Chapter 7

Trade financing techniques

Introduction
There are many different techniques that
a company can use to finance trade.
These generally fall into either of two main
approaches.
One approach is to finance trade from the
companys general working capital facility.
For example, an overdraft or general bank
line of credit will support any working capital
requirement that arises, including the time
between the payment to a supplier and
collection of payment from its customer.
Working capital

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The alternative is to finance each

transaction separately. For example, a
company could choose to discount the
invoices, or negotiate the trade documents
associated with each distinct transaction.
As with any financing decision, there
are advantages and disadvantages to each
technique. Some techniques will not be
available to some companies, depending
on their location, creditworthiness or size.
Selecting one technique to finance some trade
transactions may have other implications
for the business as a whole. For example,
discounting liquid invoices may result in
cheaper financing of a particular transaction,
but may prompt a bank to require additional
security on assets protecting another line of
credit. Similarly, using general working capital
facilities to finance trade may reduce the
companys liquidity metrics, and push it close
to breaching covenants on other loans.
There is no single right way to finance
trade. Each company will usually have a
variety of options (although circumstance
may make only a small number of these
realistic). It is, though, important to consider
financing options in the context of their
potential impact on the companys overall
cost of funds.

The Treasurers Guide to Trade Finance

Availability

Suitability

Overdraft

Allows a company to run its

current or checking account
with a debit balance.
However, may be repayable
on demand.

Available in most
locations, although they
are prohibited in some
jurisdictions.

Relatively flexible and usually

available (where permitted) to
companies of all sizes. Easy
to establish and operate.

Bank line
of credit

Offers more secure

financing than an overdraft.
Can be in the form of either
a term loan or a revolving
facility.

Available in every
location.

Widely available and can be

used for a variety of activities.
Critical for treasurers to
negotiate appropriate terms
and conditions with lender.

Allows the holder of a trade

document, such as a bill
of exchange, to arrange
finance by discounting it with
a third party.

Usually easy to
arrange, although
dependent on market
conditions and the
credit status of the
documents acceptor.

Allows holder of document

to accelerate cash flow, so
is a useful source of working
capital finance. However, it
can be an expensive source
of short-term finance.

Allows a company to raise

finance against invoiced
receivables. Invoices are
sold to a factor, which then
collects invoiced receivables
from the companys
customers.

Available in most
locations under a longerterm arrangement.
Requires company to
disclose the arrangement
to customers, as factor
will collect receivables.

Most suited to small and

medium-sized companies
where the company has a
relatively large number of
customers all trading on the
same terms.

Similar to factoring, in that

the company raises finance
against invoiced receivables.
However, the company
retains responsibility for
collecting receivables from
its customers.

As with factoring,
available in most
locations. Will require
the company to
open its accounts
receivable process to
the invoice discounter
before funding can be
arranged.

Suitable for companies with

a relatively large number of
customers all trading on the
same terms (as factoring), but
which want to retain control
over their sales ledger.

Supply chain finance

A technique which allows

companies to facilitate the
provision of credit to their
suppliers. It allows stronger
credits to leverage their own
credit status so that finance
can be provided to suppliers
at lower rates than they can
usually access themselves.

For a supply chain

finance structure to
work, one entity in
a particular supply
chain must have a
significantly stronger
credit status than most
of its suppliers.

For a programme to be
successful, there must
be an established trading
relationship between both
parties, who must each feel
confident that the structure is
in their mutual interest, both in
the short and longer terms.

A similar technique to invoice

discounting, although the
finance is usually arranged
on presentation of a debt
instrument, rather than an
invoice.

Only available against

a transferable debt
instrument.

Usually arranged against

receivables over a period of
two or more years, although
shorter terms can be possible.

Invoice discounting

Factoring

Negotiable
trade document

Nature of financing

Forfaiting

A Reference Guide to Trade Finance Techniques

The Treasurers Guide to Trade Finance

105

Availability

Often used where the

underlying goods are raw
materials, sometimes
perishable, easily moved and
saleable in their current state
(rather than as a finished
product), tradable and where
a terminal market exists to
hedge price risk.

The nature of the

commodity being
financed usually
determines whether the
financier wants to take
control of the commodity
itself as security for
the finance and also
what sort of financing is
required.

A useful technique which

significantly reduces credit
risk between a commoditys
producer, a trader and the
ultimate buyer.

Leasing

A technique allowing a
company to have access
to a particular asset without
necessarily having to hold the
full value of the asset on the
companys balance sheet.

Leases are commonly

available in almost all
locations.

An attractive technique for

companies seeking to ensure
the use of a particular asset
for a set period of time.

Project
finance

Usually arranged to finance

large-scale construction and
manufacturing projects, via
a separate entity which is
established to manage and
fund the project.

A variety of different
techniques are
available to provide
project finance to reflect
the requirements of the
various participants.

Best suited where a discrete

project can be identified
and where a number of
different companies will
be participating in the
construction process.

This refers to many different

techniques offered by banks
and other providers to
support a supply chain. These
techniques can be used to
support both domestic and
international trade. Common
forms include: pre-export
(pre- and post-shipment)
finance, warehouse finance,
prepayment finance, and
limited recourse financing.

