In this article, guest contributor Sharad Sinha, Executive Director for Transaction Banking at Standard Chartered and member of the ICC Banking Commission, discusses the open account side of trade finance – including products such as supply chain finance, factoring, forfaiting, and export financing.
The views and opinions expressed in this article are those of the author for education purposes and do not necessarily reflect the official policy or position of ICC Academy, ICC, or Standard Chartered.
In Part 1, we examined…
In the first installment of this guide, we examined how banks and other financial institutions use a variety of products to help in the exchange of goods and services, and how types of trade products offered address issues around a typical international cross-border sale and purchase of goods, including:
- Addressing foreign exchange and country risk issues
- Buyer and seller not knowing each other;
- Overcoming local regulations;
- Ensuring shipment and transportation issues
- Ensuring payment and financing options;
We looked at three key trade finance products – letters of credit (also known as documentary credits), and bank guarantees and documentary collections.
Read Part 1 here: Key trade finance products: Definitions and use cases
In Part 2, we will discuss…
Having covered documentary trade products – letters of credit, bank guarantees, and documentary collections in Part 1 – we now explore the open account side of trade finance in the second part of this guide. These products, including supply chain finance, factoring, forfaiting, and export financing, have grown in importance as global trade relationships have matured and buyers and sellers seek more flexible financing arrangements.
Key trade finance products: Definitions and use cases
Supply chain financing (SCF)
What is supply chain financing and who is it for?
Simply put, supply chain finance enables suppliers of a large corporate buyer to access to easy working capital solutions based on the anchor buyer’s creditworthiness.
Typically, it involves large number of sellers supplying an anchor buyer. The motivation for establishing a supply chain finance programme is to ensure a steady and stable source of supplies.
What are the main types of supply chain financing?
Reverse factoring or Payable financing
In payable financing, a financier purchases a buyer-approved invoice at a discount, anticipating receipt of the full invoice value on the due date. In a typical scenario, the financier relies on the buyer’s credit worthiness for financing, and it is non-recourse to the supplier.
Accounts receivable financing
The seller sells all the outstanding invoices for one or more buyers to a financier and receives funds immediately, minus discounting charges. The funding may be with or without recourse.
Distributor financing
A large manufacturer wants to secure its distributor network by helping distributors meet their working capital requirements.
Distributors needs time to sell goods and realise proceeds before paying the anchor seller. To bridge this gap, the distributor enters into an agreement with a financer who provides a loan to the distributor and pays the anchor seller directly.
In most cases, the financer also enters into an agreement with the anchor seller, primarily to mitigate risks like funds diversion or establish triggers for controlling overdue payments (such as stopping supply).
Certified Trade Finance Professional (CTFP)
How does it work?
- The buyer (anchor) has a long-standing contractual relationship with one or more suppliers.
- These suppliers enter into an agreement to finance the accepted invoices with a bank or financier.
- The supplier raises an invoice for goods supplied, which is accepted by the anchor buyer.
- The bank discounts the invoices based on agreed credit terms.
- On the due date, the bank receives payment from (or debits) the anchor’s account.
What are the benefits of using SCF?
Buyer:
- Continued contractual relationship for the supply of goods.
- Favourable payment terms allow for improved credit terms.
- Supports, and in some cases helps maintain ESG goals.
Supplier:
- A stronger contractual relationship, as SCF embeds the supplier into the supply chain of the anchor buyer.
- The creditworthiness of the anchor enables suppliers to access financial liquidity on favourable terms that may not be possible on their own.
- Better working capital management through faster, more affordable financing.
Use case: How SCF helps suppliers and buyers optimise their working capital
Context: AXL is an automobile manufacturer that relies on numerous suppliers to provide them with accessories – such as car seats, headlamps, and windshields – needed to deliver the end product. To maintain their production cycle, AXL needs a reliable, timely supply of these components.
The challenge:
- The suppliers may be geographically widespread and may lack affordable financing options to meet their supply agreement with AXL.
- Their credit profile may not be sufficient for them to fulfil their contractual obligations with AXL.
The solution:
AXL is a large corporate with access to financing with good credit standing based on its balance sheet. This puts AXL in a position to enter into a supply chain financing agreement with a bank, where the primary risk the bank takes is on AXL.
