SUPPLIER CREDIT

Supplier credit is a non-bank financing modality in companies. It consists of acquiring the

raw material necessary for the production process, assuming a commitment to pay in the
future without interest charges.

In other words, the company negotiates with its supplier (s) to stock up on inputs without having
to pay them in cash. Thus, there is an outstanding debt that must usually be paid in 30, 60 or 90
days and where financial expenses are not generated.

Advantages and disadvantages of supplier credit

Among the advantages of supplier credit, the following stand out:

 It allows the development of productive activity without the need to lose liquidity,
maintaining greater resources in cash and its equivalents.
 Capital is released that can be used for other expenses or emergencies in the short term.
This is important taking into account that, in general, a part of the sales of the companies
is on credit. That is, even if the company has made transactions of a large volume, the
cash inflows may not be as high.
 It is requested according to the needs of the company. The time to pay suppliers can then
be matched with the date of collection for sales.
 Usually does not require guarantees.
 There is no interest payment.
 Increases the volume of sales, both for the supplier and the financed organization.
However, there are also some disadvantages:

 If the company makes use of credit, it loses the opportunity to obtain a discount for
prompt payment. Sometimes, the borrower can access a reduction of his debt if he
cancels it in a very short term.
 As in any financing modality, there is a credit risk, which in this case is assumed by the
provider.
 The supplier can inflate the price of its product to recoup the cost of the loan, so
financing could be expensive even if there is no interest.
 The destination of the credit is limited to the acquisition of inputs with a specific supplier.
Stages of supplier credit

The stages of supplier credit are as follows:

 Analysis of potential debtors: It is the process to determine the solvency of the client.
Variables such as the company’s equity, its financial ratios and credit history are taken
into account. For the latter, the credit bureaus are consulted.
  Establishment of credit conditions: If the operation is approved, the main
characteristics of the financing are set, such as the term for payment and late fees. The
provider usually also offers a discount for prompt payment. Thus, the borrower has the
option of canceling his obligation before the agreed period, agreeing to a reduction of his
debt.
 Credit instrumentation: The financing is materialized with some type of contract, such
as a promissory note, bill of exchange or documentary credit.
 Delivery of the merchandise: The company obtains the inputs for the production
process.
 Payment of the credit: After the agreed time, the provider should receive the respective
compensation, although there is always the probability of non-payment.
Supplier credit example

A company makes a purchase from its supplier for US $ 15,000. They agree that payment must
be made in 60 days. If the debt is paid off in 30 days or less, the lender offers a 5% discount.
Also, in case of delay, a commission of 0.8% per day will be applied.

If the debtor takes advantage of the discount, he will pay US $ 14,250. On the contrary, if it takes
10 days more than agreed, for example, you will have to pay US $ 16,200.

TRADE CREDIT
Trade credit is where one business provides a line of credit to another business for buying
goods and services.
For example, a garden landscaping business might use trade credit to buy materials for a
landscaping project, buying on credit and promising to pay within a set term – usually 30 days.
As a business, you can offer trade credit to other companies and also use trade credit facilities
offered by other companies.
Trade credit is less formal than a loan from a bankopens in new window, though there are
usually terms and conditions attached, including penalties and interest for late payments.
Trade credit is a mutually beneficial arrangement – customers are able to buy goods on credit,
and suppliersopens in new window can attract more customers by not demanding cash up
frontopens in new window.
Trade credit advantages and disadvantages are different depending on whether your business is
the buyer in the agreement and using trade credit, or a supplier of trade credit.
Before accepting trade credit, it’s best to know the positives and negatives of any agreement.

Advantages of trade credit for buyers

While there are some trade credit disadvantages for buyers, there are overwhelming more
advantages for businesses looking to use trade credit to buy goods, materials and services
without having to pay up front or on delivery.
 Benefits range from accessibility and cash flow advantages to helping new startup
businesses get off the ground.
  Help startup businesses get up-and-running
Trade credit can be useful for new businesses unable to raise funding or secure business loans,
yet need stock quickly.
However small businesses can be hamstrung by a lack of trading history which makes obtaining
trade credit difficultopens in new window.

 Get a competitive edge

Buying goods as required on credit gives businesses a competitive advantageopens in new
window over rival firms that may have to pay upfront.
Using trade credit allows your business to be more flexible, adapting to market demands
and seasonal variation so that you have a constant supply of goods even when your finances
aren’t stable.