There is no standard
technique for structured
trade finance.
Availability depends
on the nature of the
entities in a particular
supply chain and
the relationships the
company is seeking to
support.

Solutions can be tailored

to meet almost any set of
circumstances.

An escrow account is
used when a buyer and
a seller both want to
protect themselves against
counterparty risk.

Availability is dependent
on both parties agreeing
to use the same bank (or
other provider) to provide
the escrow account.

Best suited where the two

parties are unknown to each
other.

These provide a range

of support for companies
seeking to expand their
export sales.

Most countries operate

some form of export
credit scheme. The
scope of the different
schemes varies from
country to country.

Suitability will vary according to

the terms of the scheme offered
in the relevant country. In most
cases, a scheme will provide
support to smaller companies
seeking to expand its exports
and project finance for larger
companies engaged in foreign
infrastructure projects.

Export credit
schemes

Trade-related
escrow

Commodity financing

Nature of financing

Structured trade finance

Chapter 7 Trade financing techniques

106

Suitability

The Treasurers Guide to Trade Finance

A Reference Guide to Trade Finance Techniques

Bank lines of credit

As an alternative to an overdraft facility,
companies can arrange lines of credit with
one or more of their banks. These are
appropriate when the company requires
greater security of finance, or in locations
where overdraft facilities are prohibited or
not available.

How it works
The company can arrange a line of credit
with a bank, which it can draw against
as necessary. This will require formal
documentation to be drawn up between
the company and the bank, so a line of
credit will take longer to arrange than an
overdraft facility. The bank will charge an

arrangement fee (for establishing the facility),

a commitment fee (for putting funds aside for
the companys use) and a margin on all funds
actually drawn down from the facility.
Different credit lines are available. Some
will require all the committed lines to be
drawn down at the start of the facility and
then repaid over the term (a term loan).
Others will allow committed funds to be drawn
down and repaid as often as necessary (a
revolving facility), as long as the maximum
level of the commitment is never exceeded
at any one time. Banks require all committed
funds to be repaid at the end of the facility,
although it can be possible to roll one facility
into another without repayment.

Case study

A company using revolving credit facility to finance working

capital
A UK commodities trading company specialises in the international physical
trade of dried edible pulses (sesame seed, lentils, kidney beans, etc.).
Recently, the company has seen a noticeable increase in demand, and
approached its bank to discuss an increased facility that could meet the
consequent anticipated increase in the working capital needs of the business
over the following 1218 months.
One particular concern for the customer
was to avoid incurring an unnecessary
increase in costs associated with an
increased facility that might not see full
utilisation at the outset, but with the
anticipation that utilisation would rise as
additional demand and/or higher prices
kicked in. The banks solution was to
replace the existing overdraft structure,
which had suited the ongoing operational
needs of the business thus far, with a
smaller overdraft combined with a new
revolving credit facility arranged with core
facility limit to be available immediately,

The Treasurers Guide to Trade Finance

but with a further two tranches available at

the customers election within 30 days of
two specific pre-agreed dates, to coincide
with the forecast increase in demand.
From the banks point of view, the
restructured facility better reflected the
amount of debt required, whilst the
customer could confidently seek out new
business opportunities in the knowledge
that additional financing would be
available as and when required, with the
added benefit of only paying for the level
of facilities actually being used.

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Chapter 7 Trade financing techniques

Advantages
Lines of credit provide committed funds.
This means a company has access to
those funds for the term of the facility.
However, the company will need to be
aware that its bank may refuse to renew a
line of credit at the end of the term.
This form of bank finance is available
in all locations, including those where
overdrafts are not available or not
permitted.
Committed funds are generally available
at a lower cost than an overdraft facility.
If they wish, an international company
can diversify its sources of funding
by encouraging local subsidiaries to
access their local markets. This allows
the international group to diversify away
from reliance on the funding arranged at
the corporate centre. This is also useful
in locations which apply strict exchange
controls (making funding into and out of
the country difficult).

Disadvantages
The entire loan has to be repaid or
renegotiated at maturity (although
amortisation features can be included).
There is a risk that changed market
or business conditions may mean that
the companys banks decide to cease
lending to them, whether as an individual

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counterparty or as part of a wider

withdrawal from their industry. If the funds
are not needed, this can be an expensive
element of security. This is because
the company will need to pay both an
arrangement fee and then a commitment
fee on the undrawn funds.

Evaluation
Bank lines of credit are widely available to
companies of all sizes. As such they are often
a core source of working capital finance,
especially for smaller companies and foreign
subsidiaries of large international groups.
Where possible, treasurers need to be able
to negotiate appropriate terms, which do not
place too many inappropriate restrictions on
the companys operations. They also need
to be aware of their lenders future plans,
especially if there are signs the bank may
withdraw from, or want to reduce its exposure
to, their particular market, in which case
facilities should be renegotiated or replaced
well before their final end date.
A bank line of credit can be provided on
an uncommitted basis, in which case its
availability is in many ways no more reliable
than that of an overdraft. The draw down
mechanics will be different, in that loans
are usually taken for set periods, often a
month at a time, rather than simply varying
continuously like an overdraft.

The Treasurers Guide to Trade Finance