How it works:
- The bank supports an AXL-led post-acceptance financing programme that provides suppliers with the option to have accepted invoices discounted.
The bank enters into a separate agreement with each supplier for assigning their receivables and to protect itself against any dispute or fraud.
Factoring
What is factoring and what function does it serve in trade finance?
Factoring enables a seller to assign their receivables to a financier or bank and obtain financing against them, typically on a non-recourse basis.
The UNIDROIT Convention defines a factor as an entity that provides at least two of the following functions:
- Finance for the seller, including loans and advance payments;
- Maintenance of accounts (ledgering) relating to the receivables;
- Collection of receivables;
- Protection against default in payment by buyers.
The assignment is usually disclosed, meaning the buyer is notified. However, it may also be arranged on an undisclosed basis.
How factoring works in practice
An exporter has a long-standing contractual relationship with a buyer or importer. Both deal on an open account basis, and the exporter wants financing to manage their working capital cycle.
Arrangement: A factor or a bank will typically approach the supplier and offer factoring services based on their short-term financing requirements and the volume of business they conduct with the buyer. Considerations include:
- Sales ledger management and payment history of the buyer
- Assignment law considerations
- In cases where financing is without recourse, the terms of credit insurer.
If the agreement is to finance on a non-recourse basis, the notice of assignment is typically sent to the buyer to inform them that the debt has been assigned in favour of the financier.
Process
- The exporter supplies copies of invoices to the factor, sometimes accompanied by transport documents as evidence of shipment.
- The factor then discounts the invoices. In some cases, the seller may only require credit protection, making the arrangement less costly.
- On the due date, payment is received by the factor or bank directly from the buyer.
- Any overdue amounts are managed by the factor.
What are the benefits of using factoring?
- Protection against buyer insolvency and country risk.
- Non-recourse financing (where available), which can improve the working capital cycle.
- Collection of overdue amounts is managed by the factor, reducing administrative burden for the seller.
- Can support entry into new markets and business expansion.
Use case: How factoring is used to manage cash flow and support growth
Context: CapitalGrains (CG) is an agricultural commodities company that sources wheat and sugar and sells them to a major food chain, EuropeFood.
The challenge:
- CG is not concerned about country risk or buyer risk. However, they require receivables account management and want to improve their working capital cycle by reducing their Days Sales Outstanding (DSO).
- Mitigation of insolvency risk in a downturn is also a consideration.
The solution:
FactoringFinance is a Europe-based factor with considerable experience and expertise in providing flexible financing solutions and protection against bad debts. FactoringFinance approaches CG and offers them a full factoring solution based on their experience with EuropeFood, along with a credit insurer to cover losses, if any.
The outcome:
CapitalGrains enters into an agreement that provides financing against their outstanding invoices on a non-recourse basis, improving their balance sheet and supporting their expansion plans, while streamlining credit management and sales ledger administration.
Certified Trade Finance Professional (CTFP)
Forfaiting
What is forfaiting and what is its role in trade finance?
Forfaiting involves the purchase of receivables from exporters in the form of a payment obligation or negotiable instrument. The forfaiter assumes all the risks associated with the receivables.
Forfaiting differs from factoring in that forfaiting is a transaction-based operation while factoring is firm-based. In factoring, a firm typically sells all (or a portfolio) of its receivables; in forfaiting, the firm sells receivables from a specific transaction.
How does forfaiting work?
An exporter and an importer enter into a contract for the supply of goods, and the importer requests credit terms. The exporter agrees terms with a forfaiter or bank, generally on a without-recourse basis.
The agreement requires the underlying payment instrument (such as a Bill of Exchange, BoE) to be endorsed in favour of the forfaiter in accordance with applicable law, so that the forfaiter is satisfied that the debt being purchased is valid and enforceable.
The forfaiter considers:
- Country of the importer
- Standing of the importer
- Goods supplied and their value
- Shipment conditions
- Payment terms
Following shipment, documents are sent to the buyer along with the BoE, which is accepted by the buyer and returned to exporter. The exchange of documents may occur via the importer’s bank.
