Financial Trading & Investment

Must-Know Facts About Trade Finance

Since the era of globalization, the world of international trade has continuously been growing at an exponential rate. More and more countries are indulging in import and export of goods and services in order to fulfill local needs, avail specialized benefits, and meet domestic demands, so much so, that the worldwide trade volume is expected to witness a rise of almost 2.7% in 2020

However, for international trade pathways to operate smoothly, they need to be backed by a healthy dose of dynamic, consistent, and accessible finance. This type of finance does not just make global transactions easier but also facilitates multinational trade without any monetary hassles, delays, or glitches. Such commercial arrangements that streamline financial exchanges between global buyers and sellers are largely referred to as international trade finance

According to the World Trade Organization (WTO), about 80-90% of world trade currently relies on unhindered access to credible trade finance. In fact, the concept of trade finance holds immense importance in the modern, integrated landscape because: 

  • It provides liquidity to small businesses, thus helping them instantly cover the cost of their imports and exports
  • It offers loans, letters of credit, and other similar instruments to enable an incessant flow of goods and services
  • Trade finance ensures that the finances of large corporations do not remain tied up due to delayed overseas shipments

At this juncture, it becomes extremely crucial to understand a few fundamental facts about international trade finance and its basic essentials:  

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Instruments of Trade Finance 

Trade finance is usually offered by a variety of independent institutions like banks, trade finance companies, insurers, and export credit agencies. These institutions deploy a range of products and services to suit the specific requirements of different international traders. 

The trade finance instruments provided by such institutions include: 

  • Letters of credit – A letter of credit (LOC) is generally issued by the importer/buyer’s bank to protect them against any unwarranted trade risk. As per LOC, the final payment can only be released when all the specified conditions have been met by the exporter/seller. Both parties are required to honor the agreement.
  • Export credit – Also called ‘working capital’, export credit extends lines of credit to domestic exporters who require finances for their international transactions to go through. This type of credit ensures that the exporters do not lack any working capital throughout their global trading journey.
  • Bank Guarantee – In case, importers or exporters are not able to fulfill their contractual obligations, a bank guarantee works as a feasible way to provide financial protection. It extends payments to those beneficiaries who have suffered a loss while conducting international trade.

Apart from the above mentioned, these institutions also offer trade finance through loans and insurance-based products.  

Factoring and Forfaiting  

Factoring and forfaiting are two of the most common methods that are employed by multiple organizations to avail of trade finance

In factoring, exporters sell all their open invoices to an international trade finance institution at a discounted rate. This institution is called a factor. Once the sale is made, all payments due from the importer are received by the factor. As a result, the factor earns profits while the exporter gets instant working capital. 

On the other hand, in forfaiting, exporters sell all their receivable accounts to a professional forfaiter at a discounted rate. In return, the forfaiter provides the exporter with immediate cash. However, in this case, the receivables purchased by the forfaiter from the exporter hold no value unless accounted for by the importer’s bank. 

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Risk Reduction 

Because of its certainty in financial transactions, trade finance has worked wonders in reducing the inherent risk associated with international trade. In the earlier times, both exporters and importers always remained unsure as to when they would actually receive payments for their goods and services. There was also no guarantee of receiving the said products on time. 

But with trade finance, all such misgivings have been completely eliminated. International trade finance doesn’t just address such risks by assuring prompt payments; it also accelerates and streamlines the flow of goods and services between all concerned entities. 

Revenue Enhancement 

Trade finance provides a plethora of opportunities for companies to enhance their revenues and minimize their financial hardships. For instance, let us consider that there is a company in India that is willing to produce a particular good required by an importer in Japan. However, owing to a lack of resources, this company is not in a position to produce the said good. This is where trade finance comes into the picture. By seeking assistance from domestic or international trade finance agencies, this Indian company can easily manufacture the product and export it to the Japanese importer. As a result, its revenue and earnings are both enhanced. 

Similarly, trade finance can assist local organizations in overcoming their financial hardships by providing them with quick working capital. This ensures that these businesses stay afloat and do not have to bear the long-term ramifications of trade-related debts, delays, and liabilities. 

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The Way Forward

As times change, the importance of international trade finance is likely to undergo a major transformation, too. It won’t just remain an instrument to improve operational efficiency and streamline cash flow anymore. Instead, it would also become a medium for reducing financial hardships and increasing trade-based revenue. As a result, the demand for people who are well-versed with the subject of trade finance would slowly begin to soar. 

Although there are a number of platforms that claim to impart comprehensive knowledge about the world of trade finance, enrolling for a financial trading course at Shaw Academy might prove to be your best bet. This course will extensively help you strengthen your basic understanding of trade finance while making sure that you are able to make sound financial decisions within an organizational set-up. 

So, what are you waiting for? Register here and gain access to one of the best financial trading online courses now! 

Shaw Academy

Updated: Jan 16, 2020

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