If your business relies on trading, it’s likely that you will have experienced issues with cash flow. Trade finance is a type of borrowing that can help to fill larger orders. What’s more, it can offer stability and support to businesses looking to trade domestically or overseas.
Find out the various types of trade finance available, how it works and the benefits and drawbacks.
What is trade finance?
Trade finance includes a range of services offered by a bank or credit union to people and businesses who engage in international and domestic trading. This includes transactional services, financial advice and technology, risk management services and other financing solutions.
How does trade finance work?
As domestic and international trade can be volatile, it is very common for businesses to use trade finance options to improve their operations.
Trade finance helps importing and exporting businesses better manage any cash flow issues that come about due to changing market conditions and foreign exchange rates. It also offers more flexible terms compared to other business loan options.
However, trade finance also covers a range of services beyond business finance. Banks and credit unions that offer trade finance services usually have a range of options available to you and you can choose the products that best meet your business needs. Some of these services may include transactional technologies, research and analytics, trade finance facilities and financial advice.
What types of trade finance are there?
- Invoice financing. If you’re waiting on customers or trading partners to pay outstanding invoices, you can choose to have them financed and receive most of the value of the invoice upfront. Read our guide to invoice discounting for more information on this topic.
- Foreign exchange. This includes services for transactions, forwards and options that can help protect your business against unfavourable market changes, while also taking advantage of favourable currency movements.
- Export services. Exporters may require documentary collections, letters of credit, collection negotiations, working capital guarantees and financing solutions both pre- and post-shipping.
- Import services. Businesses involved in importing may take advantage of documentary letters of credit, documentary collections and trade finance.
- Cash flow services. These services include the management of foreign currency accounts, the facilitation of foreign currency overdrafts and telegraphic transfers.
How do I compare products that allow trade finance?
- Available currencies. Many Irish banks will offer trade finance in euros, although some will also have options for other currencies.
- Interest rate. You should check how often the interest will be calculated, which will ideally be daily, and you should also see how the interest rates from one bank weigh up against competitors.
- Repayments. The timing of your repayments will work differently between banks. For instance, some may require you to pay at full maturity. This timing may impact your cash flow, so keep this in mind. You may want to choose a bank that offers a repayment structure that won’t have a negative impact on your business’s financials.
- Financing terms. The financing terms for pre- and post-shipment finance will differ between lenders, and pre-shipment finance generally has shorter terms. Check the terms available before you apply to see if they will work for your business.
Pros and cons of trade finance
- Security. Your business can mitigate some of the inherent risk of paying for goods up-front before they are delivered. Also, some services allow you to protect your business against unfavourable foreign currency movements.
- Options. Banks who offer trade finance services have a range of options available for you to choose from, such as 30-, 60- or 90-day repayment plans.
- Expertise. You can take advantage of the advice and expertise offered by the bank you’re working with, which could result in more competitive rates of interest.
- Costs. As with other financing solutions, trade finance comes with costs. You’ll be charged interest on the amount provided for each trade as well as fees. Make sure you factor this cost into your business financials.
- Limited financing. As with other forms of business finance, trade finance may be limited to the size of your receivables.
Things to watch out for
As with any financing, there are risks involved. You should always read the fine print before applying for any trade finance products and look for any restrictions, especially as many of these products will need to be applicable internationally. For instance, some banks will only arrange spot and forward foreign exchange purchases for approved clients, so this is something that you would need to consider before you apply.
What other types of business loan are available?
There is a range of different types of short-term and long-term business finance which may be available to you. These include:
- Business line of credit. With a business line of credit, you draw on an account balance up to an approved limit. You can use up to that limit when you need it. Repayments can be flexible as long as you keep the account in good standing.
- Credit card. This works just like a personal credit card except it’s for business expenses, and you can add multiple additional cardholders. But watch out for high interest rates, typically ranging from from 8% to 20%, if your balance is not paid back monthly.
- Business overdraft. Business overdrafts are attached to your business banking account and allow you to overdraw up to a specified limit on that account. You only pay interest on your outstanding balance. This type of finance can be suitable for managing a business’s day-to-day cash flow fluctuations. Again, watch out for interest charges when the overdraft funds are used.
- Business vehicle or equipment finance. There are various options available to let you purchase or lease equipment or vehicles. For car finance plans there may be tax benefits available, depending on the cost of the vehicle and how it’s used. Repayment terms vary depending on the type of finance selected, but competitive rates are on offer if the loan is secured. However, your business assets could be repossessed if you don’t keep up with repayments.
The type of business loan that works for you will ultimately depend on your circumstances.