Trade financing or what is often referred to as trade financing is financial assistance related to or provided in the field of international trade and trade through the use of various financial products. Generally, trade financing is designed to represent the financial instruments and products used by companies to facilitate and facilitate importers and exporters to transact business.
How trade financing works
The nature and way of working is different from conventional financing or other credit issuances. Financing is commonly used to manage solvency or liquidity, in contrast to trade financing or trade financing it can be used to protect against the unique risks inherent in international trade, such as currency fluctuations, political instability, non-payment issues, or the creditworthiness of either party. which is involved.
The parties involved in trade finance include banks, trade finance companies, importers and exporters, insurance companies, and export credit service providers.
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The widespread use of trade finance has contributed to the growth of international trade. The following are some of the financial instruments used in trade finance such as:
- Loan lines of credit can be issued by banks to assist both importers and exporters.
- Letters of credit are useful for reducing the risks associated with international trade, as the buyer’s bank guarantees payment to the seller for the goods shipped. However, the buyer is also protected as payment will not be made unless the conditions in the LC are met by the seller. In this case both parties must respect the agreement so that the transaction can be carried out.
- Factoring is when companies are paid based on a percentage of their receivables.
- Export credit or working capital that can be given to exporters.
Insurance that can be used when shipping and delivering goods can also be used to protect the exporter from default by the buyer.
How trade financing reduces risk in foreign trade
Trade finance can help reduce the risks associated with foreign trade by aligning the different needs of exporters and importers. Ideally, the exporter would prefer the importer to pay upfront for export shipments to avoid the risk that the importer will take delivery and refuse to pay for the goods. However, on the other hand, if the importer pays the exporter in advance, the exporter may accept the payment but refuse to deliver the goods.
A common solution to this problem is that the importing bank provides a letter of credit to the exporter’s bank providing payment after the exporter presents documents proving that delivery of the goods has been made, such as a bill of lading.
The letter of credit guarantees that after the issuing bank receives proof that the exporter has delivered the goods and all the terms of the agreement have been met, the issuing bank will issue a payment to the exporter.
With a letter of credit, the buyer’s bank is responsible for paying the seller. The buyer’s bank must ensure that the buyer is financially viable. Trade financing helps facilitate both importers and exporters in building trust and relationships with each other.
Other benefits of trade financing
In addition to reducing the risk of default and non-receipt of goods, trade finance is an important tool for companies to increase efficiency and increase revenue.
Improve company’s performance and cash flow
Trade finance helps companies obtain financing to facilitate business but is also an extension of credit in most cases. Trade finance allows companies to receive cash payments based on accounts receivable in case of factoring. Such is the case in letters of credit which can help importers and exporters to conduct trade transactions and reduce the risk of default or non-receipt of goods.
Based on this of course will result in increased cash flow because the buyer’s bank has guaranteed payment, and the importer knows that the goods will be delivered. In other words, trade financing can ensure fewer delays in payments and shipments allowing importers and exporters to run their businesses and plan their cash flows more efficiently.
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Reduce the risk of late payments
Without trade financing, companies may fall behind on payments and lose key customers or suppliers which can have long term consequences for the company. Having options such as revolving credit facilities and factoring can not only help companies transact internationally but