In the previous edition of this working capital series, I touched on Receivables Finance as a means of managing the cash flow of a business using debt. This edition focuses on Trade Finance.
Trade finance is good for businesses that are importing products from or exporting to overseas (although in some cases can be used domestically). It is not only designed to fill a working capital cycle gap which may be experienced while the goods are en route, but also to provide the parties with a layer of protection (ensuring goods arrive at the destination) via Letters of Credit.
A Letter of Credit is basically a promise from the receiver’s bank to the sender’s bank that once the goods arrive at the destination, the receiver’s bank will pay the sender’s bank the money owed for the goods that have been shipped. There are several trade finance instruments that can be utilised for various requirements, thus making it an important consideration for working capital purposes.
- Letters of Credit can provide for a degree of protection – however there are still risks involved;
- Flexible – Trade loans can be taken out in different currencies and in different forms/interchangeable depending on the situation at hand;
- Cost management – Some lenders can offer ways to minimise risks associated with currency fluctuations thereby hedging against unforeseen and unfavourable currency movements.
- Very specific – Not available to all business types;
- Security – May require property security or a very strong business balance sheet to access funding;
- Short-term – Generally trade loans must be paid back within a short period of time, i.e. 30-120 days.
When utilised in the correct situation, trade finance facilities can assist businesses to fill the gap present in the working capital cycle. This is achieved by financing goods that are yet to arrive and converted into sales / cash. It may sometimes also be used to complement plant & equipment finance as an ‘escrow facility’. This is where equipment that has been purchased overseas cannot be financed with the traditional asset finance methods until the equipment arrives to your premises.
However, if you are looking for a longer term finance solution, you may need to consider alternative working capital facilities. Whilst this may involve some element of trade finance, we have to ascertain what your working capital cycle looks like and how wide the gap is. From there we will be able to determine the suitability of this solution for your business.
As always, if you need any clarification pertaining to the above, please get in contact especially if you don’t think you have the right facilities in place to suit your business’ cash flow requirements.
Disclaimer: The information provided herein is for general information purposes only and does not constitute specific advice. It should not be relied upon for the purposes of entering into any legal or financial commitments. Specific advice should be obtained from a suitably qualified professional before adopting any investment/financial strategy.