3 Common Types of Trade Finance Products Explained
There are several definitions of trade finance available online, and the terminology employed is intriguing. It is characterised as a "science" and "an imprecise term covering a variety of different activities." Both are correct, as is the nature of these things. Managing the money required for international trade is a precise science. However, within this science, Trade Finance Service has access to a vast range of tools that affect how cash, credit, investments, and other assets can be used for trade.
Common Types of Trade Finance Products:
1. Letter of CreditA letter of credit is a payment pledge provided by a bank on behalf of the importing client. It's a common trade finance document that you should be familiar with. Essentially, it is a commitment by the bank to pay the exporter the money within a specified time frame and under the terms and circumstances agreed upon.
It enables sellers and buyers to mitigate some of the inherent hazards of international trade, including currency fluctuations, non-payment, and economic instability.
2. Purchase Order (PO) FinancePurchase Order (PO) financing is intended for SMEs that are experiencing inefficiency in their cash flow. To put it simply, it gives funds to pay suppliers with the validated purchase order in order to ensure seamless cash flow. It enables firms to accept a huge volume of orders while adjusting the lending basis to match their specific requirements.
This is especially true for SMEs, who frequently get a significant amount of orders but lack the necessary working capital to process them. That is exactly what it does. Even if the volume of orders reduces, there are no ties, so you can quit using it whenever you want.
3. Supply Chain FinanceSupply Chain Finance (SCF) is for vendors, purchasers, and financial institutions. Its primary purpose is to improve payment terms and make your cash flow more flexible during the supply chain process. Payment arrangements, including an extended payment schedule, would be negotiated by the buyer. At the same time, the vendor can receive immediate payment while promptly unloading the merchandise.
First and foremost, supply chain finance is not a loan in the traditional sense. In truth, it is a cash flow solution based on technology that reduces financial costs. It mostly accomplishes the following tasks:
• Automate transactions;
• Monitor invoice approval and settlement processes
The benefit of this is that it frees up part of your operating capital while you wait for the cargo. As a result, your money will not become locked in the supply chain, making your cash flow more flexible.
Recommended Read: Trade Finance & SMEs - Reasons Why SMEs Opt For Trade Finance
Trade financing assists in resolving the opposing needs of the exporter and importer. An exporter must lessen the importer's payment risk. Therefore, it is in their best interest to accelerate receivables. On the other side, the importer wishes to lessen the exporter's supply risk, which would benefit them to gain extended credit on their payment.
Trade finance is a huge industry that encompasses many different industries, although the description above covers "traditional trade finance." To delve into further information regarding trade finance, they have divided the term into trade finance areas that they seek to cover.
What is the letter of credit process?A buyer, a seller, and an issuing financial institution are all involved in the letter of the credit process. Letter of Credit is preferable for your buyer to apply at the bank with which they do business and have an established relationship rather than a new bank, especially if their firm is new and still needs an established credit history with great scores.
They must supply full evidence of the agreement in question and the bank's requisite application forms for internal processing as part of the letter of the credit process.
For instance, if you needed your customer to apply for a letter of credit as part of a transaction and did not get payment, you provided documentation to the bank that your customer received the products or services. The bank then pays you in accordance with the terms of the letter of credit.
Benefits of a letter of credit:
The issuing bank accepts the ultimate financial obligation of the buyer.
Guaranteed payment permits the seller to borrow from the lender against the full recoverable value of the transaction.
Bank Guarantee is a financial backup provided by a financial institution that promises to fulfil a financial obligation if one party in a transaction fails to keep their end of the bargain. A bank guarantee allows the bank's client to acquire goods, purchase equipment, or engage in international trade. The bank will cover the loss if the customer fails to pay a loan or deliver promised products.
True, international commerce accounts for most countries' gross domestic product (GDP). Although International Trade finance has existed for much of human history, the world has only recently begun to recognise and appreciate its economic, political, and social significance. It is vital to highlight that conducting international trade is a far more complex procedure than conducting domestic trade. When two or more nations exchange commodities, capital, or services, a multitude of factors, such as government policy, currency, the judicial system, and markets, are involved.
Recommended Read: International Trade Finance: Types, Benefits & How It Works