 No cash required upfront

With no need to pay cash up front, buyers can stock up in time for peak demandopens in new
window, such as placing bigger orders to take advantage of key seasonal selling times such as
Christmas.
Trade credit is an advantage as cash flow may be low coming off quieter months, potentially
preventing enough stock to be purchased for peak selling times.

 Fuels business growth

Think of trade credit as an interest-free loan.
It’s one of the best ways to keep cash in your business, effectively providing access to working
capital at no cost.
There’s less administration compared to arranging a short-term loan.
Instead, rather than using cash reserves on stock, your business is effectively selling goods on
behalf of the supplier and getting a profit for doing so.

 Easy to arrange
If your business has a good credit historyopens in new window, is able to meet a supplier’s
requirements and has the ability to make regular payments then trade credit agreements are
typically easy to arrange and maintain.
There are few formal arrangements or negotiations to complete, making it quick-&-easy to use.

 Increases your company’s reputation

Demonstrating your business can make regular payments against credit is a good way of
establishing and maintaining your company as a valuable customer.
A good trade credit history can mean suppliers treat you as a

 Discounts and bulk buying

Suppliers may offer appealing discounts to trade credit customers who pay early, making it a
useful way to obtain a discount.
Companies with a good trade credit history may be offered discounts, especially for bulk
purchases, or exclusive access to goods and services.
Advantages of trade credit for sellers
For suppliers, trade credit is all about winning new customers, increasing sales and retaining
customer loyalty.

 Winning new buyers

Buyers like trade credit.
It’s an easy way to ease cash flow, which can help improve a small business’s profitability.
As a supplier, offering trade credit is a useful tactic to win new customers – especially if
competitors insist on payment upfront.

 Sell more goods and services

Suppliers can mix trade credit with bulk discounting to encourage buyers to spend more.
If buyers quickly sell out of stock, they are more likely to return and buy additional stock to
meet customer demend.

Improve buyer loyalty

Supplier trade credit can prevent buyers from looking elsewhere and strengthens the supplier-
buyer relationship.
Trade credit relies on trust between the two parties, good communication, and a mutually-
beneficial relationship that can reinforce loyalty.

DISADVANTAGES OF TRADE CREDIT FOR BUYERS

While there are fewer downsides in terms of trade credit advantages and disadvantages for
buyers than suppliers, there are still potential drawbacks that are worth understanding.
Access to free credit can seem a lifeline for a cash-strapped business but if the fundamentals of
your business mean you’re likely to miss repayments, you might want to think again about
relying on trade credit.

Hard to obtain for startups

Trade credit seems perfect for startups.
Access to stock without upfront payment could help get your business up-and-running.
However, trade credit is significantly harder for new businesses to obtain or it may be offered on
restrictive repayment terms.
Until your business has established itself and built up a consistent trading history, some suppliers
will be reluctant to offer your business trade credit.

Penalties and interest

While trade credit is effectively ‘free money’ and can be repaid without interest, missing
repayment deadlines can turn ‘free money’ into ‘expensive debt’.
Most trade credit terms and conditions include penalties for late payments and interest payable
on outstanding credit.
This can quickly spiral into significant costs if your business doesn’t work to clear trade credit
debts.
Legal action
Fall behind on trade credit payments and your business could face legal action, including goods
and assets being seized to pay outstanding bills.

Negative impact on credit rating

Prompt repayments of credit is good for your business’s credit rating; missed deadlines and late
payments can quickly harm your rating.
That can have an impact when your business later seeks to raise finance such as obtaining a , as a
poor credit rating can affect the amount of interest you’ll have to pay or even if you can secure a
loan in the first place.

Loss of suppliers
When faced with a poor-paying buyer, suppliers may be tempted to cut their losses and refuse to
work with your business.
Suppliers can pull the plug on working with you, leaving your business unable to operate or meet
customer demand – potentially resulting in the closure of your business.

Disadvantages of trade credit for suppliers

The bad news for suppliers is they tend to carry a larger part of the risk in the trade credit
advantages and disadvantages equation.
While there are lots of routes open to deal with problem buyers and getting back money your
business is owned, these can be time-consuming and costly – potentially impacting your cash
flow and causing financial problems.

