Trade Finance Basics
Financing an import / export company or any type of company that deals with international purchases and sales can very challenging. Buying goods internationally usually requires that you use a letter of credit. This is similar to prepaying for the goods because banks will only issue an L/C's if you post cash collateral as security. On the other hand, if you are selling goods to large foreign or multinational company, you will find that they will often demand payment terms - the option to pay an invoice in 30 to 60 days. However, offering payment terms in export transaction can have a negative impact on your cash flow - while being complicated and risky at the same time.
The two most common financial problems that companies find are:
- They need funds to prepay their foreign suppliers
- They can't afford to offer terms to their foreign clients
Both of these problems can be solved using factoring and purchase order financing, two little known trade financing solutions.
Problem - You can't afford to prepay foreign suppliers
Getting a large purchase order is always seen as a positive event, unless you don't have the funds to pay your supplier. Obviously, if you are unable to pay your supplier, the transaction will fall through. One trade financing instrument that can help you in this situation is po financing. It enables you to finance purchase orders, as long as the order meets this criteria:
- Issued by a credit worthy client
- Non cancelable
- Sells finished goods only (no installation or additional work)
- High gross margins - 20% or more
This trade finance solution covers your supplier expenses, enabling you to take on large orders that exceed your current capital capabilities.
Problem - You can't afford to offer payment terms to your clients
This is a common problem for companies that sell goods or services internationally. You get a contract with a well known company and as part of the contract they demand payment terms - the option to pay invoices in 30 to 60 days. This can create cash flow problems for companies that need the money sooner to cover their ongoing operating expenses. One way to solve this problem is to factor your invoices. This provides you with immediate financing based on your invoices, enabling you to run your business and take additional contracts.
Both factoring and purchase order funding can be used as effective import / export financing solutions and solve common financial problems. Often, they can be used together to finance the front and back end of a transaction. Combining both solutions usually reduces the transaction cost, providing an effective financing tool for growing companies.
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