How Does Trade Finance in International Trade Work & Why Is It Important?

Operating any supply chain network on a global scale is vastly different from running that same business domestically. When developing trading partners domestically, ascertaining the best options for credit, payment options, and lenders is much easier with a more local and familiar approach to the entire process. This works for both importing and exporting as the bottom line is simple: it almost always is easier to get financing for export trade and import trade services from a company that operates in the same country.

 

However, for international importers and exporters, the entire process of financing becomes much more convoluted and complicated, especially when considering the nuances of ocean and airfreight. Understanding the importance of finance in international trade is critical for achieving continued growth during the best of times, especially during market volatility and uncertainty. Reaching and maintaining high growth levels usually hinges on securing some financing to help cover expenses during a long-haul time, slower selling and invoicing, and payment processes. 

 

What Is Trade Finance and How Does International Shipping Affect It?

International trade financing seeks to give transportation service providers an answer as to who will pay for the goods and shipping costs before they can be shipped and sold. No business wants to pay the high costs upfront, especially with high-risk and high-value shipments. And it's a rare case when a supplier wants to gamble on whether it will receive payment from a new and unproven customer a few months down the line.

 

As explained by Trade Finance Global, "companies can also mitigate business risks by using appropriate trade finance structures. Late payments from debtors, bad debts, excess stock and demanding creditors can have detrimental effects on a business. External financing or revolving credit facilities can ease this pressure by effectively financing trade flows." Due to the risky nature of international trade,import and export trade finance options help increase the potential for shippers to secure a diverse base for financing and shipping management services. A more varied supplier network increases competition and efficiency in markets and supply chains.

 

What Does Trade Finance Mean?

When moving freight in from overseas, a buyer often gives the provider a portion of the cost of the goods paid upfront as a deposit. The remaining balance is agreed to be paid before everything finally ships. At this point, whoever is providing the trade finance backing will pay their part of the terms. The problem in this scenario usually comes down to the challenge of providing capital upfront when no guarantee can be given that a shipment will be successfully delivered without losses or damages.  

 

Essentially, a trade transaction requires a seller of goods and services or a buyer who can coordinate and work with a lender to cover overhead and upfront costs associated with international freight shipments. Various intermediaries such as banks and financial institutions can facilitate these transactions by financing the trade. The ultimate goal of this financing process is to keep the supply chain moving smoothly, to keep freight moving along international lines, and prevent shipping delays and shortages.

 

How Does Trade Finance and International Trade Credit Work?

A few decades ago, when international trade was still a relatively new concept, many exporters were never sure if or when an importer would make good on invoices and pay for their goods. Over time, exporters gained more influence within the market and sought ways to reduce the non-payment risk from importers. Likewise, the importers were also worried about making initial payments for goods in the early days as exporters were still not fully proven in most regards. They, too, had no guarantee of whether the seller would ship the goods. Both importers and exporters needed some way to protect themselves and their business investments while still relying on each other to do business. Import and export trade finance services are a solution that satisfies both sides.

 

​​​Trade finance was developed to address all of these valid concerns and to help mitigate the risks by accelerating payments to exporters. Trade financing provides peace of mind to both the importers and exporters. The importer's bank works to provide the exporter with a letter of credit to the exporter's bank as payment once shipment documents are presented. Alternatively, the exporter's bank may give a business loan to the exporter while still processing the payment made by the importer.

 

Trading intermediaries, including traditional banks and other financial institutions, work to facilitate financing export trade and import trade options. They help ensure a level playing field for exporters and importers where no one side bears more of the financial risk or burden than the other. The transactions can occur domestically but are much more common with international shipments as they carry the most significant financial risk and load in most cases. The availability of trade financing has spawned massive growth in international trade, and as interest in less-than-container-load (LCL) shipping grows, it will only get more complex. This is why international trade funding and financial backing have become vital to the global supply chain network and the global economy.

