Trade finance for businesses to pay suppliers and fulfil orders

Trade finance usually starts with a facility limit agreed for your company, and then each purchase is funded as a separate transaction within that limit. The lender pays the supplier, controls or tracks the goods while they are in transit, and is repaid when the goods are sold or your customer pays.

A typical transaction looks like this, though details vary by lender:

1. The facility is agreed. The lender reviews your accounts, suppliers and customers, then sets an overall limit and a maximum term per transaction.
2. You submit a transaction. For each purchase you send the supplier's pro-forma invoice and, where relevant, your customer's purchase order.
3. The supplier is paid. The lender pays the supplier directly, sometimes in the supplier's own currency, or arranges a letter of credit so the supplier is paid when it presents the agreed shipping documents.
4. The goods move. The goods are shipped under the delivery terms agreed with your supplier. The lender may require the shipping documents to be sent to it.
5. The transaction is repaid. When the goods are sold, your customer's payment repays the lender. If you sell on credit terms, an invoice finance facility can pay off the trade finance.
6. The limit is freed up. Once a transaction is repaid, that part of the limit becomes available again for the next purchase.

Depending on the structure, the lender may take title to the goods until repaid or control the shipping documents.

The right type of trade finance depends on who is taking the risk: you, your supplier or your customer. The main options below go further than the short descriptions above.

Letters of credit: the basics

A letter of credit (LC) involves at least four parties: your company as the applicant, your supplier as the beneficiary, the issuing bank that makes the payment promise, and usually an advising bank in the supplier's country. Most commercial letters of credit are issued subject to the International Chamber of Commerce rules known as UCP 600, which set out how documents are checked.

• Sight LC: the supplier is paid once compliant documents are presented and checked.
• Usance or deferred payment LC: the supplier is paid at a set point after presentation, for example 90 days, which gives your company time to receive and sell the goods.
• Confirmed LC: a second bank, often in the supplier's country, adds its own promise to pay.
• Standby LC: a backup promise that only pays out if your company fails to pay the supplier under normal terms.

Banks deal in documents, not goods. If the documents comply, the supplier is paid even if the goods are faulty, so ask for inspection certificates where it matters.

Purchase order finance in more detail

Purchase order finance is usually used when a company has a confirmed order from a creditworthy customer but cannot pay the supplier itself. The lender typically funds the direct supplier cost, not your overheads, wages or profit. The customer is often asked to pay the lender, or a controlled account, and the lender deducts its funding and charges before passing the balance to you.

Trade finance is usually priced per transaction, based on how much is funded and for how long, plus fixed fees. Add every charge together and compare the total with the gross profit on the goods.

Charges you may see include:

• Arrangement or facility fee for setting up or renewing the facility, often a percentage of the limit.
• Transaction charge on each amount funded, usually worked out per month or per 30 days the money is out.
• Letter of credit fees, such as issuing, amendment, confirmation and document handling charges, often charged by each bank involved.
• Discrepancy fees if documents presented under an LC do not match its terms.
• Currency costs, including the exchange rate margin on payments to overseas suppliers and the cost of any forward contract.
• Other charges such as payment, inspection, insurance and storage costs.

Lenders usually price higher where goods are harder to resell, the supply chain is long, the supplier is unproven or the customer's credit is weak. Shipping or customs delays lengthen the term and raise the cost.

Illustrative worked example

Illustrative example only: actual costs depend on the lender and your circumstances. A homeware wholesaler needs to pay an overseas supplier £100,000 for goods it will sell to a retail customer for £130,000, giving gross profit of £30,000 before finance.

• Transaction charge: 1.5% per 30 days for 90 days, which is 4.5% of £100,000, or £4,500.
• Arrangement fee allocated to this deal: £1,000.
• Total finance cost: £5,500.
• Gross profit after finance: £30,000 minus £5,500 equals £24,500.

If the goods were held up for an extra 30 days, the transaction charge would rise by £1,500 to £6,000, and profit after finance would fall to £23,000.

The amount depends on the size and track record of your company and on the quality of each transaction. Lenders set an overall facility limit, then decide how much of each purchase they will fund.

• Your company's strength: turnover, profitability, net assets and how well past orders have been delivered.
• The deal itself: many lenders fund most of the supplier cost but not all of it, so you may need a deposit from your own cash.
• The margin: a healthy gross margin gives the lender a cushion if prices or costs move.
• Your customers and suppliers: lenders look at the customer's credit standing and the supplier's record of delivering on time and to specification.

