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The new policy initiatives by Central and State governments to boost the ease of doing business have immensely facilitated the growth of Indian commerce. If you wish to start a trading business involved in global commerce, availing the trade finance option may provide you with the funds to get rolling

What is Trade Finance?

Trade finance is a financial instrument that facilitates trading companies to undertake international trade and commerce. This financing facility allows exporters and importers to run their businesses and make transactions.

Trade credit is an umbrella term used to denote various financial products that enable companies to trade internationally. 

How Trade Finance Works

Trade finance onboards a third party between the importer and exporter to mitigate payments and supply-chain risks. Such a third-party deals in international trade transactions in two ways:

  • It provides the exporter with due payments according to the trade agreement

  • It extends a credit facility to the importer to pay for the order

 

Trade financing differs from other forms of financial products in many ways. One, availing trade finance does not indicate a company’s lack of required capital. It entails that a trading company wants to safeguard itself from volatile geopolitical factors, like: 

  • Foreign exchange rate fluctuations

  • Political turmoil

  • Issue of payments and supply chain

 

Issuance of trade finance products involves the following parties:

  • Importers and Exporters: Importers and exporters are service receivers, which means they can avail of trade finance services.

  • Trade Finance Companies: Trade finance companies are enablers providing international trade finance services. Letters of credit reduce the risk associated with non-payments for goods shipped.

  • Credit Agencies: Credit agencies help banks assess the creditworthiness of your trading company.

  • Banks: Payments made by the trade financing company are transferred to the exporter’s bank account. Banks also provide line of credit to importers and exporters.

  • Insurance Corporations: The goods involved in foreign trade are insured by insurance corporations. Insurance also guarantees payments for goods shipped to the seller.

 
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Types of Trade Finance

Here are five types of trade finance facilities your trading company can avail:

  • Payments-in-advance: This finance type allows the importer to pay for imported goods in advance. Hence, trade finance is considered risky and is not popular in the global commerce space. 

  • Working Capital Loans: Such professional loans are designed to fulfil everyday working capital requirements. These may include anything from procuring raw materials to hiring skilled labour.

  • Overdraft Facility: An overdraft credit works on a line of credit mechanism, where your company can withdraw the amount needed. Your company will only have to repay interest on the amount it uses.   

  • Factoring: Factoring is a post-export funding facility that provides upfront payments to the seller. Financial entities called ‘factors’ fund these payments by purchasing account receivables. In lieu of this, they receive payments from the actual buyer when the invoice is due. 

  • Forfaiting: Forfaiting is also a post-export trade finance mechanism based on account receivables. They only differ from factoring in the sense that they fund trade transactions for medium- to long-term durations.

Trade Finance Benefits

If your trading company decides to avail trade finance in banking, here are the benefits it gets to enjoy. 

1. Trade Financing Reduces Risk

The global commercial market is inherent with numerous geopolitical risks. Trade finances are financial instruments that avert such risks. For instance, consider these two scenarios:

  • A seller may take the upfront payment for shipping goods from the importer but may not ship them eventually

  • An exporter may not receive payment from the buyer after shipping goods 

A viable solution to this problem is letters of credit issued by the importer’s bank. These letters guarantee payments to sellers once they provide proof of shipment to the bank. 

These can include a bill of lading for shipment invoice.

For this purpose, banks assess if the buyer is financially capable of making the transaction to the exporter. Between an importer and an exporter, a bank acts as an enabler of trust. Apart from these two, there are various other associated risks like political instability, wars, aggressions, etc.

2. Improves Cash Flow and Efficiency of Operations

Trade finance facilitates trade businesses by eradicating cash deficit issues and improving cash flow. As mentioned above, a company can avail the line of credit and factoring facilities to mitigate problems related to non-payment.

The importer’s bank guarantees payment to the seller once the shipment reaches its destination. In simple terms, trade finance allows international commerce to run smoothly by streamlining payments and shipping procedures. 

3. Increased Revenue and Earnings

Trade finance also enables companies to boost their earnings and revenues through the expansion of trade. For instance, an Indian exporter can ship goods to foreign markets but lack in producing that good.

However, international trade finance allows such exporters to complete this order by procuring those goods. In this way, exporters as well as importers can widen the scope of their businesses.

4. Reduce the Risk of Financial Hardship

With facilities like factoring and revolving credit, trade finance allows trade transactions to complete. 

With such financing options, exporters can fulfil their shipping orders without losing their customers. These instruments also help trading companies in times of financial crunch or hardships. 

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Who Provides Trade Finance?

As mentioned above, many exporters and importers avail trade finance facilities to fill the trade cycle funding gap. Trading parties also use it as a risk-mitigation instrument. To serve this purpose, trade financing companies require the following:

  • Control over funds and goods

  • Control over the source of repayment

  • Access to monitor the trade cycle of the transaction

  • Security of shipped goods

 

The following are providers of the trade finance facility:

  • Suppliers

  • Banks

  • Importers

  • Syndicates

  • Trade Finance Houses

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Who uses Trade Finance?

Trade financing is a large industry involving many groups that use it. Here are some users of international trade and finance:

  • Producers

  • Manufacturers

  • Traders

  • Importers

  • Exporters

Trade Finance Features

The following are some features of financing foreign trade:

  • The amount of trade finance varies according to the lender and various other factors. The trade financier may assess your company’s creditworthiness before sanctioning it. 

  • The tenure of this financing facility also depends on the lender and trade finance type.

  • Such loans are generally secured which means you will have to pledge an asset to avail it. 

Conclusion

To sum up, trade finance is a financial instrument your trading company can utilise to keep up with the global commercial market. This financial facility does not just make the transaction possible between trading parties, but also improves cash flow.

Traders can also use these funds to meet working capital needs like buying machinery, procuring raw materials, or hiring labourers. On top of all this, trade finance products also act as risk-mitigation instruments against the ups and downs of global markets. 

FAQs About Trade Finance

What are the 5 types of trade finance?

The five types of trade finance products are payments-in-advance, overdraft facility, factoring, forfaiting, and working capital loans.

Is trade finance a loan?

Yes, trade finance is a credit facility that allows you to streamline payments with your exporter/importer. You can also use it to meet the expenses of working capital requirements.

What is the trade finance fee?

While the trade finance fee may vary depending on the lender, some financiers charge a 0.15% commission on the issuance of the line of credit.

What is the trade finance gap?

It refers to the difference between the total demand for trade finance by the companies and the money that banks pump in. In simple words, the distinction between the demand and supply of trade finance.

What are the 3 elements of trade finance?

The three elements of trade finance are the parties involved in the process, i.e., an importer, an exporter, and a trade financier.

What is an example of trade financing?

Consider an Indian company named A places an order for certain goods through an exporter B in the USA. In such a case, A can request their bank to issue a letter of credit for the transaction. 

 

This letter acts as a guarantee by the bank to the exporter. Once the shipment is made, B can visit the same bank with the proof of delivery to get the due payment.

What is the role of trade finance?

Trade finance has multi-faceted roles. One, it acts as a guarantee of payments between exporters and importers. It also improves cash flow and reduces financial hardships.

What are the benefits of trade finance?

The benefits of trade finance are many. One, it enables trust for transactions between exporters and importers. Moreover, they also improve the company’s cash flows along with meeting working capital requirements.   

 

International trade finance also mitigates the risks associated with global commercial markets and supply chains.

 

What are trade finance products?

The trade financial products are those financial instruments that allow trading companies to run their business smoothly. These include professional loans as well as invoice billing facilities.

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