners in differing countries is difficult, primarily due to ownership requirements and regulations. Find out more about term loans and business loans here.
Other types of Business Finance
There are other types of trade finance which we think would be useful for SMEs to know about, which aren’t strictly ‘trade finance’ as we define, but it’s worth considering.
Equity finance includes seed funding, angel investment, crowdfunding, venture capital (VC) funding and floatation. The principles however are the same. Generally, a business owner will give a proportion of his or her shares to an investor (so that they own a share of the business) and if the company grows and shares become more valuable, they will sell their shares in the business (exit) and make a return on their initial investment. It’s a rather complicated type of finance with many different types – we’ve summarised them and written a more extensive guide to equity finance here.
Leasing and asset-backed finance involves the borrowing of funds against assets such as machinery, vehicles and equipment. There are several finance mechanisms which allow SMEs to have access to assets which are repaid in smaller contractual, tax-deductible repayments.
Asset finance allows SMEs to purchase equipment or assets over a period of time, and this method of machinery use is favourable for tax treatment in many markets. There are different types of leasing/asset finance, including finance leases, hire purchase and operating leases. We’ve detailed these and written an asset finance guide which you can access here.
Trade Finance Hub
1 | Introduction and the benefits
2 | Types of trade financing
3 | Methods of payment
4 | Pre and post-shipment finance
5 | Risks and challenges
6 | Trade and export finance providers
7 | The credit process and securing finance
8 | SME Trade Finance Guide