What is Trade Finance?
Hi, I’m Sam, and I want to tell you all about trade finance, and along the journey, this might even help your clients.
Did you know, around 80-90% of global trade is reliant on trade and supply chain finance, which is estimated to be worth around $10 trillion US dollars a year.
We want to help explain some of the concepts behind trade finance, should it ever be useful for you to explain or help your clients.
Sometimes banks might not be the best funding option. We’ve seen increasing regulation, reduced standard lending, and SMEs finding it difficult to access finance from traditional means. Is this really the case?
Absolutely not! At Trade Finance Global, we help companies find debt funding. We’re impartial, flexible and work with most funders on the market to ensure SMEs really do get the most appropriate source of funding to help them grow.
So what do we offer? In a nutshell, we offer business finance solutions, through our network of lenders to companies.
This video covers trade finance – which is one type of debt finance, how it works, and everything you need to know to explain it.
What is trade finance? Trade finance is an umbrella term encompassing many types of debt finance, including those which we offer, such as, invoice finance, factoring, letters of credit, forfaiting, export credit, open account, cash advance, documentary collections, guarantees and structured finance– some of which we will discuss in later videos.
Today we’ll be talking to you about core ‘trade finance’ and how it works.
Most people think that trade finance involves international trade, however, it often just involves domestic or internal trade.
So, how does it work?
A trade finance transaction will require a seller of goods and services as well as a buyer. A lender would come in and fund this trade.
Trade finance is relevant where a seller requires a buyer to prepay for goods shipped.
In traditional long-standing relationships, there is often a lot of trust between the seller and the buyer, where they may trade on open account terms. However, in most trading relationships, trade finance will be used.
What is needed?
As an example, the buyer wants to reduce their risk by asking the seller to document that the goods have been shipped.
The buyer’s bank assists by providing a letter of credit to the seller (or the seller’s bank) providing for payment upon presentation of certain documents, such as a bill of lading.
The type of document used in the process depends on the nature of the transaction and how evidence of performance can be shown (i.e. bill of lading to show shipment).
Trade finance is the type of finance used by buyers and sellers to assist with the trade cycle funding gap. So, if you’re a UK buyer purchasing clothes from China, you might use a trade finance facility to mitigate and reduce risk.
Lenders who assist with bridging this finance gap will normally require a number of elements to make sure that the transactions are safe, effective and secure.
They will ensure:
- Control the financial elements of the transaction
- Monitor the trade cycle throughout the trade
- Security of the goods and the debt, which is also known as a receivable
What’s the risk?
When trading goods, either the buyer or the seller will have to take some form of risk.
A seller wants payment upfront, whilst a buyer would want to defer payment by receiving some form of credit terms.
So how does trade finance help?
It’s often difficult to convince a seller to provide extended payment terms, as they normally want the cash upfront.
This is particularly difficult when trading with unfamiliar partners.
Paying sellers up front for goods can be difficult when businesses are under pressure to sell products on to their end customers.
With trade finance, payments are made directly to UK or overseas sellers, which bridges the funding gap between paying suppliers and being paid by customers.
At Trade Finance Global, we know that standard forms of debt don’t work, and most business owners are not keen to put up standard security.
Within trade finance, instead, it’s possible to use purchase orders, invoices, insurance and goods to be used as security.
So, how does it work?
Using a Trade Finance facility is straightforward:
1. Firstly, an order is placed with a supplier;
2. The funder then pays the seller upon guarantee of the goods being shipped.
3. Goods are shipped and delivered to the end customers of the company and
4. Finally, the buyer repays the lender. Depending on what is agreed, this may be within 90 days from the transaction date