Trade-cycle financing refers to an assortment of financing solutions targeted towards companies that import and/or export. Every company has a unique sales cycle; each distinct phase places different challenges on a company's finances.
“All companies have a trade cycle specific to their industry and company operations,” explains Caroline Brown, first vice president of Comerica Bank. “The cycle involves the purchase of raw materials, the manufacture of goods, an inventory period, the shipment of product, and, ultimately, the collection of funds and receivables.”
Smart Business spoke with Brown about trade-cycle financing, how a company can benefit from this type of financing and what types of payment mechanisms are available.
What is trade-cycle financing?
Trade-cycle financing is a type of financing solution that is designed for importers and exporters. It can help them in financing inventory, whether it be for domestic or international purchases. This method of financing allows banks to customize financing over a certain period of time, which can vary from company to company.
How can a company benefit from this type of financing?
Primarily, a company can benefit from increasing its working capital. Importers and exporters can use funds from trade-cycle financing to support the purchase of raw materials, inventory and manufacturing costs.
Trade-cycle financing can also cover expenditures all the way up to the collection period. During this phase, there may be a lot of cash outlays with staffing, materials and other costs, depending on the complexity of the product and no funds coming in. Using trade-cycle financing to secure additional working capital can be extremely beneficial for a company under these circumstances.
What payment mechanisms are available?
Primarily, the payment options are cash in advance, letters of credit, documentary collection and open account. The decision of which payment mechanism to use depends on a number of different factors: the negotiation between buyers and sellers; the relationships that have been established; potential collateral sources; and how customized the product is. Another consideration is the value of the product: A company may be more willing to take a risk on a relatively inexpensive product versus one that is quite expensive. The country involved with the transaction is also important, as some countries have specific commercial risk and others have more political risk. Depending on all of these different criteria, the terms of the sale might vary.
What risks are involved with trade-cycle financing, and how can these risks be mitigated?
The risks vary depending on if you’re an importer or an exporter. For example, if you’re an exporter who has manufactured a product, the safest way to sell is on a cash-in-advance basis. In this case, you’re receiving funds before the product is ever shipped. However, the risk is you’re going to limit your sales and growth opportunities. If you’re an importer, the safest term would be open account sales because you’re not required to pay for a product until you have received it, inspected it, and, oftentimes, even sold and collected on it.
What role does insurance play with trade-cycle financing?
Insurance is another way that companies mitigate their risk. With foreign receivables,in addition to political risk, there is a risk of nonpayment. Insurance can help banks finance receivables for up to as much as 180 days. Cargo insurance covers the risk of your product being damaged or lost. Insurance can also be used as a financing tool and to handle in-transit inventory where a product may be manufactured, housed or even drop shipped in another country.
How can a company determine if it is qualified for trade-cycle financing?
The profile of a trade-cycle-finance customer is an established company with two to three years of successful business operations. It should have a proven track record and be able to show financial strength, profitability and a positive net worth. Also, it should have a predictable and well-defined trade cycle because a lender is lending on the specific period of time that it takes to receive the order to the time money is collected. Importers or exporters looking for additional working capital should contact a trade specialist to help them find the right product.
CAROLINE BROWN is first vice president of Comerica Bank. Reach her at (562) 590-2525 or firstname.lastname@example.org.