Finance

Trade Finance 101

There are a number of ways to obtain trade finance to purchase goods from abroad.

As technology has advanced the world has become a much smaller place, and in today's business environment it is perfectly possible, and indeed desirable, to trade overseas. Doing so can be a very profitable move for a growing business and can open up many new opportunities.

However, dealing with manufacturers and suppliers abroad is not without risk. For obvious reasons an exporter will always want to be paid before they ship their goods. Similarly, an importer will be reluctant to part with their cash before they've received their stock. There is risk on both sides.

This is one of the reasons why the vast majority of buyers use trade finance to fund their overseas purchases and allow them to trade more confidently. It also reduces pressure on their cash flow, which is essential for a growing company relying on the resale of their goods to generate income.

The World Trade Organisation estimates that up to 90 per cent of international trade is reliant on trade financing, with users ranging from tiny start-ups to global giants.

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*image courtesy of epSos.de

Paying for international goods

There are a number of ways you can pay for goods you've ordered from overseas suppliers. Firstly, there is the cash-in-advance option, using a wire transfer or a credit card for example. This is best from the exporter's perspective, but holds a lot of risk for the buyer and could also create cash flow problems if there is a long wait to receive the goods. And of course exporters who insist on being paid cash-in-advance are likely to lose out to competitors offering better payment terms.

So what are these better payment terms? Well, one of the most common ways to pay suppliers abroad is through a letter of credit, which is issued by the buyer's bank and given to the exporter or the exporter's bank once proof of the shipment has been seen in the form of certain documents. This basically guarantees payment to the seller and provides security on both sides.

Documentary collection is another option. It works in a similar way to a letter of credit in that the task of collecting payment is handed to a bank, but it does not provide the same level of security as there is limited recourse should an importer refuse to pay. It is however less complicated and less expensive than a letter of credit, so is useful in situations where a buyer and a seller have a long-standing trade relationship.

For a buyer, the most attractive way to pay is through an open account transaction, whereby goods are delivered before payment is due. This provides optimum security and also alleviates the pressure on their cash flow by offering extended payment terms. This option is not as attractive to the exporter, but it is often used because in a competitive global marketplace it can make all the difference when attracting sales. What's more, by taking out trade credit insurance exporters can protect themselves against non-payment.

Other types of trade finance

There are other options available to help buyers fund their import activities, and one of them is factoring, which is a type of asset-based loan. It allows buyers to purchase goods from overseas suppliers on short-term credit without the need to issue a bank guarantee such as a letter of credit.

In a typical factoring arrangement, an exporter will make a sale and deliver their product, generating an invoice which is then sold to a third party such as a finance company or bank at a discount in exchange for a percentage cash advance of the invoice face value. The third party, known as the factor, is then responsible for collecting payment from the buyer.

Forfeiting is another type of trade finance that is similar to factoring but involves the sale of medium-term rather than short-term trade receivables and provides buyers with much longer periods of credit. Receivables are usually guaranteed by the importer's bank.

Trade finance through e-Credit Line

Alibaba.com's e-Credit Line trade finance product has been jointly launched with the Bank of China and China Export & Credit Insurance Corporation to help importers create strong trade relationships with their overseas suppliers. It is an Open Account transaction supported by export credit insurance, and up to 80 per cent of the payment is guaranteed.

Buyers of foreign goods benefit from extended payment terms of up to 120 days as well as a credit limit of up to $2 million provided they meet the application criteria. Approval takes between seven and 30 days, and if a buyer is successful they can start sourcing from overseas suppliers straight away and enjoy much greater purchasing power.

K
Kit Chong is the marketing and business development manager for Alibaba.com in the European region. In this role, Kit is tasked with raising Alibaba.c...

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