Businesses engaging in international trade are well-acquainted with the added financial risks of importing or exporting goods and services from other countries.
From the increased pressure of the global supply chain to fluctuating currencies to the difficulty of figuring out the creditworthiness of a foreign partner – the trade industry involves a lot of risks. Good thing trade finance offers several ways to mitigate these risks.
Here are four of the most common forms of trade finance tools to choose from if you want to engage in international trade and manage your business risks accordingly.
1. Letter of Credit
A letter of credit can serve importers and exporters in various ways. This is a guarantee of payment by the bank of the importer to the exporter. The guarantee depends on the exporter meeting all the terms and conditions mentioned in the letter of credit.
Oftentimes, the conditions will require the exporter to provide some documents like a bill of lading. This document serves as a proof that the right products were delivered, or that the correct services were performed.
A letter of credit is an invaluable tool if you export goods and services to foreign customers, especially in determining the creditworthiness of such clients, and their ability to pay you on time.
Due to the fact that a letter of credit is provided by a financial institution that is local to the importer, such a bank is in a better position to figure out if the importer is creditworthy. Typically, there is no question about the bank’s ability to pay.
It is a good idea for you to require an importer to get the right type of letter of credit each time you are working with new trade partners. This can be obtained for ongoing trade deals or for single transactions.
2. Accounts Receivable Factoring
Accounts receivable factoring is among the most common trade finance options your business can use. This is otherwise known as invoice factoring and debt factoring. This is a short-term asset-based financing available to B2G and B2B businesses.
Accounts receivable factoring involves selling an invoice that will be due at a later time (usually in 30, 60 or 90 days) to a factoring company that pays you a certain percentage of that invoice in advance. If the customer pays the invoice, the remaining balance of the invoice less the factor rate will be given to you by the factoring company.
Invoice factoring is an excellent form of trade finance since it will solve two common problems experienced by exporters – competitiveness and cash flow. It allows you to give more generous credit terms to your customers since you can turn an invoice into cash immediately. Also, it helps you pay for the costs related to producing and delivering your services or products. You don’t have to wait for months for your clients to pay the bill.
Forfaiting is a trade finance form that is quite the same with invoice factoring. It allows your exporting business to sell your account receivables at a discount in exchange for cash. The only difference is that forfaiting is a non-recourse financing option for medium-term receivables instead of short-term receivables.
Forfaiting reduces the risk of non-payment by foreign customers whilst giving you a solution to near-term cash flow concerns. It turns a credit-based transaction into a cash deal. Aside from guaranteeing your customer’s creditworthiness, forfaiting also pays a medium or long-term contract instantly, thereby improving your cash flow.
4. Open Account
Open account is a convenient payment method in an international transaction, allowing you to get the most of import and export finance without the need for a documentary credit.
This arrangement can be satisfactory when the buyer is creditworthy, well-established or has demonstrated an excellent payment record. It allows you to bill your customer who will pay the agreed terms on a specific date. But before issuing a pro forma invoice to the buyer, you need to examine the political, commercial, and economic risks involved.
If you want to engage in international trade, it is crucial for you to familiarize yourself with the different trade finance solutions you can use.
From accounts receivables factoring to letters of credit and forfaiting to open account terms, there are a lot of tools available for businesses dealing with foreign customers. These trade finance options will help ensure that you get the full payment of your products and services on time. They also balance out the risks and make cash more readily available.