Trade finance has been increasing in popularity as a tool to smoothen out financial demands and drive business growth for Small Medium Enterprises in Singapore. This article will give a brief background of what Trade Finance means, its benefits, as well as the four key types of trade finances in Singapore, namely factoring, invoice financing and lines of credit, supply chain financing (buyer and supplier financing), and letters of credit.
Table of Contents
What is Trade Finance?
Due to their small size, Small Medium Enterprises (SME) may face trade cycle funding gaps and its set of risks associated with trade. During these funding gaps, the SME may not be able to continue its normal operations smoothly, or proceed with a planned product development. This is where Trade Finance can come in to ease out the kinks in funding.
The financial institution usually deals with documents related to the trade process and not its actual underlying goods. There are also complex structures that will comprise many stakeholders, not limited to buyers, sellers, bankers, insurers, two or more party logistics (2PL or more), and so on. However, not all trade finance is complicated and it need not involve all of these parties.
While Trade Finance is commonly referred to in the context of international trade and employed by large corporations, it applies to domestic trade as well for SMEs to benefit from..
Types of Trade Finances
There are four key types of Trade Finance that help SMEs to grow. They are factoring, invoice financing and lines of credit, supply chain financing (buyer and supplier financing), and letters of credit.
Sometimes referred to as debtor financing or receivables factoring, factoring is a process when a company sells to a financial institution the value of accounts receivables for which it has not received payment for. In exchange for getting the cash it needs immediately, the business sells the value of those accounts receivable to a financial institution, also known as a ‘factor’, at a discount.
Factoring can be done in two ways- with recourse or non-recourse. A finance arrangement with recourse allows the financial institution to seek compensation from the business if the accounts receivable are not fully paid. On the other hand, with non-recourse, the financial institution will absorb the loss without receiving compensation from the business.
Invoice financing and credit line
Invoice financing refers to the financial measure to help firms improve their cash flow by ensuring that invoices get paid on time or ahead of schedule. Due to operational constraints, customers may not be able to issue payment on the products or services that they have purchased in time. This financing option allows firms to pledge invoices to Financiers to obtain cash promptly and may be an alternative to traditional loans.
A line of credit, simply put, is a pre-determined borrowing limit that determines the maximum loan amount that the borrower can borrow. The borrower can take money out until the limit is reached. In the case of an open line of credit, also known as a revolving line of credit, more money can be borrowed again after the money gets repaid. This provides flexibility in terms of funds for the borrower.
A line of credit can also be secured by collateral, or unsecured. Unsecured line of credit means that the borrowed have not committed any collaterals back to the line of credit. Certain financial institutions such as Funding Societies offer Invoice Financing Line, a combination of the aforementioned Invoice Financing and Line of Credit to offer SMEs a hassle-free credit line by pledging invoices. This product does away with the cumbersome loan application processing of every single invoice funds’ drawdown by evaluating the SME and providing a revolving credit line.
Supply chain financing – buyer and supplier financing
Supply chain financing funds the purchase of goods by optimising the cash flow in the supply chain for both buyers and sellers. It enables the buyer to stagger payments to suppliers for better cash flow management while allowing suppliers to be paid on time or even earlier!
Supply chain financing is often done through an intermediary, such as a lending platform, which will first pay the invoice payable amount to the Suppliers. After disbursing funds to the supplier, the amount will be paid back by the buyer on a later date. As such, the supplier gets an early payment to facilitate a smooth flow of materials to the buyer, and the buyer gets payment terms that suit its financial position. The financing cost may be borne by either Supplier or Buyer, depending on the agreement with the financial institution.
Letters of credit
Letters of Credit are provided by banks on each side of the transaction as a form of guarantee that payment will be received under specific conditions. For instance, an SME may find it risky to deliver a large volume of products to a new buyer before getting paid.
In this situation, the SME and buyer can use a standby Letter of credit with the respective banks to guarantee that the SME will receive payment. For example, should the buyer fail to pay the SME, the bank will still compensate the SME the full amount.
Overall benefits of Trade Finance
Trade Finance helps SMEs drive growth due to a variety of reasons. Apart from narrowing trade cycle funding gaps to enable a stable cash flow within the supply chain, Trade Financing also reduces the risks associated with trade activities. The financing options also lowers the risk of non-payment and non-receipt of goods by the accountability to a neutral third-party. It ensures fewer payment delays and promotes cash flow flexibility, which in turn allows both Buyers and Suppliers to run their businesses and plan their cash flow more efficiently.
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Disclaimer: Funding Societies Pte Ltd is a crowdfunding platform licensed by the Monetary Authority of Singapore. The products offered by Funding Societies are governed by the Securities and Futures Act (SFA) and shall be construed and understood as a debt security regardless of the references to “loan”, “lending”, “finance” or “financing”. All third party trademarks product and company names are trademarks or registered trademarks of their respective holders. Use of them does not imply any affiliation with or endorsement by them. View Funding Societies disclaimer notice here. The above article was published on 9 February 2021 and accurate as of date of publication.