Trade Finance is a general term that involves financial transactions between sellers of goods and services and buyers of those goods and services. It includes both domestic and international trade transactions but is particularly helpful in protecting against overseas transactions given the inherent risks associated with global trade such as the political climate of the foreign entity, transportation issues, and even fluctuations in currency. The purpose of trade finance is to mitigate various categories of risk for both parties by introducing a trustworthy and respected third party – usually a bank or other financial institution – to the transaction.
The seller of goods (exporter) wants to minimize the risk that the buyer or receiver of goods (importer) does not provide payment for those goods. The buyer, on the other hand, wants to minimize the risk of payment if the goods are not delivered. This is where trade finance can help. The financier provides the seller with payment or receivables and provides the buyer with extended credit to fulfill the order. In doing so, the financier bridges the gap between buyer and seller needs and ensures the transaction is honored, enabling both parties to grow their businesses more effectively and confidently.
Here’s a simple illustration of how trade finance works:
Trade Financing Products
Banks and financial institutions offer a variety of trade financing solutions. A few of the more common ones include the following:
- Letters of Credit (LOCs) – This method of trade finance is given by a bank or financial institution on behalf of the buyer to the seller as long as the seller provides the necessary documents such as a Bill of Lading to the buyer’s bank or financial institution. The qualifying documents are generally outlined by the buyer in the purchase agreement. With the LOC, essentially, the buyer’s bank is guaranteeing payment to the seller for the shipped goods.
- Bank Guarantees – A bank guarantee is similar to an LOC except unlike an LOC which provides payment to the seller once the seller provides the necessary documents showing that the goods have been shipped, a bank guarantee honors payment to the seller if the buyer cannot pay for those goods.
- Factoring – This method of financing is based on receivables. It allows a seller to free up working capital locked up in outstanding invoices by selling those unpaid invoices at a discount in return for faster access to those funds.
- Trade Insurance – Trade insurance protects the seller or exporter against the risk of non-payment by a foreign buyer by giving the seller conditional assurance that payment will be made in the event that the buyer or importer is unable to pay for the goods.
Trade finance can help a business take advantage of new opportunities that they may not otherwise be willing or able to take due to the financial risks associated with commerce and its supply chains. Finding the right trade finance partner can help provide businesses with the flexibility and security to acquire new clients and grow revenue by mitigating inherent risks associated with doing business, whether domestically or overseas.
If you have any questions regarding trade finance programs, contact us or give us a call at (844) 474-5056.