Late payments
Buyers paying late is the major problem suppliers face when offering trade credit.
Depending on your industry, be prepared that most buyers will sometimes pay late.
According to Creditsafe, more invoices are paid late than on time.

Cash flow problems

Late payments or buyers simply not paying at all can lead to serious cash flow problems for
suppliers.
With the need to pay their own outstanding bills, suppliers can be effectively caught between
demands from creditors for payment and chasing after buyers for overdue cash.
Ensure your business has a strong cash reserve and doesn’t overextend on credit.
Offering discounts to buyers who make early repayments can also help alleviate cash flow
problems caused by late payers.

Bad debt
Late payments are one thing, but non-payment can present a serious challenge.
Customers using trade credit may go out of business or payment may simply be too difficult to
chase down, which means your business will need to write off the loss as a bad debt.
It’s worth investigating trade credit insurance, which can insure your business for bad debt
caused by defaults on trade credit agreements.
Customer assessment
Offering trade credit is an act of trust.
Assessing whether a customer has the means to repay you is worth doing right, but determining a
buyer’s credit worthiness can be time-consuming.
You’ll need to check references, obtain credit reports and review trading history – all of which
takes time.

Account handling
Offering trade credit involves a lot of paperwork and administration.
As a supplier, you’ll need to get professional legal to write terms and conditions, and you’ll need
dedicated account handlers to ensure that outstanding invoices are chased up.
Setting clear invoice terms and ensuring good communication can help encourage buyers to pay
promptly and regularly.
Investigate online account software with CRM and invoicing – they often include free alerts
when invoices are due.

INVOICE DISCOUNTING

Invoice discounting is a financial service in which a provider lends cash to a company up to the
value of its unpaid invoices.

Many international Suppliers work with deferred invoice payment terms - often up to 120 days -
which can put a strain on their finances. Many Suppliers also struggle to qualify for bank
loans to ease their cash flow due to having a short or poor credit history.

However, a Supplier can apply for invoice discounting from lenders that will accept unpaid
invoices (accounts receivable) as proof of money owed. The lender will advance money to the
Supplier and use the invoice(s) as collateral. On the due date, the Buyer settles the invoice and
the Supplier returns the borrowed amount to the lender and pays a pre-agreed service fee.

How Does Invoice Discounting Work?

A typical invoice discounting agreement includes the following steps:

1. A Supplier sells goods to a Buyer and raises an invoice, often with deferred payment
terms of up to 120 days.
2. The Supplier needs working capital, so submits the invoice to an invoice discounting
provider, presenting it as security for a short-term loan.
3. The invoice discounting provider evaluates the invoice and creditworthiness of the Buyer
and agrees to advance a percentage (often up to 95%) of the invoice total as a short-term
loan.
4. The provider charges a pre-agreed fee, typically 1-3% of the loan.
5. The Buyer pays the invoice within the agreed 120-day window.
6. The Supplier pays back the borrowed amount to the invoice discounting provider, plus
the pre-agreed service fee.
Example of Invoice Discounting

ABC Supplier Ltd exports goods worth £10 000 (GBP) to its overseas buyer, XYZ Buyer Ltd,
and raises an invoice with 90-day payment terms.

However, ABC Supplier needs immediate working capital to pay its bills so it submits the
unpaid invoice to an invoice discounting provider as proof of owed income.

The invoice discounting company agrees to provide ABC Supplier with 95% of the invoice
value immediately – totalling £9 500 (GBP) – in exchange for a fee of 2% of the lent amount
when the invoice is paid. This fee will amount to £190 (GBP).

XYZ Buyer pays the total £10 000 (GBP) invoice in 90 days and ABC Supplier repays the
borrowed sum to the invoice discounting provider, plus the pre-agreed 2% service fee.

The short-term trade financing loan is now paid off, and there are no long-term repayment plans
or obligations that could affect ABC Supplier’s credit score.

Benefits of Invoice Discounting

Invoice discounting provides plenty of benefits for small- and medium-sized enterprises (SMEs).
Some of the key benefits include:

 Easy and fast access to working capital that would otherwise be tied up in unpaid
invoices.
 Improved cash flow for Suppliers to pay their own suppliers or invest in the growth of the
company.
 Finance approval is based on individual invoices rather than credit history or long-term
forecasts, making it more likely that companies are given finance.
 Discounting fees usually never exceed 1-5% of an invoice amount. (N.B. This figure
depends on the terms of your facility and can vary between financiers).
 Companies are not subjected to long-term, high-interest repayment agreements.
 The invoice discounting application process is usually much simpler and quicker than
applying for a bank loan.
 Invoice discounting is usually confidential, so the Buyer never knows that the Supplier
has borrowed from a third party.

