The growth in International Trade over the past decade has led to an increase in both the demand for Trade Finance and in the degree of sophistication with which it is delivered by an increasing array of banks and financiers.
There are a wide variety of Trade Finance solutions on offer from banks and financiers for international traders, helping companies develop strategies as they source components from a range of overseas suppliers and seek to sell their products to new territories.
It should be emphasised that although Trade Finance can be a great help to companies both large and small in funding their businesses, as with any form of finance, there will be an entity (usually a bank or a financier) who has spent a considerable amount of time assessing the risks involved in providing the finance. Banks will generally insist that their Credit sanction team are assisted in the understanding of these risks by bank employees who have specialist trade knowledge and experience.
Companies state that one of their most important requirements is the provision of working capital. Clearly every company has different needs as their working capital requirement will fluctuate continually. When a company is heavily involved in importing that working capital requirement can be complicated by having to extend credit terms to buyers, or to pay suppliers early to secure vital component parts imported from global manufacturers. Being paid or paying in foreign currency can further exacerbate the challenges.
The traditional form of working capital funding – the ‘overdraft’ – is generally no longer favoured by financiers who are increasingly required to lend against specific transactions.
Whilst this inevitably raises concerns over the banks’ appetite to lend to SMEs, there are certainly options available to traders who can demonstrate strong risk management awareness and articulate to the financier a clear explanation of the underlying transaction.
Example of a Trade Cycle
The above illustration represents a trade cycle (or timeline) for a company importing components from the Far East, which are paid for upon shipment, then processed. The finished goods are sold on 60 day credit terms.
The Key Risks
The main concerns for the importer and their financier will usually include:
- the supplier’s ability to perform (produce the goods);
- quality issues;
- meeting strict deadlines for receipt of goods; and
- control over the goods once shipped.
When requesting finance, the importer should be prepared to clearly explain the transaction from start to finish, including the details for each supplier and buyer.
By way of example, in order to address the risks listed above, the bank or financier will ask the following questions:
- Who and where are your suppliers?
- How long have you been sourcing from these suppliers?
- How are goods shipped to you (sea, air etc.,)?
- Nature of goods (finished, components, perishable)?
- What is the track record regarding quality, delivery times etc.,
- How long are goods held / warehoused prior to despatch to customers?
- Who and where are your customers?
- Are you sourcing / shipping against confirmed orders?
- Have you experienced any delayed payments / bad debts?
The above questions are not exhaustive, but should help to provide your financier with the core information to help them make an informed decision.
So What Funding Solutions are Available?
It is clearly very important that any finance which a bank or other financier provides is geared to the terms and methods of payment which have been agreed in the commercial contracts between the buyer and the seller.
It may be likely that an importer requires a Documentary Letter of Credit facility to cover the all important pre-shipment period which may then be replaced by other structured import loan facilities to bridge the gap from taking delivery of the goods to point of sale, or to the eventual receipt of proceeds from the buyer. This combining of facilities, with a structured loan retiring another facility is very common in International Trade, but it is important to ensure that the bank or finance provider has a clear understanding of timing to ensure that the funding is seamless. Double funding is a constant concern for the banks.
Import Documentary Letter of Credit Facilities
A Documentary Letter of Credit (also known as a Letter of Credit) is a written undertaking given by a bank on behalf of an importer to pay the supplier an amount of money within a specified period of time, provided the supplier presents to the bank documents which strictly comply with the terms and conditions laid down in the Letter of Credit.
The documents required under the Letter of Credit will be vital in addressing the key risks and control elements that the bank is so concerned with. Typical documents may include:
- Commercial Invoice;
- Full set of Bills of Lading (an important document providing the bank with control over the goods);
- Packing List;
- Certificate of Origin;
- Inspection or Quality Certificate (usually required from new / less established suppliers).
Letters of Credit are subject to published worldwide standards defined by the International Chamber of Commerce – Uniform Customs and Practice for Documentary Credits (UCP 600). All parties dealing with Letters of Credit should be aware of and adhere to UCP.
A Letter of Credit can be issued for any amount and in any freely traded currency. It must stipulate when payment is to be made to the supplier. It can be payable either:
- At sight, i.e.: immediately following presentation of conforming documents to the bank authorised to pay or negotiate under the credit, or
- On a term basis, i.e.: after a specified and determinable period specified within the credit (e.g.: 30, 60, 90 days etc., after ‘sight’ or presentation of conforming documents to the bank). This type of credit will be said to be available by deferred payment or acceptance.
Key Points to Remember
- A Letter of credit is separate to the contract to which it relates
- All parties deal only in documents and not the goods or services to which the documents relate
- A Letter of Credit is not a guarantee that the supplier will definitely receive payment as it is subject to presentation of conforming documentation within a specified timeframe
- A Letter of Credit is not a guarantee that the importer will definitely receive the ordered goods. The associated risks can be mitigated by the importer calling for specific documentation (as above) evidencing shipment and quality.
Revised Example Trade Cycle
By using a combined Documentary Letter of Credit (payable at sight) and Import Loan facility, our importer’s trade cycle now looks as follows:
The financier may prefer to offer an additional solution within the cycle to cover the sales credit period.
Example Trade Cycle with Import and Sales Financing
The above trade cycles are illustrative only and are not intended to provide a solution to all funding requirements. Please speak to your financier for guidance.
MJ Hayward Associates Ltd is an associate of International Trade Solutions Ltd, providing training to companies concerned with the financial risks of trading internationally. We specialise in Letters of Credit (both export and import), Incoterms ® 2010 and basic export / import procedures & documentation.
MJ Hayward Associates Ltd
Tel: 0800 043 4052
Mobile: 07908 102865