Trade finance

Trade finance pays your supplier for a specific order of goods, and you repay the funder when you have sold them or been paid for them. It covers import loans, letters of credit and supplier finance. It suits a business that buys stock in large orders, often from overseas, and has to pay before the goods arrive.

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How trade finance works

A supplier, often overseas, wants paying before it ships or on shipment. Your customer will pay you weeks or months after the goods arrive. Between the two you are carrying the full cost of the order. Trade finance lends against that order: the funder pays the supplier, the goods travel, you sell them, and the funder is repaid from the sale.

Each drawing is tied to a transaction. The funder sees the purchase order, the supplier’s invoice, the shipping documents and, where there is one, the customer order the goods are going to. It lends for the length of that transaction and expects repayment when it ends. A facility sets an overall limit and a maximum term for each drawing.

Because the money pays a named supplier for named goods, the funder takes security over the goods and the documents of title, as well as a debenture over the company in most cases. When the goods are sold on credit, the trade loan can be repaid from an invoice finance advance against the sale invoice, so one facility hands over to the other.

The cost is interest on the money drawn for the days it is out, plus fees for each transaction and, for letters of credit, the banks’ charges for issuing and handling the documents. Currency matters too: an order priced in dollars or euros costs a different number of pounds on the day you pay. See international payments for fixing the rate ahead.

Types of trade finance

Import or trade loan
The funder pays your supplier directly and you repay it after a set period, by which time you have sold the goods.
Letter of credit
A bank’s promise to pay your supplier once the supplier presents documents that match the terms of the credit, such as a bill of lading and an invoice.
Documentary collection
Banks pass the shipping documents to you only when you pay or accept a bill of exchange. The banks handle documents; neither promises payment.
Supplier or supply chain finance
A funder pays your supplier early at a discount and you pay the funder on the original due date, or a later one.
Stock finance
Lending against stock you already hold in a warehouse, repaid as the stock is sold.

How a letter of credit runs

  1. 1

    You apply to your bank

    Your bank issues a letter of credit in favour of the supplier, setting out the goods, the amount, the documents required and the latest shipment date.

  2. 2

    The supplier ships

    The supplier ships the goods and presents the documents the credit asks for to its own bank, which sends them on to yours.

  3. 3

    The banks check the documents

    The banks check the documents against the terms of the credit. If they comply, your bank pays the supplier or accepts to pay on a later date.

  4. 4

    You receive the documents

    You pay your bank, or draw on a trade loan to do so, and receive the documents you need to collect the goods.

A baker taking a tray of fresh bread from a rack

Paying suppliers before the goods arrive

A letter of credit protects both sides. The supplier knows a bank will pay if it ships what was ordered and presents the right papers. You know the money goes only against those papers. Letters of credit are issued under the International Chamber of Commerce’s rules, UCP 600, which have applied since 1 July 2007 and govern a credit when its text says so.

Banks deal in documents, so a credit is only as good as its wording. If the supplier’s documents do not match the terms exactly, the bank can refuse them, and if your wording is loose, the bank must pay against documents that comply even if the goods turn out to be faulty. Agree the documents, the inspection certificate if you want one, and the shipment dates with your supplier before the credit is issued.

Letters of credit cost more to set up than paying by transfer, and they need a bank facility in place. For a supplier you know well, an import loan paid by transfer, or supplier finance, may do the same job with less paperwork.

What a trade loan costs

Illustrative example

An importer orders £100,000 of stock. A trade loan pays the supplier and runs for 120 days while the goods are shipped and sold for £140,000. The rate and fee are assumptions for the arithmetic: each funder sets its own.

Interest on £100,000 for 120 days at an assumed 10% a year
£3,287.67
Transaction fee at an assumed 0.75% of the order
£750.00
Gross profit on the order before finance (£140,000 − £100,000)
£40,000.00
Gross profit after the cost of finance
£35,962.33

The finance costs £4,037.67, about a tenth of the gross profit on the order. If the goods take 60 days longer to sell, the interest rises to £4,931.51 and the margin falls with it. Price the order on the longest realistic selling period and check the facility allows drawings that long.