Is Invoice Discounting Right for My Business?

Suppliers working regularly with deferred payment terms can benefit from invoice discounting.
It might also be a good choice for any Supplier experiencing:

 Rapid growth - Working capital is essential to fund new equipment, facilities and staff
to support growth. Invoice discounting allows companies to access cash quickly rather
than wait weeks or months for invoice payments.
  Cash flow problems - Invoice discounting frees up working capital to cover business
expenses.
 Refusal for loans from banks - Many Suppliers may simply be refused loans from
banks due to limited or poor credit history. If a Supplier does get a bank loan, it often
comes with long-term repayment plans and high interest rates, which can prove difficult
to commit to. Invoice discounting ensures that cash is granted to cover money already
owed to the Supplier, with the matter closed as soon as the invoice is paid.

Invoice Discounting Advantages and Disadvantages

Sr. No. Advantages Disadvantages

1 Get Fast Cash Decreased profit

2 Release Cash that has been Locked in Invoices Industry sentiment

3 Faster way to take short term finance Offered on only commercial invoices.

4 Better way for unsecured business loan Volatile

5 Help in Quick Financial growth

ADVANTAGES OF INVOICE DISCOUNTING

Fast cash: The very obvious advantage of invoice discounting is that it allows you to raise cash
quickly for exploiting a new business opportunity. Liquid cash becomes available as soon as an
invoice is issued, which in turn can be used to boost sales, pursue growth targets, invest in capital
or repay critical debts.
Release locked finances: Invoice discounting helps you release cash that has been locked in
customer invoices for an extended period of time. It is especially beneficial in cases where
contractual obligations have been fulfilled early but the payment is due as per the original
schedule.
Short turnaround time: Unlike other business loans, invoice financing is a faster way to get a
business loan. Once you become a trusted partner of an invoice financing NBFC like LivFin, you
can permanently reduce the collection period of your invoices by submitting them for invoice
financing.
No risk to assets: Invoice financing offers unsecured business loans in lieu of your invoices and
hence does not pose any risk to your company’s movable assets.
Boosts credit sales: Since invoice discounting can help convert credit sales into cash, it helps in
quick growth and exploitation of new opportunities for an SME.
DISADVANTAGES OF INVOICE DISCOUNTING
Decreases profits: A possible downside of invoice financing is the interest and processing
charges that accompany any business finance. In the short-term, a company may witness reduced
profits on invoices that have been financed. However, the prospect of growth and early access to
cash generally offset this disadvantage.
Industry sentiment: Some stakeholders frown upon excessive use of invoice financing. But just
like every business loan product, invoice financing is a means to an end and not the means in
itself. A prudent business understands that fact and balances its borrowings while also
strengthening internal credit policies.
Borrowings on commercial invoices only: Due to the unsecured nature of this mode of finance
and the risk involved for the lender, invoice financing is generally offered on commercial
invoices. This may be a detriment for company’s which deal with general public and wish to
raise funds via invoice financing.
Volatile: Invoice financing only offers partial or full funding for current accounts receivables and
thus may not be adequate if a business is seeking a particular amount of business loan.

FACTORING
Factoring in finance is a source of immediate capital. It is acquired in exchange for
accounts receivable. Hence, it is a financial arrangement between a financial institution
(factor) and a small or medium-sized firm (client). A factor purchases trade debts or
receivables from a client firm at a discounted price.
Factoring involves three parties—a factor, a client, and a debtor. The factor is the financial
institution that offers finance to a client (in exchange for receivables). The client is the firm that
sells its receivables; the debtor is the party who owes the trade debt. The debtor, therefore, ends
up paying the factor instead of the original business.

Factoring In Finance Explained

Factoring in finance is used to generate quick money. Firms transfer their right to collect
accounts receivables to a third party—a factoring company. The factoring company extends
money to small and medium-sized firms in exchange for accounts receivables.

