All emerging businesses need a backbone of funds for running them efficiently. Many times, due to the lack of working capital, the business operation faces a downfall in operation. That ultimately affects the whole functioning. While trading or dealing domestically or across borders, there are several necessary factors involved. Right from purchasing or manufacturing the product till receiving the final payment. This whole process requires funds to overcome all the problems; hence, trade financing helps in dealing in India as well as the international market. Let’s understand what is Trade Finance.
What is Trade Finance?
Trade Finance is financing to cash flows required for dealing in the domestic as well as the international market. It helps to mitigate the risk involved in trading beyond the border. Many times while transacting across borders, both the seller and buyer are unknown to each other. Thus again arises the risk of the transactions. Will the buyer return the money in time? Will he make a payment or not? This issue is solved by taking the assistance of Trade Finance.
There is the involvement of two parties in a trade transaction:
(1) exporter who requires payment for their goods or services, and
(2) importer who wants to make sure they are paying correctly according to the quality and quantity of goods or services provided by the exporter.
rade Finance helps in reducing the risk while dealing in the domestic as well as international market. Being unaware of each other, both buyer and seller need a surety for a transaction with each other, which is solved by financial instruments used in Trade Finance.
By choosing Trade Finance, the crunch of working capital will be resolved, which will increase the cash flow of the business. The main characteristic of trade finance is working capital management which generates revenue and earnings for the business.
The relationship between the buyer and seller is strengthened due to the availability of financial instruments like Bank Guarantees, LC Discounting, Factoring, etc. The financial instruments gain confidence between parties and build a relationship due to the guarantee given by a bank or a Financial Institution.
Process in Trade Finance:
- The borrower agrees to purchase the goods from a supplier.
- The borrower agrees to terms with the funder and the funder pays the agreed amount to the supplier.
- The supplier then ships the goods to the borrower.
- After receiving goods from the supplier, the borrower sold the goods to the buyer and receives payment for the goods.
- The borrower then repays the money back to the funder.
A borrower is a person who is in the trading business and needs funds for trading activities.
The buyer will buy goods from a borrower/seller.
Due to the lack of funds, the borrower seeks finances for trade from the funder/lending institution.
The supplier is the person who supplies goods to the borrower who then sells goods to the customers.
Understanding the process of Trade Financing from Case Study.
Instruments involved in Trade Finance
Factoring is available to domestic as well as international customers. Factoring is the financial instrument or debtor finance in which the seller sells its accounts receivable to a third party called ‘factor’ at a discount. There are three parties involved in such a transaction: a seller, a buyer, and a factoring company. In simple words, it is selling unpaid invoices for the requirement of instant cash.
2. Line of credit / Letter of Credit
A line of credit / Letter of Credit is a guarantee that a financial institution provides to pay sellers on behalf of buyers in case of default on their part. Letter of Credit discounting serves as financial security for businesses involved in either export or import or both.
3. Bank Guarantee
Bank Guarantee is a type of financial instrument that banks or Financial Institutions offer. It ensures the liabilities of the debtor will meet i.e, the bank will be held responsible for the non-payment of the debtor. Generally, it is a bank’s promise to a third person. So as to undertake the payment risk on behalf of its customers. The banker charges interest or fees on such an instrument which is based on the risk involved in the transaction.
The process to avail Trade finance
Why Terkar Capital?
Trade finance is the financing for undertaking trade to the clients working at the domestic as well as international level. The process is complicated, but we at Terkar Capital make it convenient for our clients. We are headquartered in Pune and our corporate office is at the Mumbai BKC location.
At Terkar Capital, we arrange several options in both debt and equity funding. We analyze all the aspects of the business and then suggest appropriate products according to the financials. Our reliable and quick process makes us different from all others.