 

A Few Top Trade Finance Terms to Know

Understanding how to finance international trade and the terms used when dealing with exporting, importing, and securing trade financing is vital to securing the best rates, partnerships, and results.

 

• Importer of Record/Exporter of Record (IOR/EOR): These designations are given to the individuals within a company that are responsible for maintaining all entry documents required by U.S. Customs and Border Protection and for the payment of duties and taxes in international trade.
• Transfer Risk: This describes the risk that a government or central bank might block a transaction by preventing currency from leaving the country, resulting in a halt to an international shipment.
• Pre-Export Finance: This unique type of financing occurs when an institution forwards the funds to a borrower for shipping based on documented orders from buyers.
• Pre-Shipment Finance: Similar to pre-export finance, pre-shipment finance provides short-term financing to sellers (exporters) based on the export contract or order. The variation of pre-export finance and pre-shipment finance essentially depends on whether it’s a seller applying for financing, a buyer applying for financing and who is exporting/importing the goods.
• Letter of Credit:  This is an important document in trade financing issued by the buyer's bank, which guarantees payment in full on a later date.
• ICC Incoterms: These are a globally-recognized set of terms used worldwide in international and domestic contracts to ensure there is no dispute over what a seller will do and when the buyer assumes liability for the shipment.

 

How Trade Financing Adds Value

Other benefits of trade finance include:

• Securing short- to medium-term working capital becomes less challenging. 
• International trade financing helps increase the revenue potential of transportation service providers.
• Trade finance allows companies to request higher stock capacity or get larger orders from their suppliers. 
• Proper financial backing and support can result in stronger logistics.
• Trade finance can also help strengthen the relationship between buyers.
• It can also give transportation service providers opportunities to be more competitive.

 

Solid management of the global supply chain is critical for the growth and expansion of any business operating within the market today. Trade and supply chain finance reduces cash constraints and can benefit suppliers, customers, third parties, employees, and service providers. Securing international trade credit and financial backing makes every step of the process easier.

How to Choose a Trade Financing Partner

Trade finance partnerships make the delicate balance of managing import and export transactions much easier and more streamlined. It also opens doors to opportunities for businesses of all sizes. The right trade financing partner can help a small business manage its first significant overseas import. It can also help multinational corporations with the functions of importing or exporting huge capacity loads every year. Partnering with the right provider is critical to maximizing market impact with import-export trade finance.

 

But first, it’s important to understand where many companies go wrong in the beginning.

 

One of the biggest challenges for transportation service providers, including shippers and carriers, is finding the right financier for their unique and individual needs. According to The Balance Small Business, "smaller businesses often have minimal access to loans and other forms of interim financing to cover the cost of goods they plan to buy or sell. Even with a confirmed order for products, many banks won't provide loans or overdraft protection for these types of transactions." Yes, importers naturally are reluctant to have their own hard-earned and much-needed money tied up in shipments of goods that could take weeks or months to receive or send, depending on the import distance, load type, and regulations. 

 

Likewise, exporters of large amounts of goods can't always afford to wait for weeks to get paid until after their export products arrive at a distant port. Optimizing the flow of freight and managing shipments to take advantage of working capital is the key to achieving long-term growth in any supply chain market. Selecting the suitable method of financing and the right partner to work with will go a long way toward securing future growth and success in any market. Proper budgeting and international trade financing can give any company a solid competitive advantage.

 

It all comes down to contacting your preferred bank or financial institution and finding out what their requirements are for international trade financing. It’s that simple. 

 

Improve Your Strategy to Trade Finance by Partnering With FreightMango

FreightMango is known throughout the shipping and transportation industry as a reliable partner that has access to trade finance solutions. With innovative technology, adaptable tools, and exceptional customer service, FreightMango offers a single platform where importers and exporters can work in tandem across FCL and LCL freight management and streamline operations. The importance of finance in international trade cannot be understated. Get on the path to success in all international trade moves by contacting FreightMango today to get started.