Trade finance, already a specialized niche within the banking and financial services industry becomes even more specialized when it focuses on just export financing. Export financing and the broader trade financing are very different than commercial lending, mortgage lending, and other common domestic banking disciplines. Trade and export financing, at a minimum, are more complicated than domestic banking by an ocean and several thousand miles.
Trade and export financing account for the fact that goods are sold and shipped overseas take longer to get paid than it would with a local transaction. Extra time and energy are required to make sure buyers are reliable, creditworthy and properly managed.
Additionally, foreign buyers, like their domestic counterparts, prefer to delay payment until they receive and resell the goods they’re supposed to be paying for. You can’t blame them, but you can worry about them because they have an ocean between them and you. Due diligence and careful financial management can mean the difference between profit and loss in export financing.
All sellers want to get paid as quickly as possible, while buyers usually prefer to delay payment, at least until they have received and resold the goods. This is true in domestic as well as international markets. Increasing globalization has created intense competition for export markets. Importers and exporters are looking for any competitive advantage that would help them to increase their sales and flexible payment terms have become a fundamental part of any sales package.
Maybe best from a marketing and sales standpoint, places all of the risk with the seller. The seller ships and turns over title of the product on a promise to pay from the buyer.
Cash-in-Advance terms place all of the risk with the buyer as they send payment on a promise that the product will be shipped on time and it will work as advertised.
Today, open account terms with extended dating are becoming more common despite the dangers. Trade finance provides alternative solutions that balance risk and payment. In this overview, we’ll outline the two broad categories of trade finance:
- Pre-shipment financing to produce or purchase the material and labor necessary to fulfill the sales order; or
- Post-shipment financing to generate immediate cash while offering payment terms to buyers.
Financing can make the sale
Just as with price, favorable payment terms make a product more competitive. If the competition offers better terms and has a similar product, a sale can be lost.
In other cases, the exporter may need financing to produce the goods or to finance other aspects of a sale, such as promotion and selling costs, engineering modifications and shipping costs. Various financing sources are available to exporters, depending on the specifics of the transaction and the exporter’s overall financing needs.
The costs of borrowing, including interest rates, insurance and fees will vary. The total cost and its effect on the price of the product and profit from the transaction should be well understood before a pro forma invoice is submitted to the buyer.
Costs increase with the length of terms. Different methods of financing are available for short, medium, and long terms. Exporters need to be fully aware of financing limitations so that they secure the right solution with the most favorable terms for seller and buyer.
The greater the risks associated with the transaction, the greater the cost to manage or mitigate the risk. The creditworthiness of the buyer directly affects the probability of payment to an exporter, but it is not the only factor of concern to a potential lender. The political and economic stability of the buyer’s country are taken into consideration. Lenders are generally concerned with two questions:
- Can the exporter perform? They want to know that the exporter can produce and ship the product on time, and that the product will be accepted by the buyer.
- Can the buyer pay? They want to know that the buyer is reliable with a good credit history. They will evaluate any commercial or political risk.
If a lender is uncertain about the exporter’s ability to perform, or if additional credit capacity is needed, government guarantee programs are available that may enable the lender to provide additional financing.
Trade finance generally refers to the financing of individual transactions or a series of revolving transactions. Also, trade finance loans are often self-liquidating—that is, the lending bank stipulates that all sales proceeds are to be collected, and then applied to payoff the loan. The remainder is credited to the exporter’s account.
The self-liquidating feature of trade finance is critical to many small, undercapitalized businesses. Lenders who may otherwise have reached their lending limits for such businesses may nevertheless finance individual export sales, if the lenders are assured that the loan proceeds will be used solely for pre-export production; and any export sale proceeds will first be collected by them before the balance is passed on to the exporter.
Given the extent of control lenders can exercise over such transactions and the existence of guaranteed payment mechanisms unique to or established for international trade, trade finance can be less risky for lenders than general working capital loans.
Accounts Receivable Factoring
Once a product has been shipped, that inventory is converted to an account receivable (A/R). A list of all accounts receivable is maintained on an aging report while the exporter waits for final payment. If you have a more immediate need for cash you can convert your accounts receivable into cash using a trade finance method known as factoring.
Factoring is the discounting of foreign accounts receivable that do not involve drafts as the method of payment. A Factor (an organization that specializes in the financing of accounts receivable) takes title for immediate cash at a discount from the face value. Although factoring is often done without recourse to the exporter, verify these specific arrangements. Factors typically provide 70% of the face value within 3-5 working days, and assume responsibility for collection from the buyer. After final payment, the Factor will pay the remaining 30% – less a service fee of 4% – 5%.
Global Trade Funding has a great deal of information about Accounts Receivable Factoring available for clients and visitors and additionally offers Accounts Receivable Factoring as a service. Visit
Similar to accounts receivable factoring, forfaiting is the selling, at a discount, of longer term accounts receivable or promissory notes of the foreign buyer. These instruments may also carry guarantees from the foreign government or other documentary guarantees. Because forfaiting may be done either with or without recourse, verify all of the specific arrangements.
It is almost inevitable that you will have to extend competitive credit terms to foreign buyers in you are going to grow your international business, which means absorbing more risk. What happens if you don’t get paid? Your foreign customers could go out of business or file bankruptcy, face currency devaluations or foreign exchange problems, run short on cash, or fail to pay you for any number of other commercial or political reasons. You can protect your foreign receivables against virtually all non-payment risks with an export credit insurance policy.
Export credit insurance is an effective sales tool that enables you to extend competitive payment terms without significantly increasing your risk. It can help you penetrate new markets, negotiate larger order quantities, establish or expand distribution, and increase the profitability of your export business. If you finance your receivables, the coverage will also make your foreign A/R more attractive to banks, factors, and other lenders so you can negotiate the most favorable advance rates and loan terms.