Is Trade Finance worth the cost? For those SMEs that deal with suppliers with either long lead times, various geographical locations or other complexities, financing the purchase of goods can be a challenge.
Beyond the options of using cash reserves or other traditional debt facilities, trade finance can be a viable option in multiple scenarios.
Trade Finance is a type of working capital facility. Typically, it is used to support the time between the purchase of inventory and the ultimate sale of goods and the collection of payment from the customer. These terms can range from 30 days to 120 days with some financiers.
This facility is typically associated with purchasing goods from overseas. However, it is not limited to this and can be used for domestic and local supplier arrangements.
It usually works as a line of credit or limit facility, with repayment terms that allow the deferral of payment for goods until they are sold.
You must understand your business cash flows before jumping into debt. Like all working capital facilities, SMEs need to ensure that there is a match between their funding needs and the structure of their facilities. For example, too often we see short-term funding used for long-term assets or vice versa. This can be an expensive asset finance mistake.
Put together well, using a trade finance funding mechanism can be great for growing businesses. It means your business has the cash flow to increase purchasing ability, enabling more stock acquisition to grow sales volumes.
Beyond the traditional commercial finance information, there is a greater focus on Debtors and Creditors Ageing, Contracts and Supply Agreements. Insurance of the goods between shipment and the pay-down of the facility delivery is required, as often this is the financier's effective security. So it is important that this is in order.
Like any working capital facility, where it is not supported by other collateral such as property, the relative cost isn't cheap, and the structure of how it is charged is more complicated.
Of course, where the loan or credit limit is relatively small, the interest rate may not be material. Though be prepared for a structure that includes:
- Establishment Fee (as a set $ amount)
- Management Fee (as a % of each trade transaction)
- Line Fee (as a % of the total Trade $ outstanding)
As a result, the effective cost will depend on the size and timing of the transaction that drives the overall costs. Outside major banks, this may end up costing more than a traditional overdraft. As a rough guide, there could be an all-in costs of say 12.5% - 17.5%.
Some good financial forecasting is crucial. If you do not understand your working capital cycle, talk to someone who does. Short-term and pressured decisions in relation to financing tend to be less optimal ones.
Our Business Cash Flow Guide can be a useful resource for understanding your working capital cycle.