The factoring company is also referred to as a factor. So, the factoring company buys unpaid
invoices at a lower or discounted price from a firm (client). The client provides a margin or
commission to the factor. The factor encashes accounts receivables (collected from the debtors)
on the due date.

Such a trade debt would involve immense credit risk. If a debtor defaults on an outstanding
payment, the liability to pay the invoice value falls on the client. However, if it is a non-recourse
factoring, then the factoring company bears the credit risk.
Simply put, this arrangement resembles a loan—short-term financing raised against accounts
receivables. Here, accounts receivables are shown as a current asset on the company’s balance
sheet.

Often, small or medium-scale firms make excessive credit sales and run short of operating cash.
Due to this, they cannot meet their short-term financial obligations— electricity bills, rent,
salary, etc. In such scenarios, factoring comes in handy. Struggling firms can clear cash
flow deficits and pay off immediate expenses. To avail of such provisions, the client’s
accounting books must reflect transparency and fairness.

BENEFITS

Even after efficient cash flow management, business entities regularly face a cash crunch. Thus,
factoring is crucial in fulfilling an urgent need for capital.

Given below are the various advantages of factoring in finance:

 Facilitates Short-Term Financial Needs: By utilizing this provision, businesses meet

numerous operational expenses such as salary disbursement, bill settlement, payment
to creditors, inventory purchase, etc.
 Provides Liquidity: It allows companies to convert their trade receivables into cash in
an emergency.
 Non-recourse Factoring Protects Against Bad Debts: The non-recourse option
transfers the credit risk and the receivables. This way, clients insulate themselves from
bad debts.
 Boosts Working Capital: When companies run out of working capital, they can raise
additional funds quickly.
 No Collateral Required: Since the factor extends funds in exchange for the receivables,
the client firm is not required to submit any collateral.
 Easily Available: Compared to business loans, factoring is easier to avail. Business loans
require thorough background checks and credit rating checks.

DRAWBACKS

Factoring also has certain drawbacks that cannot be overlooked.

 Primarily, it reduces the profit margin for client firms.

 Also, the factor’s decision depends upon the debtors’ credibility.
 Some customers may not prefer factoring addition; the factor directly deals with the
debtor (customer), which may hinder the relationship between the client firm and the
debtor (customer).
 Also, desperate firms end up incurring hidden costs. It further increases the financial
burden of a struggling firm.

What are the types of factoring in finance?

 The different types of factoring in finance include:
– Recourse and non-recourse factoring
– Domestic and export factoring
– Disclosed and undisclosed factoring
– Advance and maturity factoring

FORFAITING
Forfaiting is a means of financing that enables exporters to receive immediate cash by selling
their medium and long-term receivables—the amount an importer owes the exporter—at a
discount through an intermediary. The exporter eliminates risk by making the sale without
recourse. It has no liability regarding the importer's possible default on the receivables.

The forfaiter is the individual or entity that purchases the receivables. The importer then pays
the amount of the receivables to the forfaiter. A forfaiter is typically a bank or a financial firm
that specializes in export financing.

KEY TAKEAWAYS

 Forfaiting is a type of financing that helps exporters receive immediate cash by selling
their receivables at a discount through a third party.
 The payment amount is typically guaranteed by an intermediary such as a bank, which is
the forfaiter.
 Forfaiting also protects against credit risk, transfer risk, and the risks posed by foreign
exchange rate or interest rate changes.
 The receivables convert into a debt instrument—such as an unconditional bill of
exchange or a promissory note—which can then be traded on a secondary market.
 While these debt instruments can have a range of maturities, most maturity dates are
between one and three years from the time of sale.

How Forfaiting Works

A forfaiter's purchase of the receivables expedites payment and cash flow for the exporter. The
importer's bank typically guarantees the amount.

The purchase also eliminates the credit risk involved in a credit sale to an importer. Forfaiting
facilitates the transaction for an importer that cannot afford to pay in full for goods upon
delivery.

The importer's receivables convert into a debt instrument that it can freely trade on a secondary
market. The receivables are typically in the form of unconditional bills of
exchange or promissory notes that are legally enforceable, thus providing security for the
forfaiter or a subsequent purchaser of the debt.

