Almost 90% of world trade relies on trade finance. Trade financing gives a business access to capital and facilitates it to trade goods and services with other businesses without risk. It can be used to buy and sell within or outside India, and can greatly improve the ease of doing business.
Such credit instruments are especially crucial for small businesses, which cannot afford to have cash flow disrupted. Trade finance helps such businesses to trade in international markets, without having to wait for payments to come through.
It aids by bridging financing gaps while also providing security against issues such as supply-chain risks and fluctuating foreign currency rates. Read on to understand more about how trade finance can be used to take a small business to the global stage.
How Trade Finance Works to Globalise Small Businesses
An international trade transaction takes place between an importer who is the buyer and an exporter who is the seller. To help both parties mitigate risk, a bank or trade finance house is onboarded.
This third party removes the payment risk of the exporter by providing advance payment. It also guarantees delivery to the importer and extends credit, thus removing supply risk. Other parties involved when a business applies for trade finance are:
- Credit Agency: Businesses seeking to export their goods and services need to be extremely creditworthy. This is because the bank or trade finance house assumes responsibility for fulfillment of the order and pays you in advance. Credit agencies help them assess your small business’s creditworthiness.
- Insurance Corporation: The goods involved in foreign trade are usually insured by insurance corporations. This helps insure the goods against damage or mishandling during shipping. It also helps to guarantee payments to the exporter.
Which Trade Finance Product is Ideal for Your Small Business?
There are many trade finance instruments available for different business needs. You can pick any of the below to start buying and selling in international markets.
- Letter of Credit: A letter of credit or LC guarantees that the importer will make the payment to the exporter on time and for the full amount. It also states that if the importer can’t make a payment on the purchase, the bank or trade finance house will cover the full or remaining amount owed to the exporter. The exporter will be required to submit proof of shipment, to avail of a letter of credit.
- Factoring: This is a trade finance product that allows exporters to receive payment upfront against their bills receivable rather than waiting for payment from the importer. The exporter sells the bills receivable to a bank or trade finance house known as the ‘factor’ at a discounted rate. The factor then advances payment to the exporter and assumes the risk of non-payment.
- Forfaiting: This allows exporters to convert a credit sale into a cash sale by giving up their rights to receive payment from the importer. In exchange, a bank or a trade finance house known as a ‘forfaitor’ supplies them with immediate cash.
- Export Finance: This is a short-term funding instrument available to exporters. Banks or trade finance houses supply exporters with working capital, based on their bills receivable. This helps them bridge the financing gap between shipping the goods and receiving the payment.
How Trade Finance Enables Small Businesses to Tap into Global Markets
Most businesses aged 2 to 4 years, with a strong credit history and impeccable business profile, can avail of trade finance. Here are some of the benefits associated with using trade financing products:
- Mitigates Risk
Trade finance breeds trust between the importer and exporter, as both parties are safe from the risk of default by each other. It also provides security against risks due to political instability, wars, fluctuation of foreign currency rates and more.
- Hassle-Free International Transactions
There is no need to worry about foreign currency conversions as the bank or trade finance house address this. Also, guarantees against payment and delivery enable the importer and exporter to have a good relationship, as there is no risk of default.
- Eliminates Cash Flow Issues
For small businesses especially, having to wait long periods to receive international payments can jeopardize their liquidity. Trade financing ensures that the exporter’s cash flow is not affected, allowing for smooth business operation.
- Opens Avenues for Growth
With trade financing, small businesses can expand their operations overseas without the worry of cash flow shortages and payment risk. As such, it opens up more avenues for growth and profitability.
Pre-Approved Business Loans as an Alternate Financing Option
If trade finance is not your cup of tea, you can consider using simpler financing solutions. Pre-approved business loans are an easy way of securing funds for your small business. A lender will be willing to offer you a pre-approved business loan based on your relationship with them.
Such loans are offered to existing businesses with strong financials and a good CIBIL score. Usually, the lender decides the loan amount based on factors such as:
- Business financials
- Revenue stability
- Loan repayment history
It provides quicker access to funds, compared to trade finance products which have longer approval processes. It can also be used to meet all types of business expenses, such as the purchase of equipment, payment of staff salary, cost of raw materials, rent and more.
International trading may seem very risky for many reasons. The potentially differing laws in the countries of the businesses involved, and the difficulty of involved parties meeting in person are a few.
However, trade finance ensures that your export business is fully safe from payment risk, liquidity problems, turbulence in international markets and more. Hence, trade financing is extremely beneficial for small businesses involved in international trade.
If you are a small-business owner seeking global exposure, trade finance is a must. To take your products and services to the world, make sure to invest some time to understand the various trade finance offerings available. Take the help of experienced traders and choose the best trade financing option for your needs.