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What is trade finance and what are the 3 elements of trade finance

What is trade finance and what are the 3 elements of trade finance
What is trade finance and what are the 3 elements of trade finance

Trade finance is the term for the financial support given in the area of international trade and commerce using different financial instruments. International trade finance encompasses a wide range of financial products, all of which are intended to make it easier for importers and exporters to conduct business globally.

Since 1983, Trade Finance has reviewed the international trade and export finance markets. Since then, what was once simply a letter of credit has evolved into options like factoring and bill discounting and many more.

For those of you who are new to the market or those who are simply seeking an explanation, the following is a little introduction to trade finance.

What is the goal of the trade finance?

The goal of trade finance is to remove supply and payment risks from deals by bringing in a third party. While the importer may be given credit to complete the trade order, trade finance provides the exporter with receivables or payment in accordance with the arrangement.

Trade financing involves a wide range of partners, which can include:

· Banks

· Trade finance firms

· both exporters and importers

· Insurers

· agencies and service providers for export credit

Contrary to traditional finance or credit issuance, trade financing is unique. Trade finance may not always be a sign that a buyer is short on cash or liquid, whereas general financing is used to manage solvency or liquidity. Instead, trade finance can be used to guard against the special risks that come with international trade, such as exchange rate changes, political unpredictability, problems with non-payment, or the creditworthiness of one of the parties.

When buyers and sellers need financing to close the funding gap in the trade cycle, trade finance is used. Trade finance is an option for risk reduction for both buyers and sellers. The financier needs the following in order for this to be successful:

· Control over the use of funds, control over the commodities, and control over the source of payback

·Security over the goods and receivables

· Visibility and monitoring of the trade cycle through the transaction

For instance, it can take weeks for products to be sent and arrive at the buyer's warehouse. Therefore, this is the ideal time to request a payment postponement. Consider ordering a couple containers of shoes from Delhi and having them shipped to Bangalore. The delivery of the cargo would take about 45 days.

Wouldn't it benefit your cash flow if you and your supplier could come to an agreement to pay on the 60th day? "YES" is unquestionably the answer.

Similar to this, in a long-standing business partnership, the buyer may want longer instalments.

The three elements of trade financing

1. Letter of Credit

A letter of credit is, in essence, a bank's promise to make payment on behalf of the importing client.

You must be aware of this typical trade finance document.

In essence, it is an agreement between the bank and the exporter that the bank will make the agreed-upon payments to the exporter within a specified time frame.

It enables vendors and consumers to reduce some of the risks that come with doing business internationally, such as fluctuating currency values, late payments, and unstable economies.

2. Invoice discounting or invoice factoring

For a quicker liquidation, you can go to your bank, a financial institution, or a trade finance or invoice factoring firm and give your invoice to them. The financial institution or the banker may buy, collect, or even discount the bill.

For instance, many firms advance up to 80% of the invoice value within 24 hours when you submit your invoice along with a few other papers for invoice discounting. When the invoice matures, the importer pays it to the invoice discounting company, which settles the balance after deducting the pre-agreed charge.

An invoice factoring or invoice discounting company and a business enter into an agreement under which the latter will manage the former's sales and credit for a specified period of time.

Companies that factor offer products and services to clients who have strong credit and then produce accurate invoices. The business will then pay you the remaining sum after deducting their commission once the operation is finished.

3. Working capital limits

Overdraft and cash credit are two different types of credit designed to finance international trade. As long as the credit line is active, both importers and exporters can apply for cash as and when they need it.

The main distinction between these lines of credit and other borrowing methods is that they are used for short-term funding, and the quantity and length of time that they are used determine how much interest is charged.

Businesses are advised to take out minor loans from their line of credit when they don't have enough money in their current accounts to cover operational business expenses, and to pay them back as soon as they get the money to avoid paying exorbitant interest rates.

What advantages can trade finance offer to your company?

You must first raise the capital required for your company's expansion before you can buy products or stocks. The best way to do so is by utilizing a technology that aids in managing working capital and cash flow or the provisions of advance factoring, invoice discounting and more.

The benefit of trade finance options like factoring and bill discounting is that it can release capital from your company's current inventory or receivables based on the business's trade cycles.

The most important thing is to close any payment gaps, as such Skyscend is all set to introduce its trade finance solutions helping the business to capture more benefits. To know more contact us or connect with us on LinkedIn or Twitter.


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