Trade Finance: Everything You Need to Know

One of the biggest areas of economic activity in South Africa is trade: The import and export of goods internationally, as well as the domestic trade  but more often than not, substantial funding is required for these transactions to take place.

Trade finance is a solution designed specifically to help your business with finance the trade of goods. It is a cash flow alleviation tool to make sure the cogs of your business keep on turning.

Various trade finance opportunities are provided by banks and other financial institutions to help with these sales and purchases, because providing certain products or services (or purchasing them) can be expensive and carry risks for both parties.

Why would you need trade finance?

If you’re selling or exporting a product, you would ideally want a buyer to prepay before receiving the goods. However, this doesn’t always work for many buyers, and this can be due to a number of reasons.

Cash-flow

Of course, if an importer requires goods, but can’t pay upfront for them, they would utilise the support of a credit provider - either a bank or private financing source - to give trade financing.

This funding would enable the importer to go ahead with the transaction and deliver payment to the exporter, even though the immediate cash-flow wasn’t available for the purchase.

Risk

Alongside the capital requirements, there is an element of risk involved with expecting people to pay for goods before receiving them. As you can imagine, there are always concerns with putting down a lot of money for something prior to receiving it, as there could be defects, issues, or quality-checks needed to be done. Therefore, the importer will use trade financing to help facilitate and minimise this risk, providing the funding as a third-party risk-management tool for both parties.

These trade funding options are essentially loans or guarantees, in one form or another, but it’s good as a business owner to know that these should be treated as lines of credit which are owed back.

Types of trade finance

While the trade finance industry is essentially in place to help promote and facilitate trade opportunities between importers and exporters, there are a few various options available based on what type of risk mitigation or financial help you require:

Documentary collection

This is a security measure whereby the banks or financial providers between the buyer and seller would coordinate with one another. The buyer can receive goods that they’ve ordered, but the seller’s bank will withhold all the important documentation (bill of lading, certificate of origin, etc) until payment is made.

The documentation (which the buyer needs) is almost a form of collateral for the transaction.

Trade credit insurance

If even greater security is needed for an import/export transaction, trade credit insurance is often used.

It’s essentially an insurance policy for the sale of the goods, therefore protecting the seller for any problems that may arise, such as the bankruptcy or non-payment of the buyer.

Third-party financing

If a seller/exporter wants to minimise all their risk, and doesn’t mind incurring a cost as a result, full third-party financing support can be used.

Known as forfaiting, this is when a financing entity can cover all the costs and risks for the transaction, but charge a rate or demand a margin on what the transaction is valued at. While this can be costly, it often provides either the buyer or seller peace of mind and security on the transaction.

Factoring

If a company requires cash and cannot wait for buyers to pay, they could look to factoring (sometimes called debtor financing). This is where a business will sell the value of the payments due to them at a discounted rate to a bank or financial institution. The bank will then provide cash immediately, and resolve the transactions themselves to make a profit.

Forfaiting

Similar to Factoring, but different in its period and nature, Forfaiting is the purchase of an exporter's receivables – the amount that the importer owes the exporter – and rights to trade at a discount by paying cash. This is usually done for capital goods and for more long-term trade deals.

Document requirements for trade finance

Even with the assistance of banks and other financial institutions, there are some required documents which can help facilitate and streamline funding for imports and exports.

Letter of credit

Like any other letter of credit for a traditional loan, this is essentially a guarantee from the buyer’s bank, confirming that if all the documents for the sale and shipping/logistics are presented, the buyer’s bank will make payment to the seller.

This allows both the buyer and seller of the transaction to follow the agreement and provides security for both parties too.

Bank guarantee

This form of guarantee will kick into place even if the buyer or seller fails to fulfil their agreement terms or is unable to provide or pay for the product or service outlined. The guarantor bank will then pay out the other party.

These are often utilised when notable risk is in place, and the bank guarantee enables companies to purchase goods from suppliers which, without it, could not happen due to the uncertainty of payment.

Why look for trade finance?

Many companies thrive off doing international trade, however, many can’t afford for their finances to be tied up to shipments or delivery terms which could take weeks or even months. Therefore, a trade finance agreement with a bank or financial institution could suit your business, allowing you to focus on trade deals, but still keep your cash-flow in a healthy state.

Other benefits include:

Less risk for both parties

Importers are often concerned that exporters won’t pay, and exporters are often concerned about the quality of their goods or whether they’d even receive them, therefore payment tends to be withheld from both sides due to risk. Trade finance from a bank or third-party will help reduce this worry and alleviate risk for both the buyer and seller.

Less pressure

With bank guarantees, buyers and sellers of international goods can now have less concern about a buyer or seller defaulting or failing to meet their end of the agreement. Financiers provide a level of assurance to both the buyer and seller, which helps spur growth and relationships.

Find the trade finance arrangement that works for you

The South African economy relies on trade a substantial amount, and trade financing can help propel your business into the world of exports and imports.

Just remember to seek the suitable arrangement and model that suits your business, clients, and customers, and you’ll be able to reduce risk, ease up cash-flow, and create relationships.

There are of course government regulations to abide by, which you can read on the International Trade Administration Commission website.