A company using import finance or trade finance, when importing goods from overseas, can reduce or wipe out completely its working capital requirements.
Opportunities for international trade are often limited by payment demands of suppliers (sellers) and the cash-flow limitations of the buyer (importer) who must wait for the goods to be delivered and distributed to the end customer. Trade finance, available through specialist financing companies, helps to:
- Promote international trade by easing the pressure on a businesses’ cash-flow;
- Enable suppliers to receive prompt payment without the need to advance credit or take risks;
- Encourages business development because it can become a template for further transactions once other suppliers see the process working and want to take advantage of the benefits it offers.
Trade finance provides the means to bridge the gap between the payment requirements of sellers and funding constraints of the buyers, strengthens the financial position of both parties by ensuring continuity of supply, and increases supplier confidence. Moreover, a combination of trade financing and invoice financing can enable a business to fund the full trade cycle.
Trade finance encompasses many different areas, including:
- Import finance;
- Export finance;
- Letters of Credit (LCs) negotiation and discounting;
- Bills of Exchange (BofEx); and
- Credit Insurance.
Completion of relevant documents can be complex and using the services of a financing company removes the need for the business to retain its own specialist staff. International banks can also provide extra security around these processes.
Import finance: letters of credit
Import financing offers a solution to companies which may feel unable to accept a large order
for goods required from overseas because of the risk it poses, and as a result, lose profitable trading opportunities. Financing can be through an independent credit line, outside normal bank borrowings, where a financier, who can lend more flexibly than banks which have stringent underwriting criteria, will prepare a Letter of Credit so that imported supplies can be purchased on a regular basis. However, before import finance can be raised certain criteria must be met, including:
- A credit worth customer has confirmed an order; and
- The customer is invoiced on credit terms.
The Letter of Credit guarantees payment, on the provision that the correct goods are shipped to the right place. The supplier is paid through the Trade finance facility; the business raises an invoice for the company buying the goods, which in turn is financed through Invoice financing which means the trade finance facility is repaid.
Some financiers are prepared to offer Stock Financing. This is based on the level of finished goods available, and a line of revolving credit is established based on a percentage of the cost price of the goods. If goods are already pre-sold, made to order, a higher credit line can usually be obtained.
An alternative to Letters of Credit
An alternative way for an importer to raise money is by approaching a specialist trade financier. The financier will examine:
- The company’s trading history;
- The type of goods being imported; and
- How quickly stock is turned over.
Following these considerations, a decision will be made on whether to fund based on the transaction in-hand rather than factors such as the strength of the balance sheet, profit margin or length of time the company has been trading. When finance is raised by the above means, Letters of Credit are not required as the trade financer pays for the goods either when they land in the UK, or on the basis of shipping documentation. Trade finance by this method can fund up to 100% of an overseas trade purchase. Companies offering this service together with specialist factoring or invoice discounting, and which have an international division, can fund the transaction from beginning to end; for both import of goods and for the sales process.
Invoice factoring and invoice discounting
Invoice factoring/discounting works in the usual way. Once the goods enter the UK and are delivered to the customer an invoice is raised. The import facility can then be replaced by invoice factoring or invoice discounting which will raise between 80%-90% of the end sales price, enough to clear the import facility (costs of the goods) in full. On payment of the invoice by the customer, the company receives the remaining difference between the amount advanced and 100%,
Export factoring works in a similar way to invoice discounting including, if required, bad debt protection on overseas clients. Help in collecting bad debt can also be obtained from local banks in the area where the goods are being exported to, which are part of a reciprocal agreement with the UK.
Advantages of Export factoring
There are some clear advantages to businesses of export factoring including:
- Helping them to develop overseas profits without worrying about losing large amounts of money;
- Enabling cash to be raised against the value of outstanding export invoices; and
- Removing the need to pursue overseas customers for payment.
However, general requirements include:
- A minimum gross margin for the goods of 20%;
- The transaction is business-to-business; and
- The invoice will be raised post delivery.
The UK has an official export credit agency which operates under the name of UK Export Finance, although it is in fact the Export Credits Guarantee Department (ECGD) of the U.K. Government. The ECGD operates under the provisions of the 1991 Exports and Investment Guarantees Act. The principal aims of the ECGD are to:
- Help exporters of UK goods to open up export markets; and
- Encourage UK firms to invest in overseas business by providing guarantees and insurance against loss.
When funding is provided by ECGD, slightly more is recovered by applying premiums which reflect potential risks.
Underwriting long-term loans
Long-term loans can be underwritten by ECGD to support the sale of capital goods like aircraft, bridges, machinery and services, and also, if it helps a UK business play a part in improving the importing country’s infrastructure, large projects such as the construction of oil and gas pipelines, airports and power stations, hospital refurbishment and upgrades. Financial backing can range from £1000 to well over £1billion.
The Productive Expenditure Test
The ECGD judges the ability of a country to meet its debts and uses a mechanism called the “productive expenditure test” to make sure that export credits are only given to countries described as heavily indebted poor countries, or are exclusively dependant on International Development Association financing, and where the project the British company is going to support will help that country’s economic development without creating further debt burdens for them.
Bank loans offered to buyers of goods based overseas
ECGD will also underwrite bank loans. This increases the possibility that the bank will provide a loan, and helps exporters to:
- Raise tender and contract bonds;
- Access working capital finance; and
- Obtain Letters of Credit.
ECGD Export Refinancing Facility (ERF)
ECDG also offers an Export refinancing facility as an add-on to its standard buyer facility. This provides an undertaking:
- To the bank, that the ECDG will take over the export loan by an agreed time; and
- To the borrower that, if bonds have been taken out to refinance the loan, UK Export Finance will guarantee repayment.
Buyers of exported goods, paying in a foreign currency, can access Export Refinancing in the form of buyer credit loans, the value of which usually has to exceed £50m. In addition there must be a clear intention that the Debt Capital Market or another commercial provider will provide refinance. In the absence in the UK of that type of commercial refinancing, UK Export Finance will guarantee the borrower and the banks that it will fund the loan until the markets re-open.
Providing the business is UK based and the buyer is overseas, UK Export Finance will consider, on a case by case basis, insuring UK exporters against the risk of non-payment by the overseas buyer.
Applying to the ERF
To apply for ERF the business should:.
- Consult their bank;
- Read all the information provided on the ERF site to make sure that the ERF can provide the support needed, and make sure that it will apply to the country the company is trading with;
- Consult the ERF customer services to find out what the premium would be;
- Complete the between 80%-90% of the import facility which should be enough to pay the import facility (costs of the goods) in full;
- Complete the Buyer Credit application form and schedule; and
- Send the completed documents to UK Export Finance Business Group.
The benefits of an ERF
The benefits of an ERF include:
- Banks can adjust their loan price as the lending commitment they make will be shorter;
- Refinancing the loan at a fixed rate of interest over a longer period through debt capital markets or other commercial funding becomes an option;
- Buyer/borrower has the option to arrange commercial refinancing during the draw-down of the buyer credit loan, and up to 12 months after the scheduled final draw down.
If commercial refinancing hasn’t taken place as expected, UK Export Finance will cover the loan at a higher rate of interest until refinancing can take place.
Eligibility for ERF
- Must be a UK based business;
- Loans to borrowers in EU are not available;
- Value of loan must be at least £50M; and
- If UK Export Finance is needed to purchase loan, interest rate will be higher.
Maximum loan amount
The maximum amount of the loan is usually about 85% of the value of the export contract, of which 15%, at least, must be paid to the exporter by the buyer before loan repayments start, including 5% paid at contract signing.