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What is trade finance and how does it work?

Trade finance, also known as export finance, can help UK businesses succeed at trading internationally.

Businesses selling goods or services overseas may face risks regarding cash flow and payment from buyers.

Trade finance helps businesses to manage those risks by providing guarantees and advance payments.

This guide outlines some of the benefits and potential drawbacks of trade finance, but always seek independent and specialist financial advice when looking to obtain finance, as individual circumstances will vary.

Read our guide on how to export to new markets.

There are various types of trade finance products – from letters of credit to export factoring.

This is a legally binding guarantee from a bank that a seller of goods will receive payment from a buyer if the goods or services are delivered on time, and all necessary documents are provided according to the terms and conditions.

Letters of credit are useful to an exporter and importer located in different countries and who don’t know each other.

In some countries, a letter of credit is a legal requirement for international trade activities.

This insurance policy protects an exporter of goods or services from not receiving payment from an overseas buyer.

An overseas buyer may request a bond or guarantee.

This guarantees payment if you meet your side of the contract.

Bonds are issued by banks and can be:

  • advance payment bonds
  • performance bonds
  • warranty bonds.

This method of trade finance helps businesses unlock working capital by selling an invoice at a discount to a factoring company.

The business then receives up to 95% of the value of the invoice, usually within 24 hours.

Read our guide on working capital finance options.

Why consider trade finance?

Trade finance could provide a crucial advantage for UK businesses looking to trade overseas as it can tackle common challenges they are likely to face when exporting.

Exporting businesses may be hit by a long wait between purchasing goods from suppliers and receiving payment from a buyer once a product is sold.

Businesses may also be required to offer attractive payment terms to secure a buyer.

All this could put a strain on cash flow and working capital.

Another challenge for exporters is the risk of non-payment from a buyer.

Due to the nature of international trade and the two parties being based in different countries, chasing and securing payment could be harder than non-payment for a transaction involving two parties in the UK.

Trade finance could help tackle international trade challenges and generate other benefits, such as boosting cash flow and improving competitiveness.

Trade finance could free up working capital by reducing the time a business needs to wait to receive payment from an overseas customer.

The risk of non-payment by an overseas buyer and the subsequent impact on cash flow could be significantly reduced by using a trade finance product such as export insurance.

Trade finance could help to make your international trade strategy a success and open up your business to new revenue and customers.

Trade finance could help to make your international offering more competitive by providing the finances you need to invest in export-ready products or services.

There are some potential disadvantages to trade finance, including:

New start-ups may struggle to access trade finance because it is usually only available to established businesses with assets and trading history.

Businesses with a poor credit history may also struggle to access trade finance.

Trade finance can be costly due to the fees and interest charged.

You may also face charges if you default on payments, which could negatively impact your credit score.

Securing trade finance can be complex, which means you need to dedicate time and resources to making a successful application.

You may also require the services of an external expert.

How to choose the right trade finance

If you decide trade finance could be suitable for your business, consulting your bank may be a good place to start.

Your bank knows your business the best so they should be able to outline the options available to you.

If your bank can’t help, research other finance providers, such as export credit agencies and development finance institutions.

It’s advisable to compare their products, fees, eligibility criteria, and conditions.

It’s also a good idea to consider all possible costs and ensure that your business can deal with them.

You will need to provide documentation as part of your application, such as export contracts and shipping agreements.

If your bank or another lender is unable to provide your business with export finance, you might be eligible for support through UK Export Finance (UKEF), the government’s export credit agency that works alongside the Department for Business and Trade.

Established in 1919 as the world’s first export credit agency, UKEF helps businesses sell overseas with products, including its bond support scheme, export working capital scheme and export insurance.

UKEF also offers support in over 60 pre-approved local currencies.

In April 2023, the government granted UKEF an extra £10 billion of capacity, raising its maximum exposure limit from £50 billion to £60 billion.

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Finance Hub guidance and information

Reference to any organisation, business and event on this page does not constitute an endorsement or recommendation from the British Business Bank or its subsidiaries the UK Government. Whilst we make reasonable efforts to keep the information on this page up to date, we do not guarantee or warrant (implied or otherwise) that it is current, accurate or complete. The information is intended for general information purposes only and does not take into account your personal situation, nor does it constitute legal, financial, tax or other professional advice. You should always consider whether the information is applicable to your particular circumstances and, where appropriate, seek professional or specialist advice or support.

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Funding can be critical to keeping a business afloat and positioning it for long-term success, especially in uncertain financial times.

But, knowing the right place to turn to for guidance can be a challenge.

With tips on everything from debt and equity financing to accessing Community Development Finance Institutions, our Guide to Building Business Resilience could help your business prepare for the future.