What are the Trade Finance Basics?
Trade Finance Basics: This is a kind of commercial financing provided by a financial institution or trade finance house to help cover the costs of international sales of goods. It is mainly used when the sellers and buyers are in need of financial assistance to help with the trading process.
This financing can be obtained by different modes such as factoring, export credits, lending, letter of credit, and insurance. This type of financing allow the buyers and the sellers to reduce their trading risks and to settle their different divergent needs mainly related to the payments’ terms and conditions between both entities.
A usual scenario consist of a financial institution either lending the necessary funds to the importer or by issuing a letter of credit to the exporter, once the products have been shipped, which guarantees the payments of those products by this financial institution to the exporter. However the financial institution will only be responsible for the administrative part, dealing with the documents necessary for such a transaction, but not with the actual products or services.
Based on the World Trade Organization, trade financing consist of 80-90% of the global trade financing method used worldwide. This allows us to see the important role of trade financing on the global economy. Among the sectors which are using that method we can find traders, exporters, importers, producers, manufacturers and others.
Trade/Export Finance Basics: Pros and cons
The advantages of trade/export finance:
- The financial institutions will probably offer credit protection to minimize the risk of bad debts.
- It’s an easy to arrange and secured financing method on the short term.
- The companies can focus on their growth instead of generating funds for their trades.
- It is very convenient for sellers and buyers by settling their conflicting needs.
- It’s flexible and based on the need of the lender.
- The financial instructions might provide the documents needed for such a transaction.
- Trade financing normally doesn’t require collateral.
- The companies might generate additional profits from such a transaction.
The disadvantages of trade/export finance:
- First of all, the cost might be expensive depending on the type of products and transaction.
- Furthermore, it is dependent on your history of previous trade financing.
- Plus, there is a risk of late payment fees.
- The buyers have some risk of high cost of administration and accounting.
- The buyers might lose their suppliers if they don’t comply with the terms of financing.
- The buyers might lose the discounts made for cash or early payments.
- An increase of the cost of the material.
- The suppliers might end up with some huge debts.
- The suppliers in most cases depend on the willingness of the buyers to pay.
In conclusion of Trade Finance Basics, if you are managing big amount of orders and trading then trade and export finance could turn out as a very important tool for your trading process. Trade and export finance is the financing of trades. This type of financing in very convenient to the buyers and the sellers by allowing them to reduce their trading risks and to settle their different divergent needs.