A sale is not a sale until you get paid for it, or until the money hits your bank account!
On ExportandExpand, I’ve focused on the front end of exporting—business opportunities, market prioritisation, and new category and trade developments. However, access to capital, whether to start a business or finance ongoing operations, is crucial, especially for younger companies.
A recent presentation indicated that 40% of SMEs have unmet trade financing needs.
Another report highlighted that trade finance is generally easier to obtain after five years in business, provided you have collateral plus a good relationship with your bank.
Until then, younger companies often rely on informal financing methods, such as owners’ funds and retained earnings.
I know, I’ve been there!
Main Forms of Formal Trade Financing
1. Letter of Credit (LC)
The importer asks its bank to issue an LC, guaranteeing payment to the exporter upon proof of delivery. To mitigate the risk of non-payment by the issuing bank, the exporter may have a bank in its own country confirm the LC. LCs account for around 12% of trade finance and are common for large-value orders, especially commodities. LC are less common for FMCG or garments.
LC fees range between 1.5-4% of the invoice, with additional increments for amendments or specific requirements.
2. Pre & Post Shipment Financing
For example, a textile business might take out a packing loan to cover the cost of raw materials and temporary labour to fulfil an order. In post-shipment financing, a firm may sell its invoices to a bank at a discount to receive faster payment.
3. Trade Credit Insurance
This accounts for around 15% of global trade financing, protects suppliers against insolvency, default, or political risks. Major players include private sector companies like Coface and Euler Hermes – now called Allianz Trade, as well as government-backed export credit agencies such as EXIM (US), UKEF (UK), and NEXI (Japan). Premiums typically range between 0.1%-1% of sales, lower than LC fees.
4. Bank Guarantees (BG)
BG’s build trust between trading partners. They involve a promise from the bank to pay the importer if the exporter fails to adhere to contractual terms. For example, a packaged food exporter might ask an overseas retailer for an advance payment for private label goods. If the exporter fails to deliver, the bank refunds the advance payment to the retailer.
5. Factoring
This involves selling account receivables to a financial institution. Factoring accounts for 10-15% of trade financing and is popular with SMEs, especially when exporters have long payment terms (e.g., 60 or 90 days). The financial institution pays 70-90% of the invoice upfront.
Dos & Don’ts of Trade Financing
Do:
- Understand your export market and potential customers. Assess their financial soundness through credit reports. Look for clues of instability like frequent staff changes. What do you see when you visit their offices?
- Consider direct trading with large, established customers like retailers or e-commerce platforms to mitigate insolvency risk. They may have long payment terms but are usually financially stronger.
- Maintain accurate documentation. Ensure your staff knows the process. Do you take photos of shipments for example in case of disputes later? For new markets and customers, consider testing shipments in advance.
- Factor in the costs of trade financing in your pricing and P&Ls. Include charges for LCs or BGs and longer payment terms.
- Discuss risk hedging options with your bank or financial institution and use secure payment methods.
- Adjust trading and payment terms for customers you deem risky.
Don’t:
- Forget about exchange rates and shipping costs.
- Neglect compliance, especially with regulatory changes like new ingredient declarations or health claims that could invalidate your products.
- Assume that the big banks always have all the answers. Digital new entrants are also looking to build business with exporters.
- Put all your eggs in one basket. Build contingency plans in case your trading partner experiences financial risk.
Never take your eye of the cash flow because it’s the lifeblood of the business
Richard Branson