These debt instruments have a range of maturities from as short as one month to as long as 10
years. Most maturities fall between one and three years from the time of sale.
Advantages and Disadvantages of Forfaiting

Advantages
Forfaiting eliminates the risk that the exporter will receive payment. The practice also protects
against credit risk, transfer risk, and the risks posed by foreign exchange rate or interest rate
changes. Forfaiting simplifies the transaction by transforming a credit-based sale into a cash
transaction. This credit-to-cash process gives immediate cash flow for the seller and eliminates
collection costs. Additionally, the exporter can remove the accounts receivable, a liability, from
its balance sheet.

Forfaiting is flexible. A forfaiter can tailor its offering to suit an exporter's needs and adapt it to
a variety of international transactions. Exporters can use forfaiting in place of credit or
insurance coverage for a sale. Forfaiting is helpful in situations where a country or a specific
bank within the country does not have access to an export credit agency (ECA). The practice
allows an exporter to transact business with buyers in countries with high levels of political risk.

Disadvantages
Forfaiting mitigates risks for exporters, but it is generally more expensive than commercial
lender financing leading to higher export costs. These higher costs are generally pushed onto the
importer as part of the standard pricing. Additionally, only transactions over $100,000 with
longer terms are eligible for forfaiting, but forfaiting is not available for deferred payments.

Some discrimination exists where developing countries are concerned compared to developed
countries. For example, only selected currencies are taken for forfaiting because they have
international liquidity. Lastly, there is no international credit agency that can provide guarantees
for forfaiting companies. This lack of guarantee affects long-term forfaiting.

Real World Example

The Black Sea Trade & Development Bank (BSTDB) lists forfaiting in its list of special
products along with underwriting, hedging instruments, financial leasing, and discounting.
BSTDB was established as a source of financing for development projects by 11 founding
countries—Albania, Armenia, Azerbaijan, Bulgaria, Georgia, Greece, Moldova, Romania,
Russia, Turkey, and Ukraine.1

The bank explains that "the importer’s obligations are evidenced by accepted bills of exchange
or promissory notes which a bank avals, or guarantees." The minimum operation size that
BSTDB will finance through forfaiting is euro 5 million with a repayment period of one to five
years. The bank may also apply option, commitment, termination, or discount rate fees.2

BUYER CREDIT
Buyer's credit is a short-term loan facility extended to an importer by an overseas lender such as
a bank or financial institution to finance the purchase of capital goods, services, and other big-
ticket items. The importer, to whom the loan is issued, is the buyer of goods, while the exporter
is the seller. Buyer’s credit is a very useful financing method in international trade as it gives
importers access to cheaper funds compared to what may be available locally.

KEY TAKEAWAYS

 Buyer's credit is a short-term loan to an importer by an overseas lender for the purchase
of goods or services.
 An export finance agency guarantees the loan, mitigating the risk for the exporter.
 Buyer's credit allows the buyer, or the importer, to borrow at rates lower than what
would be available domestically.
 With buyer's credit, exporters are guaranteed payment(s) on the due date.
 Buyer's credit allows an exporter to execute large orders and allows the importer to
obtain financing and flexibility to pay for large orders.
 Because of the complexity involved, buyer's credit is only made available for large
orders with minimum monetary thresholds.

Understanding Buyer's Credit

A buyer’s credit facility involves a bank that extends credit to an importer of goods, as well as
an export finance agency based in the exporter's country that guarantees the loan. Since buyer’s
credit involves multiple parties and cross-border legalities, it is generally only available for
large export orders with a minimum threshold of a few million dollars.

The availability of buyer’s credit also makes it possible for the seller to pursue and execute
large export orders. The importer obtains the flexibility to pay for the purchase over a period of
time as stipulated in the terms of the credit facility. The importer can also request funding in a
major currency that is more stable than the domestic currency, especially if the latter has a
significant risk of devaluation.

The export finance agency's involvement is critical to the success of the buyer’s credit
mechanism. That's because its guarantee protects the financial institution making the loan from
the risk of non-payment by the buyer.

The export finance agency also provides coverage to the lending bank from other political,
economic, and commercial risks. In return for this guarantee and risk coverage, the export
agency charges a fee that is paid for by the importer. Costs associated with buyer's credit
include interest and arrangement fees on the loan.

Buyer's credits are often confused with letters of credit; however, they are different products. A
buyer's credit is a loan facility whereas a letter of credit is a promise by a bank to a seller that
payment will be received on time, and if the buyer cannot pay, the bank will be responsible for
the entire amount of the purchase.

