What is Trade Finance?

Malcolm Tatum

Trade finance is the collective term for the various strategies that are employed in the process of conducting international trade transactions. The process may rely on various methods of money management, the use of different banking services, making investments, and in general utilizing all resources so that the highest degree of satisfaction possible is achieved by both the buyer and the seller. In making use of various trade finance tools and strategies, both parties are subject to laws and regulations that apply at the port of origin and the port of destination involved in the transaction.

Understanding trade finance is critical for companies who regularly import and export goods.
Understanding trade finance is critical for companies who regularly import and export goods.

Companies that routinely utilize international trade as part of their business efforts will make sure they understand all factors that must be addressed in order to successfully execute a trade. This means identifying reliable exporting and importing professionals to help manage the process. In some cases, those professionals will be in the full-time employ of the buyer or seller. A company may also choose to outsource the trade finance process to professionals who manage the activity on behalf of a number of different clients.

Whether managed in-house or via outsourcing, trade finance must comply with laws relating to the trade. This means preparing the correct documents to arrange for the export of the products, as well as the paperwork required to allow the goods to enter the country where the buyer resides. Unless the documents are in order, the successful completion of the order may be delayed or even rendered null and void.

Along with the shipping documents, trade finance also addresses how payment is rendered for the products purchased. This usually involves working through the banks of both the buyer and the seller. The buyer’s bank may provide a letter of credit to the seller’s bank, effectively providing proof that the resources to complete the transaction are in place. Often, this letter of credit requires the presentation of documents that affirm that the items ordered have been received, with a bill of lading being the most commonly used document. Upon verification that the buyer has received his or her order, the funds are transferred to the seller’s designated bank account, and the trade is considered complete.

Trade finance also normally involves insurance that helps to define which party is responsible for damages at each step in the shipping process. For example, the seller may be held liable for any damages that are discovered or incurred right up to the point that the goods are unloaded on the pier at the port of delivery. Should the goods be damaged once they are unloaded on the pier, the buyer assumes responsibility for any damages or losses. Generally, the insurance terms are highly detailed, leaving no room for miscommunication of which party is held responsible at any time during the execution of the international trade.

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