The Trade Dilemma

A common dilemma faced when engaging in the sale and purchase of goods and services, especially where international trade is concerned, is the seller wanting to get paid before shipping the goods and the buyer wanting to receive the goods before paying the seller. In simple terms, this can be called the trade dilemma, where certainty around the inherent risks associated with trade, and the need to bridge working capital cash flow gaps through access to external sources of funding, become key in the facilitation of trade transactions. In order to provide a solution for buyers and sellers, the financial sector intervenes by providing them with trade finance products and services, increasing certainty for both parties involved in a trade as well as funding where necessary.

Trade finance is a set of techniques aimed at mitigating and transferring trade risks to the financial sector, and/or using bank funding to enable domestic and cross border/international trade flows. Trade finance focuses on supporting the physical flow of goods across borders while primarily using the goods, receivables and cash generated from the trade as the principal security.

Trade finance focuses on supporting the physical flow of goods across borders while primarily using the goods, receivables and cash generated from the trade as the principal security.”

Trade Finance deals typically involve at least three parties: the exporter (seller), the importer (buyer) and the financier, and differ from other types of credit products as transactions should have the following features:

  • An underlying supply of a product or service
  • A purchase and sales contract
  • Shipping and delivery details
  • Other required documentation (certificates of origin etc)
  • Insurance cover
  • Terms and instruments of payment (letter of credit, advance payment, deferred payment etc.)

Trade participants to manage the capital required for trade, while mitigating or reducing the risks involved in an international trade deal. Finance exists to finance the trade cycle at various points of the transaction, also allowing participants to manage the capital required for trade, while mitigating or reducing the risks involved in an international trade deal.

International and local financial institutions support international trade through a wide range of products that help manage their international payments and associated risks, as well as catering for the need for working capital.

Examples of Providers of Trade Finance
  • Banks
  • Funds (such as WeFundTrade)
  • Alternative Financiers
  • Insurance Underwriters
  • Trading Companies
Users of Trade Finance
  • Importers
  • Exporters
  • Trading Companies
Why Is Trade Finance Necessary?

Trade Finance (also known as Supply Chain Finance and Import & Export Finance) is a massive driver of economic development and helps maintain the flow of credit in supply chains. It is estimated that 80-90% of global trade, worth $10 trillion per year, is reliant on trade and supply chain finance.

Types of Trade Finance

'Trade Finance’ is a catch-all term for the financing of international trade. Below, we have briefly summarised the main trade finance products which are available to businesses.

Trade Credit

Usually, the seller of goods or services requires payment by the buyer within 30, 60 or 90 days after the product is shipped (post-shipment). Trade credit is the easiest and cheapest arrangement for the buyer. It is based mostly on trust directly between the buyer and the seller. Insurance cover is usually taken by the seller on the buyer, due to the risk of non-payment.

Cash Advances

A cash advance is a payment of funds (unsecured) to the exporting business prior to the shipment of goods. It is often based on trust; a cash advance is usually favourable and sought by the exporters so that they can manufacture or produce goods following an order. However, it is a high-risk financing structure for the buyer, as there may be delays on sending product or non-delivery.

Purchase Order (PO) Finance

Purchase Order (PO) finance is commonly used for trading businesses – who buy and sell; having suppliers and end buyers. Financing is on the basis of purchase orders that allow a shot of finance into a growing company – this type of facility is sometimes used or not known about by many companies and is at many times an alternative to investment. It also provides huge advantages when negotiating with suppliers and end buyers – gaining credibility within the transaction chain.

PO finance usually goes hand in hand with invoice finance, as purchase order financier is paid back by an invoice finance lender when goods are received by the customer.

Receivables Discounting

Invoices, post-dated checks or bills of exchange can be immediately sold on the market at a reduced rate, to the invoice value. Receivables are mainly commercial and financial documents, and banks, finance houses and marketplaces allow such documents to be sold at discounted prices in return for immediate payment. The discount rate, which may be relatively high and can be costly for SMEs is calculated based on the risk of default, the creditworthiness of the seller or buyer and whether the transaction is international or domestic.

Term Loans

Longer-term debt (including term loans and overdraft facilities) can be a more sustainable source of funding. They are often backed by security or guarantees. Often in the world of international trade and finance, securing against assets owned by business owners in differing countries is difficult.

Other Types of Business Finance

There are other types of trade finance which we think would be useful for SMEs to know about, which aren’t strictly ‘trade finance’ as we define it, but they’re worth considering:

Equity finance includes seed funding, angel investment, crowdfunding, venture capital (VC) funding and flotation. The principles however are the same. Generally, a business owner will give a proportion of his or her shares to an investor and if the company grows and shares become more valuable, they will sell their shares in the business (exit) and make a return on their initial investment.

Leasing and asset-backed finance involves the borrowing of funds against assets such as machinery, vehicles and equipment. There are several finance mechanisms which allow SMEs to have access to assets which are repaid in smaller contractual, tax-deductible repayments.

Asset finance allows SMEs to purchase equipment or assets over a period of time, and this method of machinery use is favourable for tax treatment in many markets. There are different types of leasing/ asset finance, including finance leases, hire purchase and operating leases.