If you’re in the import or export industry, you know the scenario all too well: Goods leave the exporter. The exporter waits for the importer to receive the goods. Then, the exporter waits to be paid for the goods.
The importer, who may be wholly dependent upon the receipt of the goods, is also left to sit and wait. Will they arrive and will the goods meet expectations? No matter how much you trust the person on the other side of the business deal, there is always risk involved. Moreover, precious time is lost waiting for items in transport. What can importers and exporters do during this gap?
Trade Finance Defined
Trade finance can be summed up as financial solutions that deal with the gaps that come from transportation through payment. There are a multitude of options, with some catering just to importers or just to exporters, and others which can help them both.
Benefits of Trade Finance
The biggest benefit to trade finance is that it makes it easier for businesses to conduct trade—especially small and mid-sized companies. It can help ensure that the business has enough working capital on hand and minimize the risk of global trade. Because of this, it also means businesses experience less financial hardship and can increase their revenue by completing more or larger orders.
Options in Trade Finance
Banks and other financial institutions offer many options to help importers and exporters. Each works a bit differently.
- Letter of Credit
- SBA Loans
- EXIM Bank
Letter of Credit
If you’re exporting goods to a company and are unsure whether that company can make good on payment after delivery, a letter of credit (LC) can provide reassurance. The LC is written by a bank local to the importer and guarantees the importer has funds up to a defined amount. The bank charges a fee for this, though it’s usually under one percent, and the importer is typically responsible for paying it.
When exporters have unpaid short-term deliverables (invoices from importers) slowing their cash flow, factoring can help. In these cases, the exporter sells invoices to a third party, known as a factor. The factor pays the exporter right away and collects from the importer later. Because of this, many exporters also use factoring to be more competitive. It enables them to give their clients longer to pay, which can help them win more business, but it doesn’t leave them empty-handed while waiting.
There are few requirements that the exporter must meet to qualify for factoring, but factors typically only purchase invoices that will be paid by established creditworthy businesses. It’s also worth noting that these deals may be considered recourse, meaning the exporter may be on the hook if the importer doesn’t eventually pay, or non-recourse, meaning the factor assumes all risk if the business goes bankrupt. On the flip side, factoring companies may also perform due diligence and help their export clients identify how much credit can be safely extended to any importer, thus reducing the risk of non-payment.
Forfaiting works similar to factoring in that the invoices are sold to a third party, but there are a few key differences between the two. First, forfaiting is typically only used for longer terms. Payment from the importer could be due anywhere from six months to seven years down the road. Secondly, forfaiters will not usually work with amounts less than $100,000, and the amount must be guaranteed by the importer’s bank. Thirdly, the funds are converted into debt instruments, such as bills of exchange or promissory notes, which means the debt can be sold or traded on a secondary market. Lastly, these deals are always non-recourse, meaning the importer transfers all risk to the forfaiter. The guidelines for forfaiting vary, but they are stricter for both the exporter and importer. Both businesses must be well-established and be creditworthy. The exporter must have a history of exporting, and the importer must be able to get a letter of credit.
The United States Small Business Administration also supports the export industry by offering guarantees to lenders to encourage them to provide more loans to small export companies. There are presently three different SBA export loan programs. The amount available and terms vary, though all require the exporter to be well-established and have good credit.
- Export Express Loan
- Export Working Capital Loan
- International Trade Loan
As an independent federal agency, the Export-Import Bank of the United States (EXIM Bank) offers a variety of solutions, though it typically offers services or guarantees loans rather than providing them directly.
- Direct Loan
- Export Credit Insurance
- Finance Lease Guarantee
- Loan Guarantee
- Working Capital Guarantee
Learn More About Factoring
Factoring is cost-effective and has few requirements for export companies, so it’s easier to get approved and doesn’t require taking on debt. To learn more about how it works and to find out if it’s the right solution for you, download our free factoring guide.