The exporter presents the accepted BoE, endorsed in favour of the forfaiter, and receives payment minus discounting charges. Since payment is without recourse, the exporter has no further interest in the transaction. It is the forfaiter who collects future payments due from the importer, and it is the forfaiter who bears all the risks of non-payment.
On the due date, payment is received from the importer via their bank.
What are the benefits of using forfaiting?
- Provides an alternative financing option based on the credit rating of the buyer.
- Can support working capital optimisation, especially when dealing with markets where there is limited information on buyers or open account transactions are uncommon.
- Available as a secondary financing option where traditional bank financing may be limited.
- Offers exporters without-recourse financing on a transactional basis.
Use case: How risk is managed using forfaiting
Context: XMG is a high-end fashion garment manufacturer.
They receive an enquiry from a buyer in a jurisdiction not well known to them, although the buyer (GMG) may have good standing in the market.
The challenge:
- GMG is not willing to issue a letter of credit in favour of XMG, but is willing to deal on an open account basis with favourable payment terms: 30 days from the shipment date.
- XMG wants to enter the market as it has growth potential, but does not want to take on the risk of non-payment.
The solution:
XMG enters into an agreement with a forfaiter, who is willing to discount the accepted bill of exchange (BoE) from GMG, which is then endorsed by XMG in the forfaiter’s favour.
The financing is on a non-recourse basis, giving XMG protection against default by GMG.
The forfaiter builds in discounting charges based on country risk, buyer risk, and payment terms. Their knowledge of the jurisdiction and the legal provisions governing the purchase of payment instruments such as BoEs forms the basis of this forfaiting transaction.
Certified Trade Finance Professional (CTFP)
Export financing
What is export financing?
Export financing, as the name suggests, refers to the various financing and risk mitigation options available to exporters to mitigate:
- Country risk – the risk of loss due to political instability or foreign exchange controls
- Commercial risk – the risk of non-payment by the buyer due to insolvency, dispute, or similar causes
Export financing bridges the gap between when goods are produced or shipped and when payment is received from the importer, a period often prolonged by international logistics and payment terms. The primary goal of export financing is to ensure that exporters have sufficient liquidity to fulfil orders, manage cash flow, and compete effectively in global markets.
What options are available?
Pre-shipment finance
Funding provided before goods are shipped.
- Export packing credit/Pre-shipment credit:
- Short-term financing provided to exporters to cover expenses related to the procurement of raw materials, manufacturing, processing, packaging, and transportation of goods to the port of shipment.
- Typically extended against a confirmed export order or letter of credit (LC).
- Advances against export bills:
- Banks provide advances to exporters against the security of export bills (e.g., bills of exchange, promissory notes) that will be drawn on the importer once the goods are shipped.
- Revolving credit facilities:
- A flexible line of credit that allows exporters to repeatedly borrow, repay, and re-borrow funds up to a specified limit, often used for continuous export orders.
- Pre-shipment export factoring:
- The factor provides an advance to the exporter against an export order, with the understanding that the factor will purchase the resulting receivables once the goods are shipped.
Post-shipment finance
- Negotiation/discounting of export bills:
- Banks purchase (negotiate) or discount export bills (documents against payment or acceptance) presented by the exporter after shipment, providing immediate funds.
- Export factoring:
- The sale of an exporter’s accounts receivable to a third party (factor) at a discount. The factor takes on the responsibility of collecting payments from the importer and assumes the credit risk.
- Forfaiting:
- The non-recourse purchase of medium to long-term trade receivables (e.g., promissory notes, bills of exchange) from an exporter, usually guaranteed by a bank in the importer’s country. The forfaiter assumes all political and commercial risks.
- Export credit insurance:
- Not direct financing, but a crucial enabler. Export credit insurance protects exporters against the risk of non-payment by overseas buyers due to commercial or political risks. This often makes banks more willing to provide financing.
- Supplier credit/buyer credit (under ECAs):
- Supplier credit: The exporter extends credit to the importer, and the exporter’s bank provides financing to the exporter. Often backed by an Export Credit Agency (ECA) guarantee.
