Disadvantages of Trade Finance and how to avoid them
30 Oct 2018 - by
At first glance, trade finance offers huge benefits to all parties involved in an international transaction.
Importers can invest in profitable new international ventures without extracting capital from their business or compromising cash flow. They can also repay the finance using profits generated from their imported receivable on lengthy repayment terms, whilst suppliers receive payment as soon as goods are dispatched.
Both also benefit from the security of a middleman who enforces their contractual obligations and insures them against non-payment.
While there are several advantages of using trade finance there can be disadvantages to using trade finance as well, which usually result from lack of awareness about the product.
In this article we look at the disadvantages of trade finance and offer five key pieces of advice to avoid/overcome these disadvantages.
Trade finance products usually reflect some form of invoice financing, where loans are advanced to firms on the basis of their accounts receivable, invoices, or the goods within the transaction being financed. This means firms are not required to own or commit any assets to act as security.
This is a huge advantage of trade finance, as it can free up capital from businesses with constricted cashflow due to extended trade cycles to invest in further profitable ventures. However, many lenders continue to offer trade finance products which require some level of capital requirement, which negates this key benefit of the product, or can only offer trade finance products at certain costs and scales
Advice – as with any other financial product, work with a firm that offers you the widest range of good value trade finance products.
2) Choose the Right Product
There are subtleties to trade finance products, which some firms are ill advised about or simply ignore. Dependent on an importing firm’s financial structure, product, and trading history, an invoice discounting product (where firms sell their unpaid invoices to financiers and receive loans) or a receivable factoring product (where the future receivable itself underpins the finance) might be more appropriate. In contrast, reverse factoring can provide greater certainty and faster repayment terms for suppliers working with large customers.
Advice – take independent advice from an experienced trade financier who is well versed in your business and proposed venture and can offer you a range of appropriate products.
It is relatively easy to secure trade finance if you have a strong trading record of paying suppliers and meeting debt obligations, and a willing buyer or seller in your proposed international venture.
However, newer companies with less established supplier relationships can struggle to access trade finance from traditional trade finance houses at major banks, who generally operate higher thresholds of risk.
This can also affect companies proposing international ventures which expand into new products or territories. Finally, without proven internal processes, some trade financiers will not consider you for certain trade finance products (such as invoice discounting).
Advice – prepare a detailed business plan of your proposed venture and have it assessed by specialist trade financiers, who can more accurately judge operational risk and offer you better terms.
Trade finance products are designed to provide certainty to buyers and suppliers in international transactions. The contractual obligations of the venture will be clearly laid out and agreed prior to a sale being agreed.
Once signed, exporters will only receive payment if they keep to the strict terms of the contract and provide documentary proof that they have supplied exactly what they were contracted to provide.
As an exporter, if you are unprepared for this, this can cause delays in payment to yourself and to the overall transaction, damaging supplier relationships.
Advice – take advice from your trade financier about what it is you will need to do to comply with your contract, and think about how you will do so.
Trade finance is a vital source of working capital finance to many companies who export or import goods.
Despite its comparatively lengthy repayment terms, it is a form of short-term credit typically used by companies to finance a one off venture with a defined quantity of receivable which can be dispatched to a buyer (for exporters) or sold on profitably to agents and wholesalers (for importers) in a timescale that fits within the terms of the finance.
If payments are not made on time, trade finance can therefore become extremely expensive. Moreover, if firms overextend themselves and allow themselves to become overly dependent on invoice discounting as a funding facility, they can embed themselves in a trade finance cycle which can leave them overexposed to changes in macroeconomic conditions.
Tip – have a clear idea of why you are seeking trade finance and how your proposed venture will grow your business.
Many companies, large and small, successfully use some form of trade finance as part of their overall strategy for managing their cashflow, supply chain and revenue streams.
If your firm is considering initiating or expanding activities underpinned by import or export transactions, trade finance offers huge financial benefits and decreases the inherent risk involved in such ventures.
Moreover, with a clear business plan for the future and good advice from an independent trade financier, all the disadvantages discussed above can be avoided.