When importing and exporting goods, companies face various operational and financial challenges. Trade finance is a facility that makes it easier to trade internationally, easing cash flow issues and keeping the supply chain running smoothly.

In this article, we discuss the key elements of trade finance, how you can qualify and the main benefits for businesses.

What is trade finance?

Trade finance covers financial support for those involved in the import and export process, with the purpose being to prevent bottlenecks and cash flow problems as businesses transport goods across different countries. 

Trade finance consists of various financial products and components, such as issuing letters of credit, lending and forfaiting.

The different parties involved in trade finance include banks, trade finance companies, importers and exporters, insurers and export credit agencies, who collaborate on credit agreements to ensure relevant parties get paid at the right time to maintain healthy liquidity and SLAs for delivering goods.

Why use trade finance?

Trade finance agreements help prevent financial risks and gaps in cash flow from impacting the transportation of goods and give various parties within the import/export process more room to manoeuvre. Using the credit facilities for trading internationally reduces hold-ups and financial issues and allows operations to continue thanks to available working capital.

How does trade finance work?

The primary goal of trade finance is to mitigate the risks associated with international trade, ensuring smooth transactions between importers and exporters. 

Here's a breakdown of the key types of trade finance available and the typical process of applying and securing agreements.:

Key types of trade finance

• A letter of credit: An importer's bank makes a promise to the exporter that it will immediately make a payment once the transaction has been completed.
• A bank guarantee: This is where a bank acts as a guarantor in case the importer or exporter fails to fulfil the terms and conditions of the contract. This means the bank would pay a sum of money to the beneficiary.
• Factoring: Here, an exporter sells their invoices to a trade financer (the factor) at a discount. The factoring company then sells it on to the importer, who pays the full price for the product. This is for short-term financing, with the exporter remaining responsible if invoices are not paid.
• Forfaiting: This allows exporters to obtain cash by selling their medium and long-term foreign accounts receivable at a discounted rate. In forfaiting, the lender assumes the risk of default of invoice payments.
• Export insurance: This helps mitigate trade risks and protects businesses against the risks of non-payment.
• Lines of credit: Banks or other finance providers can offer lines of credit to importers and exporters to draw from when required, repay monthly and top up credit agreements, typically for working capital purposes.
  

Trade finance process

As you can see, there are various trade finance options for businesses importing and exporting goods. Taking the example of a letter of credit or bank guarantee, here are the typical steps in the trade finance process:

1. Agreement and contract: Importers and exporters agree on the terms of the sale, including payment terms, delivery conditions, and the use of trade finance instruments, like letters of credit, to help operations run smoothly.
2. Issuance of financial instruments: The importer's bank issues a letter of credit or bank guarantee, providing security to the exporter.
3. Shipment and documentation: The exporter ships the goods and provides the necessary documentation (e.g., bill of lading, invoice, etc.) to the importer's bank.
4. Verification and payment: The importer's bank verifies the documentation and releases payment to the exporter.
5. Settlement: The importer repays the bank according to the agreed terms, completing the transaction.
   

Who offers trade finance?

Banks and other financial institutions and brokers can provide different forms of trade finance, depending on the size of your lending needs, creditworthiness and other key eligibility factors. Also, the UK government has a dedicated trade finance arm, called UK Export Finance, which offers various working capital products, export insurance and dedicated guidance and support for businesses. 

How to choose the right trade finance solutions

Choosing the right trade finance solutions for your business depends on your key challenges with exporting and importing goods, whether your finance needs are short-term or long-term, and what level of risk you’re prepared to accept.

Weigh up the pros and cons of different solutions, check eligibility criteria and determine which best matches your needs, challenges and growth ambitions.

Trade finance software

Modern finance software solutions are helping to speed up various processes involved in trade finance, such as automating certain compliance steps, enhancing visibility and accelerating cross-border transactions.

Tech innovations and integrated solutions, such as open banking and blockchain, are pushing the boundaries, using real-time data to enable faster processing, verify transactions and provide crucial audit trails.  

Trade finance vs supply chain finance

Trade finance and supply chain finance are often confused and incorrectly deemed interchangeable. However, while similar in that they support B2B transactions and relationships and help to keep business moving, they serve slightly different purposes and needs.

Here is a summary of the key differences between trade finance and supply chain finance:

Using trade finance

Trade finance helps businesses manage the financial risks of international trade, ensuring importers and exporters can safely and efficiently complete transactions. Guarantees, credit facilities and invoice advances all help businesses get money or promises of funds they need to move goods without the risk of financial loss.

So, if you’re manufacturing, exporting and importing goods, trade finance can ease financial concerns and enable faster transactions.

Using supply chain finance

Also known as reverse factoring, supply chain finance sees lenders advancing payments to suppliers (with lending decisions based on the buyer's creditworthiness). It supports businesses when goods are delivered, allowing suppliers to get paid faster to prevent cash flow issues. 

Trade finance helps simplify international importing and exporting whilst reducing risks for various parties. Supply chain finance is more focused on improving cash flow for suppliers, initiated by buyers with strong credit.

Is a trade finance facility right for my business?

If your business regularly trades internationally, this form of financing is a useful way to manage and mitigate the various risks involved. Trade finance solutions offer a layer of protection to help you operate with more confidence and be more growth-focused. 

There are lots of benefits to consider, from better cash flow management and operational efficiency to having more available working capital to invest in new initiatives and meet tax obligations more easily.

So, if your revenue is inconsistent and you’re battling existing cash flow issues, trade finance could be an effective source of funding for your business. 

Trade finance vs. a short-term loan

While trade finance is a trusted business finance solution for countless businesses involved in exporting and importing goods, depending on your particular needs, a short-term business loan might be a better option.

Using a short-term loan can provide your business with a large sum of working capital for a range of operational needs, whereas most forms of trade finance solve a particular transaction purpose when importing and exporting goods. 

Here are a few reasons why you might want to use a short-term business loan instead of trade finance:

• Flexibility – short-term loans can be used for a variety of purposes beyond the trading of goods, such as meeting regular liabilities, boosting inventory or covering unexpected expenses.
• Easier and faster to obtain – applications for short-term loans, especially when using digital lenders like iwoca, can be completed easily online with same-day approval decisions and fast access to funds. 
• Eligibility/suitability – if you largely operate domestically, you may not qualify for certain trade finance agreements, while there are typically less specific eligibility criteria with most short-term loan agreements, especially unsecured loans from private lenders.

Iwoca offers tailored business loans for companies in need of fast and flexible finance solutions to address cash flow challenges, simplify business purchases and fuel business growth. You can borrow between £1,000 and £1 million for a matter of days or weeks or up to 60 months, and you only pay interest on what you use. 

Learn more about our flexible business loans and use our loan calculator to see your likely repayments.