- Buyer credit: A bank in the exporting country lends directly to the importer or the importer’s bank to finance the purchase of goods from the exporter. Also typically supported by an ECA.
What are the benefits of export financing?
- Improved cash flow: Provides immediate access to funds, preventing cash flow bottlenecks that can arise from long payment cycles in international trade.
- Enhanced liquidity: Ensures exporters have sufficient working capital to undertake new orders and grow their business.
- Risk mitigation:
- Reduces the risk of non-payment from overseas buyers (especially with factoring, forfaiting, and credit insurance).
- Can mitigate currency fluctuation risks, depending on the financing structure.
- Increased competitiveness: Allows exporters to offer more attractive payment terms to buyers, securing more orders.
- Access to larger markets: Enables small and medium-sized enterprises (SMEs) to engage in international trade by providing the necessary financial support.
- Efficiency: Streamlines the payment and collection process, allowing exporters to focus on production and sales.
Use case: How export financing covers production costs before shipping
Context: An Indian textile manufacturer, Bharat Tex, receives a large export order for custom-designed garments from a buyer in Germany, Euro Fashions. The order value is $500,000, and the production cycle is 60 days. Euro Fashions has agreed to payment 90 days after shipment (Documents Against Acceptance, or D/A).
The challenge: Bharat Tex needs to procure specialised fabrics, dyes, and pay labour wages upfront to fulfil the order. They lack sufficient working capital to cover these production costs without impacting their ongoing domestic operations.
The solution: Export packing credit (Pre-shipment finance)
- Export order and LC or confirmed order: Bharat Tex receives the confirmed purchase order from Euro Fashions (or ideally, an irrevocable letter of credit confirmed by a reputable German bank, which makes financing easier).
- Application for packing credit: Bharat Tex approaches its bank, Global Bank of India, with the confirmed export order.
- Credit assessment and sanction: Global Bank of India assesses Bharat Tex’s creditworthiness, track record, and the viability of the export order. Based on this, they sanction an export packing credit facility of, say, $350,000 (covering a significant portion of the production costs).
- Disbursement and production: Global Bank of India disburses the funds to Bharat Tex, who uses them to:
- Purchase high-quality fabrics from local and international suppliers
- Procure specialised dyes and accessories
- Pay their skilled labour force
- Cover overheads related to production
- Shipment: After 60 days, Bharat Tex completes production, packages the garments, and ships them to Euro Fashions in Germany, presenting the shipping documents to Global Bank of India.
- Repayment: Once the goods are shipped and the D/A bill is accepted by Euro Fashions, Global Bank of India can either discount the bill (post-shipment finance) or await payment from Euro Fashions after 90 days. The proceeds from the export sale are used to repay the Export Packing Credit loan, along with interest, to Global Bank of India.
The outcome: Bharat Tex secures the necessary funds to cover production costs before receiving payment from the overseas buyer, ensuring timely fulfilment of the order and maintaining healthy cash flow. This allows them to capitalise on a significant export opportunity without financial strain.
Key takeaways
It is important that all parties in trade finance – buyers, sellers, finance providers – understand the range of products available to mitigate the risks of international trade. Each product has inherent risk mitigation and provides flexibility for pre-shipment or post-shipment finance, helping buyers and sellers improve their working capital position.
Exporters and importers should evaluate how to mitigate their risks based on the sales contract.
It is important that the correct Incoterms® rule is used to delineate responsibilities in terms of costs and risk associated with transport and delivery of goods. For example, advance payment terms with an EXW sales term may be most favourable to an exporter, while documents against acceptance on a DDP term may be most favourable to an importer.
Read: ‘Document risk in supply chain finance (SCF): What happens when invoices go wrong?’
During the contract phase, it is advisable to agree payment terms that will help identify a product that mitigates risk while enabling opportunities for financing.
The evolution of supply chain finance (SCF) has changed the landscape of traditional trade products such as documentary collections, letters of credit, and standby letters of credit. The majority of SCF techniques allow smaller suppliers to access flexible financing options and risk mitigation.
Additionally, Export Credit Agencies (ECAs), which are backed by national governments, also provide financial support to exporters. This includes export loans and risk mitigation tools such as payment guarantees and country risk cover.