For a wider view of how lenders size facilities, read how much a limited company can borrow.

The main risks are personal liability, unsold goods and charges that run on when shipments are delayed. Check:

• Security: whether the lender takes a debenture, title to the goods or control of shipping documents, and what that means for your other lenders.
• Personal guarantees: the amount, whether it is capped and when it can be released. Our guide on what a personal guarantee means explains the basics.
• Recourse: if your customer pays late, disputes the goods or fails to pay, your company usually has to repay the lender anyway.
• Maximum transaction term: what happens and what extra charges apply if a transaction runs past its agreed term.
• Termination and notice: how much notice either side must give, whether there is a minimum term or minimum usage, and any exit fees.
• Early settlement: whether repaying a transaction early reduces the charge or a minimum period is charged regardless.
• Currency exposure: who bears the loss if the exchange rate moves between order and payment.

Trade finance usually fits funding specific purchases of goods that you will sell quickly. Other products may fit better depending on where your cash is tied up.

• Stock finance suits companies that need to borrow against stock they already hold or want an ongoing inventory facility rather than per-deal funding.
• Invoice finance suits companies whose cash is tied up after the sale, in unpaid customer invoices. It is often combined with trade finance.
• A revolving credit facility suits regular, smaller cash needs where you want to draw and repay freely without submitting each purchase for approval.
• A working capital loan can be simpler for a one-off need, as it pays a lump sum you can spend on supplier payments and other costs.

Sometimes, but it is harder and depends on the lender. Because trade finance is tied to individual transactions, some lenders place more weight on the strength of the customer, the supplier and the margin than on your company's own history.

A company with past credit problems may still be considered if they are explained and resolved, though terms may be tighter. Lenders set their own minimum trading period and turnover. A strong order from a creditworthy customer can help, but approval is never certain.

Trade finance for limited companies, LLPs and partnerships of four or more partners is generally unregulated. That means it is not covered by the Consumer Credit Act protections that apply to many personal loans.

The agreement you sign sets out your rights, so read it in full and consider taking independent legal or accounting advice, particularly on personal guarantees and security. Our guide to regulated vs unregulated business finance explains the difference in plain English.

We are a commercial finance broker, not a lender. Your company gets a dedicated relationship manager, a real person you can reach by phone, email and chat, from your first enquiry until the lender pays out.

1. Check your eligibility in about 60 seconds without affecting your credit score.
2. Talk through your suppliers, customers and margins with your relationship manager.
3. We approach suitable lenders on our panel, and lenders run their own credit checks only once you decide to apply.
4. We help you compare offers on total cost, security and terms, through to funding.

We do not charge your company a fee. We are paid a commission by the lender when your finance completes. You can ask how much it will be, and the amount can differ between lenders. Lenders make their own decisions and approval is never certain.

What are Incoterms and why do they matter?

Incoterms are standard delivery terms published by the International Chamber of Commerce. They set out when risk passes from supplier to buyer and who pays for shipping and insurance, which affects what a lender will fund and when.

What happens if documents under a letter of credit do not match?

The bank can refuse to pay until the discrepancy is resolved or the applicant agrees to waive it. This can delay payment and add fees, so suppliers need clear instructions on exactly which documents to present.

Can trade finance pay suppliers in euros or US dollars?

Many trade finance lenders can pay overseas suppliers in their own currency. Ask how the exchange rate is set and whether you can fix it in advance.

Does purchase order finance cover the whole order value?

Usually not. It typically covers the supplier cost of fulfilling the order, and your profit is paid to you after the customer has paid and the lender has deducted its funding and charges.

What if my customer pays late?

Charges usually keep running until the lender is repaid. If the customer does not pay, your company is normally liable for the balance under the agreement.

Is trade finance only for physical goods?

It is mainly used for goods, because lenders rely on being able to track and if necessary sell them. Service contracts are usually better suited to other forms of cash flow finance.

Can one facility fund several suppliers?

Usually, yes. A lender may set limits for each approved supplier or country.

Can my customer's payment go straight to me?

Often it goes to the lender or a controlled account first, so the lender can deduct what it is owed. Some lenders allow other arrangements for established customers.