If you are a businessman who is running an international business in different corners of the world, you might be aware of the situation when you need financial help for importing or exporting goods in other countries faster and easier. This is a situation where the concept of Trade Finance comes into the picture.
What is Trade Finance?
Trade finance is the collection of essential financial instruments and products that are used by financial companies to facilitate finance to global businessmen so that they could perform their international transactions with smooth, ease and comfort. In simple words, trade finance makes it easier and possible for importers & exporters to transact their business through trade. It eliminates or reduces the risks involved in an international business transaction. Trade finance is an umbrella term that means it covers those financial instruments that are being used by many banks and companies to make trade finance transactions feasible.
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There are two concerning parties in Trade Finance:
Who provides Trade Finance?
Trade Finance is required by both importers and exporters to assist them in the smooth execution of their international business transactions. There is a wide variety of institutions that provide trade finance to firms with unique offered products and services. However, the size, cost, and terms of finance depend on the nature of the provider’s source of capital, their ability to assess the operational risk of borrower and zeal for investment risk. In this perspective, the trade financiers i.e. providers are divided into three parts:
- Traditional commercial banks - Both small domestic banks and larger multinational banks like Axios Credit Bank Ltd offer trade finance products. The larger banks often attract global businesses with their extensive capital reserves, sound credibility and global presence while small banks offer finance products to SMEs with niche needs.
- Non-Bank Lenders - The non-banking lenders who are extensively focused on trade finance products and willing for great trade finance investments also provide these products to international businesses by offering flexible terms and requirements of less tangible securities.
- Government-backed export creditors and development bank - They also offer trade finance products and usually focused on longer-term trade finance.
Users of Trade Finance
Trade finance is quite a large industry that covers many sectors that require funds for their business. The users of Trade Finance are -
- Producers
- Manufacturers
- Importers
- Traders
- Exporters
In simple words, trade finance settles the arising needs of both importers and exporters. On one hand, it mitigates the payment risk for the exporter while for the importers, it makes sure that they are paying for the right quality and quantity.
How Trade Finance Works?
It is important to understand the complexities and procedures of trade finance to avail of its benefits in the right way. The main function of the trade finance is to introduce a third party to the international business transaction so that both importers and exporters could either mitigate or reduce the supply and payment risk.
In trade finance, the exporter gets the receivables or payment according to the agreement while the importer might be extended credit to complete the trade order. The concept of trade finance should not be confused with conventional financing or credit issuance, they both are completely different concepts. General financing comes with the management of solvency or liquidity while the trade finance may not include the buyer’s lack of funds. Instead, it deals with protection against international trade’s unique risks like currency fluctuations, issues of non-payment or anything else.
Types of Trade Finance
Trade finance is an important instrument of financial services that are being used by many international banks including Axios Credit Bank Ltd. In this blog post, you will know about the Trade Finance and its various types. Here they are as follows:
- Trade Credit- It is one of the easiest and cheapest payment arrangements based mainly on the trustworthy relationship between the buyers and sellers. Usually, the exporters require payment of goods within 30 or 60 days post shipment but when the concerning parties are not familiar with each other or less known or the credibility of both is unknown, a bank-backed bill of exchange will be issued as well as guaranteed by the buyer’s bank.
- Cash Advances - A cash advance is simply a payment of funds (unsecured) to the exporter so that they could manage the manufacturing and production of the good for the order. It is based on trust and it is generally favorable and sought by the exporters.
- Receivables Discounting - They are more secure and beneficial options in comparison to invoices, post-dated cheques, and bills of exchange. The receivables discounting are commercial and financial documents issued by new finance houses and marketplace, can be sold in the market at discounted prices in return for immediate payment while invoices, post-dated cheques, and bills of exchange take reduced rates in the market. The discount rate can be calculated on the risk of default, the credibility of the seller and type of transaction ie. international or domestic.
- Term Loans - These are more sustainable sources of funding and include loans, commercial mortgages and overdraft facilities. They are secure and guarantee backed i.e. your business is required to have its own assets up to the value of the loan being sought as most of the time, when it comes to international trade and finance, the security against assets owned by the businessmen is in another country which is more tricky especially if there is a case of different ownership regulations in other jurisdictions.
- Leasing and Asset-backed Finance - Leasing is the procedure of borrowing funds against assets such as machinery, vehicles or equipment. There are several types of finance mechanisms through which SMEs can have access to the assets that have been repaid in smaller contractual or tax-deductible payments.
Other Types Of Trade Finance
Many other types of trade finance are useful for SMEs. Though they are not defined as “Trade Finance they are worth considering. One of them is equity Finance that includes seed funding, angel investment, crowdfunding, venture capital (VC) funding and floatation.