Buyer's Credit Process

There are several steps involved in the buyer's credit process. The exporter first enters into a
commercial contract with a foreign buyer or importer. The contract specifies the goods or
services supplied along with prices, payment terms, etc.

The buyer then obtains credit from a financial institution for the purchase. An export credit
agency based in the exporter’s country provides a guarantee to the lending bank to cover the
risk of default by the buyer.

Once the exporter ships the goods, the lending bank pays the exporter according to the contract
terms. The buyer makes principal and interest payments to the lending bank according to the
loan agreement until the loan is repaid in full.

Advantages of Buyer's Credit

Buyer’s credit benefits both the seller and the buyer in a trade transaction. As mentioned above,
borrowing rates are generally cheaper than what an importer may find with domestic lenders.
The rates are typically based on London Interbank Offered Rate (LIBOR); the point of reference
for most short-term interest rates. The importer also gets an extended amount of time for
repayments, rather than having to pay upfront at once directly to the exporter.

Another benefit extends to the exporter. Payment is made on time on the due date or according
to the terms of the sales contract with the importer without any undue delays. The certainty of
the time of payment helps to manage loan receivables, which in turn allows a financial
institution to manage its deposits and regulatory requirements.

PRE-SHIPMENT

Pre-shipment finance can be a useful tool for businesses that need to secure financing to
complete a production run or meet customer demand but need more cash on hand.

It can help businesses to manage their cash flow and ensure that they have the necessary funds to
complete their production and delivery schedules. Read more to get an in-depth knowledge of
pre-shipment finance.

Meaning of Pre-Shipment Finance

Pre-shipment finance is a type of financing solution that is provided to a business before the
goods or products have been shipped to the customer.

It is typically used to cover the costs of production, such as raw materials, labour, and
transportation, as well as any other expenses incurred before the goods are ready to be shipped.

Pre-shipment finance can be provided by banks, financial institutions, or other lenders and is
typically secured by the goods being produced or by a letter of credit from the customer.
It is usually provided for a short period, typically around 30 to 90 days, and is intended to help
the business bridge the gap between the time the goods are produced and the time the customer
pays for them.
What are the Types Of Pre-Shipment Finance?

The prominent types of pre-shipment finance include:

Extended Packing Credit Loan

Extended packing credit loan is a type of pre-shipment finance provided to businesses to cover
the costs of production and packing of goods being exported.
It is typically provided by banks or other financial institutions and secured by the goods being
produced or by a letter of credit from the customer.

The loan is intended to help the business cover production costs, including the purchase of raw
materials, labour, and transportation, as well as the costs of packing the goods for export.

Packing Credit Loan (Pledge)

A packing credit loan (pledge) is a type of pre-shipment finance provided to businesses to cover
the costs of production and packing of goods being exported.

It is typically provided by banks or other financial institutions and secured by a pledge of the
goods being produced or by a letter of credit from the customer.

A pledge is a legal agreement in which a borrower gives the lender the right to seize and sell
certain assets if the borrower fails to repay the loan.

In the case of a packing credit loan (pledge), the goods being produced or exported are used as
collateral for the loan.

Packing Credit Loan (Hypothecation)

The loan is typically extended by a bank or financial institution and secured by a hypothecation
agreement, which is a legal document that allows the lender to seize the goods being financed if
the borrower defaults on the loan.

The lender may also require collateral, such as real estate or other assets, to secure the loan.

Advances Against Red Clause L/C

An advance against a red clause letter of credit (L/C) is a type of loan that is extended to a
business based on the strength of a red clause letter of credit issued by a bank.

A red clause letter of credit is a special type of L/C that allows the beneficiary (usually the seller
of goods or services) to request an advance payment before the goods or services are shipped.
The advance payment is typically made by the bank issuing the red clause L/C and secured by
the L/C itself.

Pre-Shipment Credit in Foreign Currency (PCFC)

In India, pre-shipment credit in foreign currency (PCFC) is a type of short-term loan that banks
and financial institutions extend to businesses to finance the purchase and transportation of
goods or services that are being exported.
The loan is typically secured by the goods or services being exported and denominated in the
importing country's currency.

PCFC loans are typically used to cover the cost of purchasing raw materials, transportation and
other related expenses.

