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What is Trade Finance? How Does it Help Business?

Published on 07 Jun,2021

Understanding the mechanisms via which trade financing can be carried out and the ease with which it allows for exporters, importers, and companies alike to conduct business transactions has been examined below.

Defining Trade Finance

Trade finance can be understood to be a term that encompasses the financial implements, tools, and products made use of by a wide variety of companies in order to allow for international trade and commerce to occur. With the aid of trade finance, it is possible – not to mention more efficient, for importers and exporters to conduct business transactions. It is important to note that trade finance has under its wing a wide range of financial products that companies along with banks make use of in order to allow for their trade to be conducted.

Mechanisms in Place that Allow for Trade Finance  

Trade finance operates by way of introducing a third party into all transactions conducted such that risks associated with payment and supply are mitigated. Under trade finance –  

  • Exporters are provided with what they are meant to receive or are given a payment based on the terms agreed to.
  • Importers may be entitled to extended credit lines such that the trade order can be fulfilled.

Trade finance makes use of a wide variety of participants including but not limited to banks, companies that deal with trade finance, export credit agencies, importers and exporters, insurers, and service providers.

What Makes Trade Finance Stand Out

Trade finance differs from conventionally understood forms of financing. While the latter is used to increase liquidity or manage solvency, the former i.e., trade financing, is used to protect oneself against the risks associated with international trade. These range from currency fluctuations and issues of lack of payment to political instability and the creditworthiness of an involved member Availing of trade financing does not necessarily imply a buyer’s lack of liquidity.

Tools Made Use of in Trade Finance

Trade financing makes use of an ample number of tools a few of which have been listed below.

  • Export credit or working capital may be provided to exporters involved.
  • Understanding and accounting for when a given company (or companies) is paid keeping in mind a portion of their accounts receivable.
  • Insurance can be provided to cover shipping fees and the delivery of commodities and can be used to provide the exporter with a layer of financial security should the buyer not pay the funds owed.
  • Banks may seek to issue lending lines of credit which can aid both exporters as well as importer.
  •  Letters of credit help mitigate the risks known to arise when global trade is carried out. Providing dual benefits as – 
    • The bank guarantees on behalf of the buyer, a payment to the seller for the commodities shipped
    • The buyer has a layer of protection as the payment will only be issued provided the terms outlined are fulfilled by the seller. The transaction takes place provided both parties involved choose to honor the stipulated agreement.

Understanding How Trade Finance Helps with Business  

Trade finance has allowed international trade to advance in leaps and bounds. Owing to its frequent usage, volumes of international trade have reached new heights. Trade finance allows for ease with which business is conducted owing to a number of reasons some of which have been examined below.

  1. Reduces risks associated with global trade – This is made possible by accommodating the diametrically opposed requirements of exporters and importers in play.
  1. Cash flows improve and operations are carried out with greater ease – Fewer setbacks in payments, as well as shipments, occur owed to the use of trade financing thereby allowing importers as well as exporters to conduct their respective businesses with ease and plan their flow of cash in accordance with the same. 
  1. Revenue and earnings witness a rise – With the aid of trade financing, it is possible for companies to increase their volume of business and they can therefore generate a greater revenue via trade.
  1. Financial inabilities are less likely – Trade financing has made it possible for a wide variety of companies to continue making payments on a regular basis and avoid missing out on payments that can cost them greatly in the long run.

Conclusion

This article is of particular use to those considering expanding their business horizons on a global level as well as those wanting to learn more about the instruments that have allowed for international trade to flourish.

Referencehttps://www.investopedia.com/terms/t/tradefinance.asp

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