What is Foreign Trade Financing for SMEs?

Foreign trade, also known as international trade, refers to the exchange of goods, services, and capital between countries. It involves the buying and selling of products and services across international borders, which can also be accessed via the best online banking in Sri Lanka. The activities involved in foreign trade can be broadly categorised into three main types: export trade, import trade, and entrepot trade.

1. Export Trade

Export trade refers to the selling of goods and services produced in one country to another country.

Activities:

• Market Research: Identifying potential markets for exports.
• Compliance: Ensuring products meet the legal and regulatory requirements of the importing country.
• Logistics: Arranging for transportation, warehousing, and insurance.
• Documentation: Preparing and managing necessary export documents like commercial invoices, packing lists, bills of lading, and export licences.
• Payment: Managing international payments and securing payment terms like letters of credit.

2. Import Trade

Import trade refers to the buying of goods and services from another country to be sold or used in the home country.

Activities:

• Supplier Identification: Finding reliable foreign suppliers.
• Quality Control: Ensuring imported goods meet quality standards.
• Customs Clearance: Complying with import regulations, paying tariffs, and clearing customs.
• Logistics: Coordinating shipping, warehousing, and transportation within the home country.
• Documentation: Managing import documentation like import licences, customs declarations, and certificates of origin.
• Payment: Arranging for payment to foreign suppliers, often involving currency exchange and international banking.

3. Entrepot Trade

Entrepot trade involves importing goods into a country, which are then stored temporarily and re-exported to another country without significant alteration.

Activities:

• Warehousing: Storing imported goods temporarily in bonded warehouses.
• Repackaging and Labelling: Sometimes involves minor modifications like repackaging and labelling to meet the requirements of the destination market.
• Documentation: Handling import and re-export documentation.
• Logistics: Managing the transportation of goods from the import country to the final destination.
• Customs Procedures: Navigating the customs procedures for both importing and re-exporting goods.

Additional activities in foreign trade

• Trade Negotiations: Engaging in trade negotiations and agreements between countries.
• Trade Promotion: Activities to promote trade, such as trade fairs, exhibitions, and trade missions.
• Risk Management: Managing risks related to currency fluctuations, political instability, and credit risk.
• Legal and Regulatory Compliance: Ensuring compliance with international trade laws and regulations, such as trade sanctions, export controls, and anti-dumping measures.

Foreign trade plays a crucial role in the global economy, enabling countries to access goods and services not available domestically, fostering economic growth, and promoting international cooperation and development.

What is foreign trade financing for SMEs?

Foreign trade financing for SMEs (Small and Medium-sized Enterprises), or SME banking in Sri Lanka, refers to the financial support and instruments provided to small and medium-sized businesses engaged in international trade. These financial services help SMEs manage the risks and cash flow challenges associated with exporting and importing goods and services.

Key Aspects of Foreign Trade Financing for SMEs

• Cash Flow Management: Ensuring that SMEs have sufficient working capital to cover the time gap between paying suppliers and receiving payment from buyers.
• Risk Mitigation: Protecting SMEs from various risks such as non-payment by buyers, currency fluctuations, and political instability.
• Credit Enhancement: Improving the creditworthiness of SMEs to secure better financing terms and access to international markets.

Common Foreign Trade Financing Instruments

1. Letters of Credit (LCs)

Definition: A letter of credit is a guarantee from a bank that a buyer’s payment to a seller will be received on time and for the correct amount. There are many LC opening banks in Sri Lanka.

Purpose: Ensures the exporter gets paid as long as the terms of the LC are met, thereby reducing the payment risk.

Types: Can be revocable or irrevocable, confirmed or unconfirmed.

2. Trade Credit Insurance

Definition: Insurance that protects exporters against the risk of non-payment by foreign buyers.

Purpose: Mitigates the risk of buyer default, allowing SMEs to offer competitive credit terms.

3. Export Factoring

Definition: The sale of an exporter’s accounts receivable to a factoring company at a discount.

Purpose: Provides immediate cash flow to the exporter while transferring the collection risk to the factor.

4. Forfaiting

Definition: The sale of an exporter’s receivables at a discount to a forfaiter, who assumes the credit risk.

Purpose: Offers the exporter immediate cash and removes the risk of non-payment.

5. Pre-shipment Finance and Post-shipment Finance

Pre-shipment Financing: Loans or advances given to exporters before the goods are shipped.

Post-shipment Financing: Loans or advances given after the goods have been shipped to bridge the gap until payment is received.

6. Export Credit Agencies (ECAs)

Definition: Governmental or quasi-governmental institutions that provide financing and insurance to promote exports.

Purpose: Offers direct loans, guarantees, and insurance to mitigate risks and promote international trade.

7. Working Capital Loans

Definition: Short-term loans to finance day-to-day operations of the business.

Purpose: Provides necessary liquidity to cover operating expenses, especially when there are delays in payment.

8. Supply Chain Financing

Definition: Financial arrangements that optimise the flow of funds within the supply chain.

Purpose: Improves cash flow and working capital efficiency for both suppliers and buyers.

Steps to Secure Foreign Trade Financing

• Business Plan: Develop a robust business plan outlining the trade transactions, potential markets, and risk management strategies.
• Credit Assessment: Undergo a credit assessment to evaluate the SMEs financial health and creditworthiness.
• Documentation: Prepare necessary documentation including trade contracts, invoices, shipping documents, and financial statements.
• Choosing Financial Instruments: Select appropriate financing instruments based on the specific needs and risks associated with the trade transactions.
• Engage with Financial Institutions: Approach banks, trade finance providers, and ECAs to negotiate and secure financing.
• Monitoring and Compliance: Ensure continuous monitoring of trade transactions and compliance with financing terms and regulatory requirements.

Benefits of Foreign Trade Financing for SMEs

• Increased Liquidity: Provides immediate access to funds, improving cash flow.
• Risk Reduction: Mitigates risks associated with international trade.
• Enhanced Competitiveness: Enables SMEs to offer better payment terms to buyers, making them more competitive in the global market.
• Market Expansion: Facilitates entry into new international markets by providing financial support and reducing trade barriers.

Foreign trade financing is essential for SMEs looking to expand their operations globally, as it addresses financial constraints and risks that could otherwise hinder their international trade activities.