They are often used by businesses to finance the export of goods or services to foreign countries
and typically offered to businesses that have a good credit history and a proven track record of
exporting.

What are the Documents Required for Pre-Shipment Finance?

In India, the documents required for pre-shipment finance will vary depending on the specific
circumstances of the export transaction and the type of financing being used. However, some
common documents that may be required include:

Export contract:
This is the main document outlining the terms and conditions of the export transaction, including
the goods being sold, the price, and the payment terms.

Proforma invoice:
This is a preliminary invoice that provides an estimate of the total cost of the goods being
exported. A proforma invoice may be used to obtain financing or as a basis for the final invoice.
Letter of credit:
This is a financial instrument issued by a bank on behalf of the buyer, which guarantees payment
to the exporter once the goods have been shipped and the required documents have been
presented.

Shipping documents:
These documents include the bill of lading, which is a receipt for the goods being shipped, and
the commercial invoice, which is a detailed list of the goods being exported and their associated
costs.

Insurance documents: These documents, such as a marine insurance policy, protect against the
risk of damage or loss to the goods during shipping.
Certificates of origin:
The certificates of origin documents are essential to show that the exported goods originate from
a specific country and may be required for certain types of goods or markets.
What is the Pre-Shipment Finance Procedure?
In India, the pre-shipment finance procedure typically involves the following steps:

1. Identify the need for financing:

Businesses should first assess their financial needs and determine whether they require pre-
shipment finance to cover the costs of purchasing and transporting goods or services for export.

2. Research and compare lenders: Businesses should research and compare different lenders,
including banks and financial institutions, to find the best pre-shipment finance options for their
needs.
3. Prepare and submit a loan application:
Businesses should prepare and submit a loan application to the lender of their choice.

The application should include information about the business, the goods or services being
exported, the requested financing, and any collateral the business is willing to provide.

4. Review and negotiate the loan terms:

Once the loan application has been received, the lender will review it and may request additional
information or documentation.

The business and the lender will then negotiate the loan terms, including the interest rate,
repayment schedule, and any fees or charges.

5. Sign the loan agreement:

If the business and the lender agree on the terms of the loan, they will sign a loan agreement
outlining the terms of the loan.

6. Obtain the loan:

Once the loan agreement has been signed, the lender will disburse the loan to the business, which
can then use the funds to purchase and transport the goods or services for export.

What are the Benefits of Pre-Shipment Finance?

There are several benefits to using pre-shipment finance, including:

Improved cash flow:

Pre-shipment finance can help businesses to improve their cash flow by providing the funds
needed to purchase and transport goods or services for export.

This can allow businesses to manage their financial resources better and reduce the risk of
financial difficulties.

Enhanced competitiveness:
Pre-shipment finance can enable businesses to better compete in international markets by
providing the funds needed to take advantage of export opportunities.

Increased flexibility:
It can provide businesses with greater flexibility in their operations by allowing them to finance
the purchase and transportation of goods or services for export as needed.

Reduced risk:
Pre-shipment finance allows businesses to reduce the risk of financial losses by providing the
funds needed to purchase and transport goods or services for export.

This can help businesses to manage their risks better and increase their chances of success in
international markets.

Improved supplier relationships:

It can help businesses to strengthen their relationships with suppliers by providing the funds
needed to purchase goods or services for export on time.

This empowers businesses to secure better terms and conditions with their suppliers, which can
improve their competitiveness and profitability.

What are the Risks of Pre-Shipment Finance?

There are several risks involved in pre-shipment finance, including:

Credit risk:
Credit risk is the risk that the buyer will not be able to make the required payments due to
financial difficulties or bankruptcy.

Political risk:
This explores the risk that political events, such as revolutions, coups, or wars, may disrupt trade
or result in non-payment.

Exchange rate risk:

The risk includes the possibility of fluctuations in exchange rates that will affect the value of the
payment in the exporting company's domestic currency.

Shipping risk:
This is the threat of goods being damaged or lost during shipping.

Documentation risk:
This includes the risk that documents required for the export, such as letters of credit or
insurance documents, will be incorrect or incomplete.

Fraud risk:
It entails the danger that the buyer or intermediaries involved in the transaction will commit
fraud or engage in deceptive practices.

To mitigate these risks, exporters can use a variety of tools and strategies, such as obtaining
credit insurance, using letters of credit, and conducting thorough due diligence on buyers.