International Trade Finance Methods
There are five essential and primary methods of payments for any international trade that are explained here. Let’s have a look:
- Cash in Advance - It is the most secure and popular method of international trade finance in which the exporters can eliminate or avoid the credit risk as they have already received the payment in advance before the transfer of ownership of the goods. For international trade, the most commonly used cash-in-advance options are wire transfer and credit cards while with the advancement of the internet, Escrow services of Axios Credit Bank Ltd are also getting popularity as a cash-in-advance option for small export transactions.
- Letter of Credit - It is a letter that is issued by the bak as a guarantee to the seller stating if the payment is due by the buyer to the seller, it will be made on time with the exact amount by the bank. In simple words, if the buyer is not in a condition to make a payment, the entire or remaining portion of the payment will be done by the bank.
- Documentary Collection - It is a transaction procedure where the exporter allows his bank to collect the funds from the importer's bank in exchange for the documents stating shipped merchandise. In simple words, a documentary collection is where the exporter’s bank acts as a collection agent for the payment of shipped goods to the buyer.
- Open Account - It is a transaction where the goods are shipped and delivered before the due date of payment which is in international sales is 30, 60 or 90 days. This is the most beneficial option for the importers in terms of cash flow and cost but at the same time, it is one of the high-level risk options for the exporters.
- Consignment - It is a variation of the open account in which the exporter only gets paid when the foreign distributor has delivered the goods to the end customer. This international consignment transaction is executed after the contractual agreement in which foreign distributor is entitled to receive, manage and sell the goods for the exporters who owns the title of the goods until their selling.
Export and Import Finance
Export Finance
Export international trade finance services are extremely focused on supporting international businessmen with their global business transactions. These global businessmen require export trade finance when they want to assure the affordability in the production of goods as well as the assurance of getting paid on time while exporting goods in another country.
It helps them in mitigating or eliminating their risks such as default or delayed payment and fills the finance gap between manufacturers and overseas suppliers. Manufacturers face challenges while importing raw material and overseas suppliers want the assurance to get paid on time.
Tools of Export Finance
Export finance deals with a wide range of tools that are being used by banks to finance the international business to allow easier & smoother international trade as secure as possible. Here are the traditional tools:
- Bonds and Guarantees - If the exporter is unable or fails to deliver the goods on time as mentioned in the contract, the importer has an option to “call” the bond or guarantee to receive financial compensation from the exporter’s bank. These bonds and guarantee include tender guarantees, advance payment guarantees, retention money guarantees and custom bonds.
- Letter of Credit - These are issued by banks such as in which the bank provides the guarantee to the seller i.e. exporter that if the buyer ie. importer is unable or not in a condition to make payment to the seller, the whole or partial payment as the case may be will be done by the bank to the seller.
Import Finance
Import trade finance is simply the process of financing capital to the global business by the bank or financial institution so that the goods could be brought in own country by the importer. They need import finance when they face difficulties in trading overseas and this import finance helps the importers to mitigate the funding gap between an order taken from overseas customers and the payment demanded by their overseas suppliers. By taking import finance, the importers can decrease the pressure of cash flow as well as take care of complex paperwork procedures.
Types of Import Finance
- Standby Letter Of Credit
- Bank Guarantees
- Invoice Finance
- Asset-Backed Facilities
What Are The Risks Of International Trade Finance?
The procedure of international trade is full of several risks for both importers and exporters as you are interacting or doing business with the companies you are unaware of or unfamiliar with. So there are various international risks you have to deal with and some of them are here as follows:
- Payment Risks - It is the risk for both importer and exporter i.e. insecurity that whether the payment will be made to the exporter or the importer gets the quality goods they have ordered.
- Country Risk - It deals with the collection of risks associated to do business in a foreign country for both importers and exporters. It includes exchange risks, political risks or sovereign risk.
- Corporate Risks - This is the risk associated with the company of importer and exporter regarding credit rating or sound business history.
Trade finance helps in reducing these risks associated with global trade by analyzing the needs of both parties ie. exporter and importer.
Benefits of Trade Finance
- An easier way to manage short term finance
- Helps business to concentrate on growth activities
- Flexibility
- Guaranteed security
- Helps with trade cash flow
- Conveniency in transactions
Summing Up
If you are looking for a trustworthy, genuine and faster solution for financing your business, Axios Credit Bank Ltd is the one-stop solution. Now you know what trade finance services are and how much they are beneficial & important for your business. The ultimate agenda of trade finance services is to ensure smooth and comfortable business transaction globally.
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