Whether you're importing or exporting, any business that relies on trading can experience cash-flow shortages. Trade finance takes care of these gaps in cash flow, allowing your business to import or export goods with ease. There are a number of trade finance options available, including import finance, export finance, letters of credit, payment-in-advance and payment against documents.
What is trade finance?
Trade finance is an umbrella term for a number of working capital finance solutions that help protect businesses against risks associated with importing or exporting. Trade finance aims to bridge gaps in cash flow that may otherwise cause working capital problems. This could be due to risks such as fluctuations in currency, political instability, non-payment and creditworthiness of one of the parties involved.
How does trade finance work?
As domestic and international trade can be volatile, it is common for businesses to use trade financing to improve their operations. With trade finance, banks and financial institutions act as intermediaries between the buyer and seller, providing a range of solutions addressing the complications that may arise while trading. It helps importing and exporting businesses manage cash-flow issues that may arise due to changing marketing conditions and foreign exchange rates. Compared to other finance options, it also offers more flexible terms, taking into account the peculiarities of domestic and international trade.
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What are the types of trade finance?
There are several types of trade finance, depending on what you need covered. Some of the options include the following:
- Letters of credit. This is where the financier provides a letter of credit to the seller, assuring them that they will receive the payment for the goods. The buyer, meanwhile, receives assurance that the goods will be made and shipped.
- Export and import finance. With this form of finance, the financer offers a line of credit to exporters and importers. With this line of credit, an exporter can produce or manufacture goods for sale while waiting for their payments from overseas customers to come through. For importers, it allows them to purchase goods while using their outstanding invoices as collateral for finance.
- Payment against documents/documentary trade. With payment against documents, the supplier shows documentation that the shipment is on its way. When the financier receives the documents, they will transfer the payment to the supplier. This gives importers peace of mind that they will receive their goods.
- Payment in advance/cash in advance. This is when the seller receives a payment in advance arranged by the financier to manufacture the goods ordered.
What are the pros and cons of trade finance?
- Security. Some services allow you to protect your business against unfavourable foreign currency movements.
- Wide range of options. Banks that offer trade finance services have a range of options, some of which you may not have known were available.
- Expertise. You have access to the expertise and advice offered by the bank you're working with. This can help you navigate the complicated landscape of international trade with more ease.
- Cost. As with other financing solutions, trade finance comes with a cost. Make sure you account for repayments in your budget.
- Limited financing. As with other forms of business finance, trade finance may be limited to the size of your receivables.
- Short terms. The terms are limited to the trading cycle, which could be up to 180 days.
How do I compare lenders that offer trade finance?
- Available currencies. Most Australian banks will offer trade in Australian dollars, but keep an eye out for lenders that offer finance in Australian dollars and other foreign currencies.
- Interest rate. Check how often interest is calculated. Ideally, it should be daily. Also compare interest rates and fees between banks.
- Repayments. Take a look at how the repayments are structured and consider whether this will affect your cash flow. Some banks may require you to pay at full maturity. You may want to choose a bank that offers a repayment structure that won't have a negative impact on your business's financials.
- Financing terms. The financing terms for pre- and post-shipment finance will differ between lenders. Pre-shipment finance generally has shorter terms. Check the terms available before you apply to see if they work for your business.
What are the alternatives to trade finance?
While you may be hard-pressed to find corresponding features in other loan products, there are some options that may provide finance. These include the following:
- Business overdrafts. Overdrafts are linked to your transaction account and can be either unsecured or secured for higher amounts. It allows your business to draw beyond what you have in your account, up to the approved limit. You pay interest on what you borrow.
- Line of credit. This is a form of revolving credit, giving you ongoing access to funding up to an approved limit. Both secured and unsecured lines of credit are available. You pay interest on what you borrow.
- Invoice financing. With invoice financing, you can take a loan against your unpaid invoices. You can convert some or all of your unpaid invoices into funds. Most lenders offer up to 80-90% of the total invoice amount, with the balance paid (minus a fee) after the customer has paid.
- Term loans. There are both secured and unsecured term loans you can apply for. Loan terms for these loans are generally longer than other options available, ranging up to 5 years and beyond. The funds are paid in a lump sum.
What should I watch out for?
As with any financing, there are risks involved. You should always read the fine print before applying for any trade finance product. You should also keep an eye out for any restrictions, especially as many of these products will need to be applicable internationally. For instance, some banks will only arrange spot and forward foreign exchange purchases for approved clients. This is something you would need to consider before you apply.
How can I apply for trade finance?
🤔 Work out what type of service you need, how much finance your business requires and what you can afford.
🔎 Start comparing lenders. Apart from the services they offer, don't forget to compare interest rates and fees.
✅ Select a lender. If you're using Finder's comparison table, click "go to site" to be directed to the lender's page or "more info" if you want to read about the lender.
🖨️ Organise and prepare the required documentation.
📱 Apply. Most lenders have their applications online.
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