This is how the Global Trade Review defines trade finance:
“Trade finance is the financing of international trade flows. It exists to mitigate, or reduce, the risks involved in an international trade transaction.”
Okay. But what does that actually mean?
Let’s break it down a little more.
If your business is making international transactions, there’s a certain amount of risk involved, right?
Of course, there’s risk involved in most business transactions – and you don’t have to be trading oversees to use trade finance. But trade finance tools are more commonly used in international because cross border-transactions are more risky.
You may not be familiar with the company you’re trading with, and it may be hard to find out everything you need to know about the company – like their credit rating, their reputation in the market and whether they have a history of paying for goods or fulfilling orders on time.
There are lots of things that can go wrong when you’re transporting goods long distance, which could cause serious delays in delivery.
Currencies could move between the time you place the order and the time you pay for it (or the time you get an order and receive payment, depending on whether you’re buying or selling) – making the transaction more expensive or less profitable than you expected.
If there’s any sort of political or social instability in the country you’re trading with, your transaction could get disrupted (for example, seized at customs).
If something does go wrong, it’s much harder to sort things out when you’re dealing with a different legal and regulatory system, culture and language.
Trade finance tools are designed to mitigate or eliminate some of these risks. They’re also there to help you to fill funding gaps in your international trade cycle – which brings me to the other main reason business owners use trade finance:
If you’re making and selling goods, you’ll have a whole heap of costs to bear up front – including raw materials, manufacturing, storing and shipping. If you offer credit terms you could have to wait between 30 and 90 days for payment, and with overseas shipping you could still have a long wait for payment even if your terms are cash on delivery.