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Factoring: Export finance: not just receivables finance, but trade finance
Export finance is a financial product, sometimes proposed by the most established invoice financing firms. As the name suggests, this facility is tailored for the needs of businesses selling their merchandise overseas. How does it work, and what are the different types of export finance?
The various professionals who may get involved in this kind of deals, and possible frameworks clearly indicate how these products are closely related to trade finance.
Principles of export finance
Basic principles of this financing product are quite simple, and reminiscent of any other factoring product. However, the international nature of operations involves specialised professionals and a sometimes more detailed approach.
How export finance works
Export finance works like typical factoring, but on an international scale.
- Business issues the invoice to the client and to the financial services firm,
- Business receives funding covering a very large part of the invoice value, minus fees,
- The remaining part of the value is paid to the business when the factor receives payment from the client.
Parties involved and specific difficulties
This type of financing typically involves export intermediaries, which can be:
- Export trading companies, or
- Export management companies.
Both may provide short-term financing or even purchase the products from the business to sell them to the international client.
In case financing is needed, they will evaluate the credit risk, which is very complicated on international markets, so that export credit agencies may also need to be involved.
Two issues will be looked into:
- Can the exporter fulfil the order? This is about production and delivery capacity.
- Can the importer pay the invoice? This is about creditworthiness of the company, but also about political risk and exchange rate volatility.
Based on these considerations, the greater the risk, the higher the fees will be.
Different types of export finance
More generally speaking, export finance relates to several types of financing options used for international trade, illustrating how much export financing is related to trade finance. The following are the four most common products.
Documentary credit with deferred financing
This type of financing enables businesses to offer deferred payments to their international clients. The client’s bank provides the documentary credit, and the business’s bank makes reviews and accepts it to fund the exporter.
Documentary credit with bank-to-bank financing
In this situation, the business’s bank lends money to the international client’s bank, and the interbank agreement is included in the documentary credit. The business manufacturing the goods does not take part in the arrangement, and only pays for credit charges.
Bill of exchange
Bills of exchange or promissory notes are another way of granting a more significant credit: the business and client negotiate the bills of exchange, and interest rate, then the business’s bank buys the bills of exchange.
This is an arrangement between the business’s bank and the international client or its bank. Payments are made directly between the business and its client upon shipment, and their respective banks deal with the financing together.
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