International trade finance guide for first-time exporters

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Lots of companies rely on international trade, and many of them use trade finance to help them achieve their goals. Let’s explore the basics of trade finance, how your business could potentially use it, and some of the risks to be aware of along the way

Why is trade finance necessary?

Trade finance is a powerful driver of economic development. In fact, in 2018, the International Chamber of Commerce (ICC) put the value of the global trade finance industry at $10 trillion.¹ The World Trade Organization (WTO) also estimates that up to 80% of global trade is now reliant on trade finance.²

Who benefits from trade finance?

SMEs, large corporations, and even governments use it to achieve a range of growth goals — such as increasing the size and scope of the goods and services they trade in; scaling up their global operations; or to help them fulfil large contracts.

What are the main benefits of trade finance?

Many companies use trade finance because it helps them unlock capital from their stock or receivables — which can then be used to finance future growth and development.

Businesses can use trade finance in a range of ways, such as:

To grow faster: Trade finance helps companies be more competitive – both to customers and suppliers – by reducing payment gaps in their trade cycle.

For securing finance: It’s also a solution for short- to medium-term working capital, because it uses the products or services that are being exported as security or collateral.

For increasing revenue: Trade finance helps organisations expand their revenue potential, as earlier payments allow for potentially higher margins.

To access discounts: Companies also use it to buy higher volumes of stock — and even achieve bulk discounts and economies of scale by placing larger orders.

Strengthening relationships: Trade finance helps companies build smoother and more robust trading relations, which they can use to be more competitive and profitable.

One of the reasons trade finance is popular with smaller businesses is because it’s not balance sheet-led. In other words, it focuses more on the trade than the actual underlying borrower. In turn, that allows these types of firms to deal in disproportionately larger volumes of goods or services, and serve bigger customers.

Next up, let’s explore the main types of trade finance products, and the benefits they bring:

Trade credit

This is often the cheapest and simplest payment type. It means sellers can fulfil their product or service obligation on the understanding that customers will pay them 30, 60 or 90 days later. More risk-averse businesses often take out insurance to protect them against potential non-payment. Cash advance This is an (unsecured) payment of funds given to the exporting business before the goods or services are delivered. It’s popular with exporters because it allows them to start manufacturing their goods right after the order is received. That said, it can be a high-risk approach for buyers, as production could be delayed and their order may never be fulfilled.

Purchase order (PO)

Once a customer provides a PO, a financier can pay the supplier in advance of the goods or services being delivered — then receive payment from the end user at a later date.

Receivables discounting

Companies can also ‘sell’ invoices, post-dated cheques, or bills of exchange to a bank or finance house at a ‘below true value’ rate in return for immediate payment. While this can potentially help fix urgent cash flow problems, the discounted rate can be relatively high. Find out more in this invoice factoring guide from Trade Finance Global.

Term loans

Longer-term debts such as term loans and overdrafts are more sustainable sources of funding because they’re often backed by securities or guarantees. However, securing assets that are owned by businesses abroad can be harder, mainly due to regional regulations and ownership requirements. Find out more in Trade Finance Global’s guide to term loans and business loans.

Equity finance

This includes tools like seed funding, angel investment, and venture capital (VC) funding. While the precise nature of each varies slightly, the basic principles are the same. Generally, a business owner looking to raise funds will offer a percentage of his or her shares in return for investment. Then, if the company grows and the shares become more valuable, the investor sells their shares and makes a return on their initial capital. Find out more in this equity finance guide from Trade Finance Global.

Leasing and asset-backed finance

This involves borrowing funds against assets like machinery, vehicles and equipment.

Asset finance

Mechanisms also exist that allow SMEs to access equipment, machinery or other assets — in return for smaller, contractual and tax-deductible repayments over an agreed period of time.

While other types of finance also exist, they don’t necessarily fall under the term ‘trade finance’. Nonetheless, SMEs should ensure they have a good understanding of what’s available. Learn more about these and other types of leasing and asset finance in this guide to asset finance from Trade Finance Global.

Before embarking on international trade, buyers, sellers and lenders should be aware of the different dynamics and complexities involved. Managing risk is also a big consideration — especially in international trade, where factors such as language differences, politics, legislation, and currency come into play.

Product risks

A seller’s obligation to provide performance, maintenance and other specified warranties makes product-related risk an inevitable part of any trade transaction. Buyers should also consider their exposure to external risk factors such as negligence during production, or even extreme weather damaging the product during shipping. These types of events can lead to lengthy disputes. As such, it’s vital that sellers word their sales contracts carefully — so unplanned events are covered, and clear outcomes are provided.

Manufacturing risks

These types of risks are especially common for products that are custom-built or have unique specifications. In these instances, sellers are usually expected to cover the cost of any product readjustments until the buyer is happy. After all, specialised made-to-measure products can’t simply be sold to other buyers. While this type of risk can be costly, the good news is it can be managed relatively easily. For example, customers could be asked to make part-payments — and suppliers may be obliged to make separate guarantees at each stage of the product’s design, production and eventual delivery.

Transport risks

Moving any type of product between a seller and end user naturally incurs some degree of risk. One way to mitigate this is by taking out cargo insurance. This is usually defined by standard international policy wordings,¹ and the agreed delivery terms will also typically state whether the buyer or seller is responsible for arranging the insurance.

Again, great care should be taken to ensure this is done correctly, as the insurance could end up being invalid. For example, if the transport route unexpectedly changes during shipment (and the goods arrive damaged), the insurance is only valid if it specifically covers changes in the route taken.

Currency risks

Any business that buys or sells products or services in multiple currencies should consider ways to reduce their exposure to foreign exchange (FX) rate volatility. Changes in FX rates not only eat into profit margins on international contracts, but can also impact the value of any assets, liabilities and cash flows that are denominated in a foreign currency.

When developing a risk reduction strategy, consider what proportion of your business relates to imports or exports; which currencies you’re most exposed to; when payments are to be made; and which currency is used for supplier payments and invoices.

Remember, while this type of risk can be tricky to predict and plan for, strategies such as spot contracts, forward contracts and FX options can help you manage it.

The Trade Finance Global team works with key decision makers at over 270 global banks, funds and alternative lenders, and assists companies looking to access trade and receivables finance. Its team of international staff specialises in everything from machinery to soybeans — and are ready to help you scale up and find the right trade finance product for your business, at no cost to you.

For more strategies, insights and tips on expanding your business abroad, head over to Google’s Market Finder tool. Just enter your website address to discover suitable markets for your products and services, how to set up your operations, disposable income figures, preferred payment methods in each country, and much more.