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What is Trade Finance? Your Questions Answered!

November 22, 2023
Read Time:
5 mins
Author:
Inovayt

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Trade finance is short-term working capital finance supporting domestic and cross-border trade transactions. It’s used by businesses to finance their trade activities and bridge the funding gap between buying stock and receiving payment from their customers.

It can be an extremely useful tool for businesses as it helps mitigate risk, improve cash flow, and increase revenue and earnings. This blog will dissect trade finance and how it can help your business. 

What is trade finance?

Trade finance is an umbrella term that covers many financial products that banks and companies utilise to make trade transactions feasible.

In this instance, trade financing is the process of funding a trade involving exchanging goods, commodities and financial instruments between the two parties. It allows businesses to borrow money against their purchase orders and makes it easier for importers and exporters to transact business through trade. The lender will pay for the purchase, and the company will have 120 days to repay the lender. 

The facility allows businesses to set payment terms that are favourable to them. It will also enable businesses to order more significant amounts of stock or inventory, which helps achieve lower prices on their cost price, in turn increasing the margins on their products.

How does trade finance work?

Trade financing works a little differently than traditional business financing methods or credit issuance. It introduces a third party to transactions to remove payment and supply risks. It also provides the exporter with receivables or payment according to the agreement, while the importer might be given credit to fulfil the trade order.

The parties involved in trade finance often include: 

  • Banks 
  • Trade finance companies
  • Importers and exporters
  • Insurers
  • Export credit agencies and service providers

While general financing is often used to manage solvency or liquidity, this isn’t the case for trade finance, which may not necessarily indicate a buyer’s lack of funds or liquidity. Rather, this type of finance can be used to protect against international trade risks. For example, currency fluctuations, political instability, issues of non-payment, or the creditworthiness of one of the parties involved.

Trade finance instruments

We touched on trade finance instruments earlier in this blog, but essentially, these ‘instruments’ refer to specific financial contracts or any document that acts as financial assets. This may include debentures and bonds, receivables, cash deposits, bank balances, shares, bills of exchange, forwards, FRA or forward rate agreement, etc., to one organisation and as a liability to another organisation, and these are solely taken into use for trading purposes.

what is trade finance

How does trade financing reduce risk?

Trade finance is a great opportunity for businesses, as it saves buyers from delayed receipt of supplies that might hamper the demand for their products in the market. It also helps reduce risks in the international trade market. 

Ideally, exporters would prefer importers pay for their goods upfront to reduce the risk of not receiving payment after shipping stock. On the other hand, importers would prefer to have their stock shipped rather than paying upfront in case the exporter decides not to send the goods. 

Trade finance is one way both parties can benefit whilst minimising risk. Regarding the above example, a bank or lending institution could provide a letter of credit to the exporter’s bank that offers payment once the exporter presents documents that show the shipment occurred, like a bill of lading. The letter of credit guarantees that once the issuing bank receives proof that the exporter shipped the goods and the agreement terms have been met, it will issue the payment to the exporter.

Benefits of trade finance

Aside from risk reduction, trade finance has numerous benefits for businesses and other involved parties. These include: 

Improves cash flow and efficiency of operations

One of the more significant benefits of trade finance is that it improves cash flow and the efficiency of a company’s operations. It helps businesses obtain finance they otherwise may not be able to and often provides an extension of credit in many cases. Finance instruments such as a line of credit can help importers and exporters enter into a trade agreement that will reduce the risk of a non-payment or non-receipt of goods.

Increased revenue and earnings

Another benefit of trade finance is that businesses can increase their business and revenue through trade. For example, if an Australian company lands a sale with an international business, it might not be able to fulfil the order without the assistance of trade finance. It’s through trade finance that the business can complete the order and obtain a new client they may not previously have had access to. 

Reduced risk of financial hardship 

Trade finance may mean a reduction in the risk of financial hardship for some businesses. Without it, a company may fall behind on payments and lose a key customer or supplier, which could result in long-term financial consequences for the business. This means options like revolving credit facilities and accounts receivables factoring can assist companies in international transactions and help them in economic hardship.

Flexible credit options

Some lenders offer flexible credit options to businesses using trade finance. This may include the ability to offer extended credit terms to buyers or pay suppliers early if needed.

Customised payment terms

Again, plenty of lenders offer a customised plan and payment terms for businesses. This might mean payment terms that align with your business’s trading cycle, from 7 days to 180 days. 

Finance in a currency of your choice 

Dealing with international businesses? No worries! We work with lenders who provide finance in Australian dollars or other major foreign currencies to suit domestic and international business deals. 

How can an Inovayt commercial finance broker help with trade finance?

Trade finance can be a complex topic to understand without the help of a professional. Our Inovayt commercial finance brokers are here to work with your business and help you set up for financial success. We work with your business to analyse your short and long-term goals and assess whether trade finance could benefit your company. 

If you want to learn more about how trade finance can help your business, contact an Inovayt commercial finance broker today.

Ready to see if your business is a good fit for trade finance?

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