Import VAT and duty

Import VAT can be a large cash cost on top of the goods themselves. A business registered for VAT in the UK can use postponed VAT accounting: it declares the import VAT and reclaims it on the same VAT return, so nothing is paid at the border. Gov.uk says no approval is needed to use it, for goods brought into Great Britain from anywhere outside the UK, or into Northern Ireland from outside the UK and EU. If you are paying import VAT at the border and reclaiming it months later, switching to postponed accounting reduces the cash your imports need before any finance.

Customs duty is a cost that stays with you. It is paid when the goods are cleared, or, with a duty deferment account, in one monthly payment by Direct Debit covering all your imports for the month. Build it into the amount you finance and into the price you set on the goods.

Who trade finance suits

Trade finance suits wholesalers, distributors, retailers and manufacturers that buy stock or materials in large orders, from suppliers who want paying early, and sell it on over the following months. It suits a business with a track record of importing and selling the same kinds of goods, because the funder is relying on those goods selling.

It suits a business less well if the goods are bespoke, perishable or hard to resell, because the funder cannot sell them if you fail. A first order from a new supplier in a new product line is harder to fund than a repeat order.

If you sell overseas, the funding questions turn round: you are waiting to be paid by a customer abroad. Export finance covers that side, including the government-backed support available to exporters. For stock already in your warehouse, look at a revolving credit facility.

The funding search is for limited companies and LLPs, and for sole traders and partnerships borrowing more than £25,000.

Questions people ask

What is trade finance?

It is finance for buying goods, tied to a specific order. A funder pays your supplier, or a bank guarantees payment through a letter of credit, and you repay when you have sold the goods. It includes import loans, letters of credit, documentary collections, supplier finance and stock finance.

How does a letter of credit work?

Your bank promises to pay your supplier once the supplier presents documents that match the credit’s terms, such as a bill of lading, an invoice and any inspection certificate. The banks check the documents, your bank pays, and you receive the documents to collect the goods. Letters of credit are issued under the International Chamber of Commerce’s UCP 600 rules when the credit says so.

What does trade finance cost?

You pay interest on the money drawn for the days it is out, a fee for each transaction and, with letters of credit, bank charges for issuing and checking documents. Each funder sets its own rates. Work out the total for a typical order and selling period, and compare it with the gross profit on that order.

Can trade finance pay a supplier in another currency?

Yes. Trade loans and letters of credit can be in the supplier’s currency. You then carry the risk that the pound moves between ordering and paying. You can fix the rate for a future payment with a forward contract through your bank or a payments provider.

Do I need to pay import VAT at the border?

Not if you are VAT-registered in the UK and use postponed VAT accounting. You declare the import VAT and reclaim it on the same VAT return, and gov.uk says no approval is needed. Customs duty is still payable when the goods are cleared, or monthly by Direct Debit if you have a duty deferment account.

Finance is subject to status and to the lender’s terms. A personal guarantee makes you liable for the company’s debt if it does not repay, and it can be enforced against your own assets, including your home. Nothing here is a personal recommendation.

Working capital

Export finance

Bank guarantees, bond support and insurance from UK Export Finance for businesses selling overseas.

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Invoice finance

Borrowing against unpaid invoices, through factoring, discounting or single invoices.

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Revolving credit facility

A limit you draw, repay and draw again over a fixed term, with interest only on what you use.

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International payments for business

Transfer fees, the exchange rate margin, forward contracts and how a payment firm protects your money.

Read more →
All business funding

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Funding searches run on Swoop’s platform. Swoop Finance Limited is a credit broker and not a lender, and is authorised and regulated by the Financial Conduct Authority (FRN 936513). Buzz Accounting Ltd introduces businesses to Swoop and may receive a fee from Swoop when funding is arranged. Business funding is separate from the financial advice Equity & General Financial Services Limited gives through this website. Finance is subject to status, and a lender may ask a director for a personal guarantee.

Cover for a personal guarantee

If a lender asks you to guarantee the company’s borrowing, our advisers can advise on life cover for that debt.

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