- September 11, 2020
- Posted by: avantconsulting
- Categories: Recommended Reads, Trade Financing
What is Trade Financing and Why You Should Leverage On it for Business Expansion – We are all familiar with the terms trade and finance but when put side by side, what does it exactly mean? Trade finance refers to the financial instruments and products used by companies to facilitate trade. Trading is made more efficient and effective for both buyers and sellers, especially when there is a funding gap.
To illustrate it simply, both the exporters and importers would respectively want some guarantee to their payment and goods. An exporter would want the importer to make prepayment for the goods shipped and on the flip side, the importer would expect some assurance to have the goods delivered. This is when trade financing kicks in – reducing both the payment and supply risk. Overall, trade financing makes it more seamless for both exporters and importers to conduct business. Import financing is widely adopted in Singapore given the heavy reliance on exports and imports.
Trade financing also serves to mitigate risk through control of funds and source of payment, transparency over the trade cycle through monitoring of transactions and security over goods and receivables. It is often utilised by banks and companies to make trade transactions feasible.
If your business does regular inventory purchases, chances are you are using trade financing as well. The key users of trade financing are as follows:
We strongly encourage businesses to leverage on trade financing as it can aid your business expansion. Particularly for the manufacturing, engineering and construction industries where the business engages in frequent purchase of physical goods, raw materials and inventories. As funds are needed in every stage of the business process – from purchasing of inventories to paying wages to the workers, trade financing offers the flexibility in funding. It would also be useful if your business has to grant credit terms to customers because trade financing can help to ease cash flows.
What are some key terminologies/ trade finance products?
Letter of Credit (LC)
LC is a guarantee from the bank of the buyer to ensure that the buyer pays for the goods sold to him so it reduces payment risk on the seller’s end. Should the buyer be unable to make payment, the bank will be responsible for paying the amount. This is issued only after the bank has assessed the collaterals of the buyer because ultimately, the bank would not want to pay for someone who is likely to default payment and does not have sufficient collaterals.
Trust Receipt (TR)
A TR is a financial document handled by a bank and business. It serves as a promissory note to the bank as the bank allows the buyer to take possession of the goods but the ownership title remains with the bank. It benefits businesses with the credit terms as they do not have to make payment immediately, thus freeing up working capital.
Standby Letter of Credit (SBLC) or Banker’s Guarantee
This is a common trade finance product, commonly serves as a guarantee or collateral. It is a guarantee made by the bank on behalf of a client. The issuing bank guarantees payment to the beneficiary when certain conditions or obligations are met. To issue a SBLC, the bank will underwrite the credit of the issuer and assess the quality of assets the issuer is able to pledge as collateral. A SBLC is different from LC – SBLC is paid when conditions are not fulfilled but LC is the guarantee of payment when certain conditions are met.
Documents against Acceptance (DA)/ Documents against Payment (DP)
DA/DP allows exporters to lend some credit terms to importers but would generally be considered to be less secure as compared to LC. Under the DA arrangement, the seller will pass on the ownership and shipping documents to the buyer only if the buyer accepts the accompanying bills of exchange. Meanwhile, under the DP arrangement, the seller gives instructions to the bank to release ownership and shipping documents when the buyer has fulfilled payment obligations. Hence, we observe how the banks serve as the middlemen under these arrangements but they do not provide the guarantee of payment.
What are the benefits of Trade Financing?
Fuels the growth of your business
Working capital is essential and the key to every business and trade financing opens the door to capital. You definitely not want delayed payments that could possibly restrict you in financing your business development. With trade financing, it is no longer necessary for you to wait until your customers make payment before you can make your next procurement. Therefore, it allows you to grow your business by freeing up working capital and using it for business development purposes.
Higher efficiency in trade and supply chain
Following the point as mentioned above, it therefore translates to greater efficiency in your business as well as you free up capital from the supply chain.
Mitigates risk from suppliers
Credit and payment risks often exist when it comes to running a business and since trade financing serves as a guarantee instrument, it will help to lower the risk of bad debt arising as well. Risk from suppliers is also lower because of diversification. Trade financing allows businesses to work with international suppliers which increases competition in the market, driving efficiency in supply chains.
Here in Singapore, businesses can leverage on the Loan Insurance Scheme (LIS) where a portion of the insurance premium is supported by the government. Under this programme, Small and Medium Enterprises (SMEs) can obtain trade financing credit without having to put up too many collaterals.
If you have further enquiries, feel free to contact our consultants. We are glad to be able to help you with your business development. Should you be interested in the LIS, supported by the government, you can reach out to us as well.