Trading Finance

Why should one opt for Trading Finance?

Trade financing reduces payment risk - Trade financing presents a form of payment guarantee to the seller in the form of letters of credit or bank guarantee.

Increases credibility for both the importer and exporter - It helps in assuring the each other of the financial goodwill of the other party, thereby reducing the stress on them.

Provides enhanced credit - Buyer or the seller can access increased amounts of capital while waiting for the transaction to be complete.

Enables increased cash flow - All open invoices and account receivables can be sold to trade financiers for a discount to obtain credit or cash (Factoring & Forfaiting), that can be used for development of the business.

Empowers small business units - Small business units may not get business loans, despite producing pending invoices or bills. Trading finance enables them to avail working capital through forfaiting or discounting of bills.

What are the different types of Trade Financing?

As mentioned earlier, trade financing is rather a set of monetary instruments that facilitates trade. Trade financing can be obtained in various forms as required by the borrower.

• Letter of Credit :

This is a very common method used in international trade. This is an undertaking offered by the buyers/importer’s bank stating that once the exporter presents all the shipping documents as mentioned in the purchase agreement. The common document needed for this is “Bill of Lading”. This assures the exporter of his/her payment as soon as the goods are shipped.

• Bank Guarantee :

Here, the bank accepts to act as the guarantor on behalf of the applicant and pay an agreed-upon sum of money to the beneficiary if there is a failure in the fulfilment of the purchase agreement. Bank guarantees are of different forms such as Performance guarantees, Bid Bond guarantees, Financial guarantees, Advance guarantees.

• Factoring/Discounting :

A common method used by exporters to enhance their cash flow. The exporter sells all his trade invoices to a financier for a discounted price. The exporter reduces his risk of bad debts by doing so while the financier earns a profit when the importer pays the full amount. Exporters resort to this method to increase their daily working capital.

There are other types of products such as supply chain finance, structured trade and commodity finance, export and agency finance, trade credit and political risk insurance.

How does Trade Financing work?

Upon the creation of the purchase agreement, the exporter requests the importer for a Letter of Credit from the importer’s bank. The importer’s bank issues a letter of credit stating that once the exporter presents all the necessary shipping documents, as mentioned in the agreement, the bank will immediately make the payment to the seller.

Another finance option is bank guarantee. Upon creation of the purchase agreement, the exporter or the importer can approach the bank to act as a guarantor on their behalf, to the other party, in case of any failure to meet the terms of the agreement.

Other options include, Factoring, Discounting of Bills and Forfaiting. Here, the importer or the exporter, can sell their pending bills or open invoices to a financier, for a discounted rate of the total value in order to obtain cash or credit. This provides them with immediate liquidity that can be used for working capital or to meet daily business needs.

Eligibility to apply for Trading Finance

• Age of the business :

Banks require the business to be at least 2 years old before considering for Trading Finance. The longer you have been in business, better are the financing terms offered to you

• Income stability of the business :

Banks & NBFCs give considerable importance to the stability and the income generation of the business. A business that has shown consistent performance and considerable gains is given preference.

• Credit History :

Loyal customers are always the preferred group of customers to offer loans. Your credit standing with the bank/NBFC is a testament to your creditworthiness. Making timely repayments of your existing loans, having a clean credit card history, maintaining a healthy credit cycle with all your accounts, these factors play an important role in determining your credit history, which in turn enlists you for great loan terms and benefits.

• Security/Collateral :

Providing substantial collateral and security against your loan is an added advantage. This could help you secure higher loan amounts and other offers and benefits.

Apart from the above factors, there are a few common factors like

• Minimum age – Similar to other loan products, the applicant should be minimum 18 years of age to apply, unless and otherwise specified by the bank
• Quantum of loan – this depends on the requirement of the applicant and their repayment capability. Trading Finance loans can be applied for as little as Rs.15000 up to crores of rupees
• 3. Loan tenure – the tenure can be as much as 5 years. However, it depends on the type of credit and the discretion of the bank