The modern economy is built on a free flow of goods and streamlined commerce practices. Therefore, the companies that want to make a name in such an environment need to make sure their supply chains work without any interruption and they are able to respond to market fluctuations without any delay.
Keeping that in mind, however, it should be observed that meeting these demands in today’s globalized economy where various financial hurdles can present themselves over the course of the night is becoming increasingly hard.
A growing number of international traders find the solution to these issues in some of the different trade finance products. Let us take a closer look then at all the options we have at our disposal and how we can use them to help our companies navigate the tricky waters of international commerce.
What is trade finance and how does it work?
But, before going into greater detail let us first take a moment to examine what trade finance actually is and how it can benefit your organization. So, trade finance also going under financing for trade is a form of loan service designed to facilitate situations where neither buyer nor seller is capable of moving on with the transaction due to issues with solvency or liquidity. These problems usually create a lockdown where parties can’t get mutual assurances that the requirements for finishing the transactions have been met.
Trade finance tries to reconcile the diverging needs of trade parties usually in the form of a loan or letter of credit that guarantees the exporter will receive agreed compensation upon presenting a bill of lading. This way, the parties avoid devastating delays, cancelations, and cash flow obstacles.
Now let’s see how this concept works in different real-life scenarios.
Letter of credit
This is, by far, one of the most common applications for this type of product. In the simplest of terms, this option presents a pledge issued by a third-party trade finance company that the exporter will be fully paid once it ships the goods so it doesn’t have to gamble its cargo away. On the other hand, the importer gets reasonable payment terms and avoids having to pay the full price of the shipment before receiving the cargo.
So, by extending the loan to the importer and assuring the seller that the purchase will be completed on the previously agreed terms, the line of credit effectively protects both trading parties and serves as excellent protection against delays, extra fees, and other unforeseen obstacles.
Letter of credit usually comes in one of the following forms:
- Commercial letter of credit – It confirms that the importer’s bank will release funds upon receiving confirmation of the released shipment
- Standby letter of credit – It guarantees the payment in case certain conditions of the agreement fail to meet
- Revolving letter of credit – It allows businesses to run multiple transactions until the LC expires
- Transferable letter of credit – It allows the beneficiary to transfer a part of the transaction to another exporter if the situation demands so
Supply chain finance
The third most common trade finance product is called supply chain finance and unlike the previous mentions, it doesn’t present a loan per se. It rather works as a sort of financial platform that offers two trading parties more financial flexibility, streamlined transactions, and extended payment terms. It still works within the traditional supply chain practices and infrastructure but it moves the financial aspects outside this system where funds can end up being locked for a myriad of different and unforeseen reasons. This level of flexibility is not possible unless your company takes advantage of cryptocurrencies or uses some other alternative financial channel.
Purchase order finance
This type of trade finance product solves the problems of companies who are experiencing cash flow issues so they are, at the moment, unable to raise enough capital to complete the verified purchase order. The funds the importers get from the lenders are usually capable of covering between 30% and 70% of the agreed purchase order amount. So, the importers are able to access the necessary good and keep their supply chains and cash flows going. This allows companies enough flexibility to accept large volume orders without having to wait too much time before raising enough money to access the goods.
We hope this short breakdown helped you get a better understanding of what trade finance products actually are and how you can use them to introduce more flexibility to your supply chain. And keeping in mind all the challenges the international trade had to endure over the last couple of years and keeps dealing with to this very moment, you need all the certainty, flexibility, and nimbleness you can get. Using trade finance services won’t solve all these issues but it represents a perfect place to start.
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