Trade finance is a robust suite of activities related, primarily, to the economics of overseas trading activities. More specifically, the actions of lending, factoring, export credit financing, and forfaiting fall under this designation. It’s always a multi-party interaction. Considering that you often need insurers, buyer/seller, export credit agencies, and financiers to complete a deal. With so much involved, let’s take a look at the benefits.
Payment Risk Reduction
Given the distances that are usually involved, importers take on greater risk when dealing with suppliers. As such, trade finance was introduced specifically to facilitate transactions by reducing risk (in cases of, primarily, nonpayment for goods). To do this, a bank acts as an intermediary to expedite payments to the exporter via a loan or letter of credit.
This has the same effect as the above. It is used primarily to shoer up or accelerate cash flow. Through the selling of invoices to a factoring company for 85%-90% (usually) of the total amount. The factoring company then pursues the clients for payment. Whereupon the client company is remitted payment minus the factoring fee (the remaining 15% or so).
Pressure Makes Diamonds But It Crushes Business Relationships
The existence of trade finance makes sure that business relationships remain intact by reducing economic pressures on both the importer and the exporter. The reason for this is the most prominent benefit of trade finance. It mitigates the anxiety associated with default in payments.
Trade Finance Vehicles
There are primarily two here: the letter of credit and the bank guarantee. The former simply promises that the lending institution/bank will pay the full amount as soon as shipping agreements are ratified in the importer’s purchase documents.
Insofar as the bank guarantee is concerned, the bank itself functions as a guarantor. In the same way, that the federal government guarantees loans in the event of a default via the Small Business Administration (SBA).
Forfaiting in Trade Finance
This is the most straightforward method of all: the exporter simply offloads her accounts receivable and is recompensed with cash. This debt transfer frees the exporter of liabilities and waiting times, whereas the mediating company (the forfeiture) assumes this risk. The bank once again functions as a guarantor.
For more information on the particulars of trade finance, don’t hesitate to contact Crimson Stone Capital Solutions.