Managing your business’ finances is essential to keeping a healthy cash flow. Without this, you may face financial problems like bill payment delays or even paying your local suppliers and staff late. When you have an international purchase or supply, realising returns from such a transaction can take a while. The shipment method or payment process can take longer.
Therefore, it’d be best if your finances weren’t tied up in such a trade, so getting trade financing would be helpful in this case. The reason is that trade financing can enable you to continue with your normal operations without restricting your cash flows. Besides, it can help improve your business’ credit rating among your trade partners.
How Trade Financing Works
To access a trade financing facility, you need to provide a document proving the existence of a transactional contract. Such a document can vary, depending on the transaction’s nature and the required evidence of performance. For example, you need to show a letter of lading to confirm shipment.
Naturally, trade financing helps bridge a trade cycle funding gap. But in so doing, you need to give the financier control, visibility and monitoring of the transaction. You must also provide the financing institution security over the goods and receivables.
Trade financing can differ from one region to another. For instance, the requirements and considerations for trade finance in Australia may significantly differ if you’re applying for the same in Europe. The types of trade financing you’ll get can also vary. Apart from that, here’s a brief description of how trade financing works generally:
- You enter into a trade contract for goods or services.
- The buyer or seller then applies for trade financing from a financial institution, such as a bank or an export credit agency.
- The financial institution evaluates your creditworthiness and the viability of the trade transaction.
- If the financier approves the trade financing, it provides you with the necessary funds to pay for the goods or services.
- The financial institution may also include other services like insurance or risk management.
In brief, trade financing can help your business deal with the financial stress of cross-border trading. Trade financiers come in as third parties in a trade agreement. From a supplier point of view, they help mitigate payment risks. On the other hand, they reduce supply risks to the buyer. In other words, they extend credit terms to the buyer while accelerating receivables to the supplier.
Hence, trade financing can benefit your business in various ways. Below are a few of the benefits associated with trade financing.
Benefits Of Trade Financing
- It Helps You Take Advantage Of Early Payment Discounts
Most suppliers can have discount facilities if you pay for your goods or services within a particular period. Trade financing lets you access funds immediately to settle your dues within a short period. After that, you can pay back the financier over an extended period. As such, if the supplier has a discount for early payments, you can save money in your books.
- Reduces Financial Risks
As a buyer or a seller, more than a transactional contract may be necessary to guarantee financial success. There’s a risk of either late or non-delivery of goods or services. On the other hand, there’s also the risk of late or non-payment.
Trade financing reduces these risks as it provides a financial guarantee to both parties. A letter of credit is a vital document in this scenario. A trade financier assumes the responsibility on behalf of its client. Thus, it removes the process of checking if your trading partner is viable enough to honor your transactions. In some cases, the financier can also provide insurance which helps further reduce your financial risks. Overall, trade financing can help build trust among trading partners.
- Helps Increase Your Revenue And Earnings
Sometimes, you can land a trade prospect with the potential to generate more revenue for your business. However, you may need more finances to successfully initiate or complete the transactions. Such a financial constraint can quickly become a bottleneck.
However, trade financing allows you to enter into more significant business transactions, helping increase your revenue base. Besides, it can help expand your international trade and open your business to a more extensive market base.
- Improves Your Cash Flows And Operational Efficiency
Trade financing can allow you to access cash payments using account receivables if you want such credit facilities as factoring. Besides, a letter of credit lets a financier guarantee payments or receipt of goods and services. Thus, you can enter into a trade transaction with less risk to your financial situation.
Both these scenarios let you plan your cash flows more efficiently. In short, trade financing can help you with collateral you can use for business growth or meet other financial obligations, thus improving your operational efficiency.
Risks Of Trade Financing
In spite of its various benefits, trade financing also carries risks.
- Credit risk – The financial institution may not receive repayment if the buyer defaults on payment obligations.
- Country risk – The financier may face difficulties collecting payment if the buyer’s country is experiencing economic or political instability.
- Currency risk – The financial institution may face losses if the exchange rate changes unfavourably between when the trade financing is granted and when the buyer repays the loan.
As with any undertaking, it pays to know the risks to make informed decisions.
Conclusion
Overall, trade financing can be helpful for businesses looking to expand their international trade. But it’s essential to consider the potential risks carefully and work with a reputable financial institution to mitigate them.
