International Trade Financing
It is difficult for small and medium-sized businesses to get access to funding. This problem is only aggravated in international trading, where a business must pay large expenses upfront for high-value shipments. Moreover, most exporters would be unwilling to gamble on a new and untrusted customer to make payments.
This is where international trade financing becomes necessary. It makes foreign trade possible even when there is no existing importer/exporter relationship. The following sections will cover how this type of lending works.
What Is International Trade Financing?
International trade finance involves all financial instruments used to help importers and exporters conduct transactions. Trade finance companies take care of all the various processes involved with foreign trade and commerce. They make agreements between all of the involved parties, issue financial instruments to carry trades and mitigate the high risks of these trades.
The main function of international trade financing is to introduce a third party to mitigate the payment and supply risks. When importing a product, a buyer typically must deposit a portion of the purchase cost (usually one-third) before it ships. In contrast, sellers have to take the risk of trusting an unknown foreign party.
Overseas trade financing helps both parties, offering the importer credit to fulfil his/her order and providing the exporter with payment or receivables. Unlike other forms of financing, the main purpose of trade financing is to protect against the unique risks of global trades, such as currency fluctuations, economic downturns or political instabilities.
How Does International Trade Financing Work?
In overseas trading, buyers prefer not to get their money tied to a shipment that could take an unknown length of time to arrive. In contrast, exporters sending out large shipments of goods have to take considerable risks and wait for a long time for payment. That is why around 80% to 90% of world trade happens via international trade financing.
Various financial institutions offer to act as trading intermediaries between an exporter and an importer. They offer financing to the importer by issuing financial instruments like letters of credit, lines of credit, factoring or export credit. They are also responsible for providing insurance for goods shipped and financial protection against non-payment.
There are several methods of payment for overseas transactions, with bills of exchange and documentary credits accounting for a majority of such payments. For small consignments, exporters can receive payment in advance. However, this may not be possible for large orders between firms. In such cases, foreign trades take place with documentary credit.
When one party sells its goods, no movement of currencies takes place. Instead, all transactions are settled through the banking system, where one debt is offset against another one. Banks maintain a stock of foreign currencies by buying them from exporters and claims against foreign banks. This allows them to settle such transactions easily.
Types of International Trade Financing Products
The following are some of the most popular trade financing products available:
- Open Account:
Exporters may consider supplying goods on an open account basis if the importer has an excellent reputation and credit history. In this method, they will carry out trades in a manner similar to two domestic firms. The buyer will typically settle the outstanding balance at agreed-upon intervals.
- Letters of Credit:
This is a letter issued by the importer's financial institution to the exporter. The letter of credit guarantees that the buyer will make timely payment to the seller according to their agreement. However, if he/she fails to make a payment, the bank will cover the entire or remaining payment.
- Negotiation of Bills:
When a bank issues a bill of exchange, it hands over the bill’s face value to the customer minus a discount. For discounting of bills in international trade financing, the process is called negotiation. The customer has to submit a signed undertaking stating that he/she will reimburse the bank in case of dishonouring the bill.
In this method, parties exchange goods in the place of trading hard currency. Bartering is a type of counter-trading involving exchange of goods of equal value. In a counter-purchase, the seller has to buy the buyer’s goods for a specific period.
- Accounts Receivable Financing:
In this type of international trade financing, a company offers its accounts receivables to lenders to get funds. The accounts receivable is the money that a firm’s clients owe it. The total amount of money one can receive and its time frame determines how much financing one can get.
If your accounts receivables from international businesses are locked as unpaid invoices, you use them as collateral to get necessary financing. KredX Global offers post-shipment loans that can ease your export firm’s working capital problems.
Why Do Companies Need International Trade Financing?
Trade financing ensures that the exporters manage to transport their goods and the importers pay their dues in time. Overseas trading carries considerable risks and may require a firm to place its trust in a party with which it has never traded before. This risk can increase even higher with high-value goods.
To mitigate such risks, businesses take the help of trade finance companies. These financial institutions will do their due diligence to make sure that the parties are creditworthy. Buyers can bring the financier to pay the exporter, or the supplier can sell their invoices to a lender, who will assess the risks and pay the exporter.
In addition to absorbing the risks, many lenders extend credit facilities to both parties. This improves the cash flow of businesses as the importer knows he/she will receive the goods, and the exporter knows he/she will receive payments. Thus, international trade financing ensures that exporters and importers can run their businesses smoothly. International trading carries a high amount of risks as the companies are unfamiliar with each other and their country’s conditions. That is why international trade financing plays a vital role in protecting both parties' interests. Lending institutions offer many solutions for exporters and importers to mitigate risks and delays.