Trade Finance and How to Globalise Your Business
Monday, June 2, 2014
As the global market moves away from tradition, becoming more and more accessible to businesses of all sizes, so too grows the opportunity for those businesses to grow, reduce costs, and diversify.
New supply sources in foreign markets provide for the opportunity to source materials, completed inventory, machinery, and services at a lower cost. Similarly, new markets open the door to new and diversified customers, distribution channels, and revenue sources with higher margins.
Whilst the increasingly globalised world of business provides the potential for these outcomes, the issue of funding the cash cycle still remains.
The Problem of Cashflow and Risk
For an expanding and growing business, cash flow management and risk mitigation is key in the effective management of growth. As a business expands globally, and increases its exposure in new markets, the cash flow and risk concerns increasingly require close monitoring.
For example, a business that is experiencing a steep rise in sales has an increased cost of goods, and needs to source inventory to service the demand from its clients. This requires working capital to pay for goods before the sale is made and the final product shipped. If that capital is to come from day-to-day cashflow, your growing business runs the risk of running out of cash to service the day to day operations and payables as they fall due.
Cash flow management for a small business works in the same way that people use credit cards and peronsal loans to fund daily purchases; that is, in such a way that ensures they don’t need to have an outflow of funds from their savings, and can make repayments on what they owe in instalments or a lump sum. Businesses need a cycle of operating capital to make sure they’re not overdrawn on their money, and can reconcile their debts once their client has paid the invoice for delivered goods or services.
The risk is that cash flow can be further exacerbated when dealing in foreign currencies and/or with international suppliers and clients. This is where the employment of an International Trade Finance structure is important.
The International Trade Finance Solution
International Trade Finance is a range of short term 'credit instruments and facilities' which are structured in a way that matches the trade cycle of the import or export program of a global business. It exists specifically to assist with risk mitigation, currency management and the freeing up of cash flow required to service the day to day running of a global business. Trade Finance can even be issued in the same currency as the supplier’s terms and/or the buyer’s payment.
Some businesses may rely upon traditional bank funding in 'overdrafts' and 'term lending' for the purpose of international trade. However, as those facilities are designed for domestic purposes, they can have unnecessary negative impact upon the balance sheet of a business – further so if the business has financial covenants and ratio reporting hurdles to meet; things like Gearing Ratios, Cash Coverage Ratios, Interest Coverage, and NCAO. It's important to make sure you research all of your options with a trade specialist before proceeding, as an ill-informed choice could impact your business’ growth potential.
To add further benefit to the proposition, as Trade Finance is provided against a specific matching import or export transaction, it is likely to be a cheaper source of funding than an overdraft or loan, given its short term and self-liquidating nature. Plus, don't forget there's the added luxury of your trade finance being denominated in the same currency (major currencies, of course) as your supply or sales exposure.
Help from Trade Finance Specialists
If you engage a Trade Specialist with a bank, they can also assist with advisory around things like terms of trade, the market you are entering or sourcing, counterparty due diligence, and the design of a structure to match your business's trade cycle. Trade finance specialists generally sit in a centralised operational unit within a bank, and given the complexities involved in their work, are even more specialised than say a commercial, agri, or business banker. What this means, therefore, it that it is important to request a joint call or meeting with your business banker and a trade specialist, in consideration of International Trade Finance, so that they can offer their expertise collectively, taking your unique trade situation - and your business - into consideration.
- A common mis-conception is that import and export finance is only available to large corporations. In fact, any size business that has a portion of their inventory, raw materials, plant & equipment or sales revenue sourced from offshore markets, can and should access a trade finance solution.
Want to see how Trade Finance works?
Consider this: you're an importer of widgets from a Chinese manufacturer. You place an order for a USD75,000.00 container of merchandise to wholesale locally. Upon order the manufacturer asks for a 25% pre-payment deposit, to commence its four week manufacturing process, with the remaining 75% due upon loading on the ship at Shanghai port.
You agree, and the ship then takes around 25 days to land at your Brisbane port. You introduce your new widgets into the warehouse as inventory, from which you then have an average period of 30 days until they're converted into a sale and invoiced to the end buyer. You provide that buyer with up to 45 days payment terms.
For this one shipment of widgets the business has USD75,000.00 in cash out flow, tied up, for around 128 days. A trade finance facility will provide you with that cash flow back into the business from day one to be employed in the day-to-day activities of business.
Consider the roll-on effect if you had one shipment under a similar agreement per week: the capital employed in your trade cycle becomes substantial.
(An additional consideration, too, is that 25% deposit being at risk up until the product is loaded on the ship. An instrument typically employed here to mitigate this risk for the importer, is to offer trade finance solution called a 'Letter of Credit' in place of the deposit, to the manufacturer.)
The positive cash flow effect of a well-structured trade finance facility can be like giving an internationally exposed business a blood transfusion. Implemented well, it can speed up payment, address risk, reduce costs, and assist to move goods faster. Sounds pretty good right?
It does, but how do I know if 'going global' is right for my business?
- Does your business source materials or inventory from overseas?
- Does your business sell product or service in overseas markets?
- Are you a domestic trading business which is considering global/international opportunities?
- Has your business recently secured new contracts which will place you into question 1 or 2?
If you answered yes to one or more of those questions, you may benefit from the review of your trade cycle, or new market entry, by a trade finance specialist. Early engagement is ideal so as to address the risks and cashflow needs of your business before issues or constrictions occur.