Import finance is a critical tool used by international traders. This kind of financing allows traders to run operations seamlessly without cash flow issues disrupting affairs. Also known as trade finance or inventory finance, import finance is particularly useful for international trade. Cross border trade typically has a long cash cycle and import finance supports a traders business’s cash flow.
Import financing defined – What is import finance?
The financing used to bridge the gap between the goods received via import and the payment made is known as import financing. This kind of international trade financing is the capital that allows the trader to import goods from a different country. By ensuring that the company/ trader’s cash flow is not restricted by having to fund the import, a financial institution helps the importer preserve their cash reserves and sustain cash flow.
Import Finance Examples
To give an example, Company XYZ needs to purchase a special kind of product from China, Mexico, or other countries. The prorduct is expensive, and getting it into Company XYZ’s country, the U.S.A., involves complexities that typically bring in a long gap between the order placement and product delivery. If the importer pays for the product from their balance sheet, they have severely restricted cash flow for a long period.
This delay affects the business without any significant value being added during the waiting phase. Import financing takes the burden of financing the purchase during the waiting period off the importer’s shoulders.
If the import business doesn’t have the funds to procure the product up front, there are other working capital financing solutions and credit options available. The importer may choose to utilize purchase order financing to help purchase the product. This financing occurs ahead of the invoice finance programs. It gives the trader the ability to pay foreign suppliers even if they have insufficient funds and money on hand to do so.
The financing works through a third party involved in the transaction apart from the buyer and seller of goods. This third party provides the finances to the buyer and also hedges the risk for the seller.
Why and when is import financing used?
Import financing facilitates and eases international trade in many ways. It boosts import-export transactions and helps global economies flourish. Financial institutions offer various import financing options based on buyer’s creditworthiness, business operations, and other assets. Here’s a more detailed look at why and when import financing is used on a case by case basis:
Frees up cash flow and working capital
Importing goods can be a very expensive affair that requires significant working capital requirements from the importer. Import financing allows the buyer to avoid locking up their own cash reserves when making full payment for product. In many cases such businesses can be out large sums of capital for 90-180 days before getting paid on an international transaction.
Increases the buyer’s purchasing credit
International trade comes with several risks for the seller. If they have to export their goods to a buyer who is not even geographically close by, they take on considerable risk. This risk can prevent newer companies from being able to buy quality goods.
Import financing reduces the risk for sellers by delinking the payment from the buyer as soon as the goods are dispatched. A buyer whose purchasing credibility is backed by an import financing institution is more likely to find a seller in international markets.
Mitigates risk for the buyer too
Most overseas traders will agree to dispatch goods only if they can get the payment without delay when the shipment leaves their hands. The importer cannot make payment without having some assurance of receiving the goods. This is a huge risk for them. The import finance institution mitigates the buyer’s risk here too by taking the onus of payment away from the buyer and onto themselves but without increasing risk to the buyer.
In a typical transaction The import finance company verifies the goods have been dispatched before releasing payment, thus protecting the buyer’s interests. In order to do this they may want to see shipping documents, inspection reports for raw materials, and other information.
Eliminates payment delays
The import finance option ensures that no matter what the buyer’s business’s financial state is, the payment for the goods ordered from overseas markets is not affected.
A buyer shouldn’t restrict their production because the goods they need are in short supply locally or unavailable. Similarly, the seller need not restrict themselves only to local buyers and limit their profits. They can expand their user base globally without risk. This expands markets for both the buyer and the seller.
Different types of import financing
The term import financing is a blanket term covering a variety of financial instruments. For example:
Letter of credit
The lending institution(or a bank) issues a letter of credit to the exporter’s bank, guaranteeing the payment for the goods being sent. The seller is sure to receive payment once they dispatch the goods. The buyer is assured of the goods being dispatched. The buyer has their own payment terms for the letter of credit with the import financing institution they partner with.
A letter of credit, similar to a bank guarantee, are a financial tool also used for infrastructure projects. In these cases letters of credit can also be used as guarantee of performance vs deferred payment from importers bank for import transactions.
Designed to help buyers purchase inventory, this financing can also fund international purchases. The inventory or the goods being imported are used as collateral for this kind of financing. Since it has collateral, this kind of financing is easier to get approved for. Even a fairly new company without a long history in the marketplace may find it easier to get inventory financing or other asset backed facilities.
Also known as invoice factoring, the accounts receivables are used as leverage from the import factoring company. They will typically finance up to 80% of the business’s total accounts receivables(invoice value). These funds can be used to raise capital that can be used for buying goods and improving cash flow.
Invoice discounting relies heavily on the credit worthiness of the outstanding invoices to the buyer. Often times the importers bank will require credit insurance when financing invoices to a buyer in foreign countries. In these cases the credit insurance will look at audited financials of the buyer to determine an insurable credit limit.
The buyer’s bank gives a guarantee that the payment will be made on time for the goods sent. These guarantees are typically used in local infrastructure or similar projects, but it is not unheard of for bank guarantees to be used as import financing instruments.
To summarize, the term import or trade finance covers a number of financial instruments that help importers fund their transactions. These options help the importer avoid cash crunch problems when they need substantial capital to purchase goods from overseas suppliers. In addition, it also reduces the risk for the exporter, who has to dispatch high-value goods to customers who are in different geographical locations. Thus, import finance facilitates smooth international trade.