Trade finance makes it easier to move goods around the world and participate in international business. So whether you've recently set up a small business and want to import your first product, or you're looking to expand your business's export trade, it’s important to understand trade finance and how it can help.
Confusingly, sometimes the term 'trade finance' is used when discussing trade credit – a different product which lets you purchase new stock or goods without paying cash upfront to your supplier. Read our article on trade credit for more information on this.
What is trade finance?
The definition trade finance typically refers to all the different instruments and products that allow you to trade internationally. Trade finance services bridge the financial gap between the importers and exporters, adding a third party to the mix and, in doing so, reducing risk and making it easier to trade.
The phrase is an umbrella term, meaning it covers many different financial products that banks and companies use to make trade transactions feasible. It covers activities such as issuing letters of credit, as well as lending and forfaiting – all of which we’ll discuss below.
The different parties involved in trade finance include banks, trade finance companies, importers and exporters, insurers, export credit agencies.
Examples of trade finance products and services include:
- A letter of credit: This is where an importer's bank makes a promise to the exporter that it will immediately make the payment once the transaction has been completed.
- A bank guarantee: When a bank acts as a guarantor in case the importer or exporter fails to fulfil the terms and conditions of the contract. This means the bank would pay a sum of money to the beneficiary.
- Factoring: Here, an exporter sells their invoices to a trade financer (the factor) at a discount. The factor then sells it on to the importer, who pays the full price for the product.
- Forfaiting: This is when an exporter sells all of their accounts to a forfaiter at a discount in exchange for cash.
- Insurance: This can be used for shipping and the delivery of goods.
- Lending: Lending lines of credit can be issued by banks or other providers to help both importers and exporters.
- Export credit: This can be supplied to exporters as working capital.
Is a trade finance facility right for my business?
If your business trades internationally, or is likely to in the future, then you'll need to engage with trade finance to help mitigate the risks involved. Even with a confirmed order for products, many banks won't provide loans or overdraft protection for these types of transactions, so you may need a trade loan.
Trade finance is common among businesses, with some 80 to 90 percent of world trade relying on trade finance, according to the World Trade Organisation (WTO).
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Other benefits to trade finance
There are other benefits to trade finance, too. It could help improve the efficiency of your business and boost your revenue. This is because cash flow is improved by the buyer's bank guaranteeing payment, and the importer knowing the goods will be shipped. In other words, trade finance ensures fewer delays in payments and in shipments, allowing both importers and exporters to run their businesses and plan their cash flow more efficiently.
How does trade finance work?
Trade finance helps reduce the risks associated with global trade by introducing a third party to transactions to remove, or at least reduce, payment and supply risks.
International trade – despite how it might feel from the consumer perspective – is a risky business. All sorts of external factors can delay a shipment arriving on time, for example. These include factors with natural, political, regulatory, and economic roots.
Trade finance is used to protect against international trade's unique and inherent risks, such as currency fluctuations, political instability, issues of non-payment, or the creditworthiness of one of the parties involved.
Trade finance example
A small business wants to import its first private label cosmetic product from overseas. To do his it uses trade finance UK. The trade deal is made with the involvement of a bank as a third party and trade financer. The two companies use a letter of credit and a bank guarantee. The exporter doesn’t need to worry that the importer could default in payment, and the importer can be sure that all the goods ordered have been sent by the exporter, because it has been verified by the trade financier.
Quick fire facts about trade loans
- Trade finance makes it easier and less risky for importers and exporters to transact business through trade.
- Trade finance services introduce a third party, such as a bank, and cover a range of finance products and services, such as a letter of credit or bank guarantee.
- Trade finance solutions reduce risks, such as currency fluctuations, political instability and issues of non-payment. A trade finance facility can also make your business more efficient and boost its revenue.
- Trade finance products and services include issuing letters of credit, lending, forfaiting, export credit and financing, and factoring.
- Estimates suggest that 80 percent of world trade relies on trade finance.
More to read about Trade finance
- Reverse factoring
- Forfaiting
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