Trade and Stock Finance. A Funding Whitepaper from Pegasus Funding Resources.

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1 Trade and Stock Finance A Funding Whitepaper from Pegasus Funding Resources Follow us on Follow our funding blog: To keep up to date with all the latest funding initiatives and issues, sign up to our funding newsletter at:

2 Table of Contents 1. What is Trade Finance? Page 3 2. Letters of Credit Explained Page 4 3. Am I eligable for Trade Finance? Page 6 4. Who do I Approach for Trade Finance? Page 6 5. Stock Finance Page 8 2 P a g e

3 1. What is Trade Finance? Trade Finance in its simplest form is when an exporter requires an importer to prepay for goods shipped. This gives the importer two main challenges, the first being that prepaying for goods from places such as China or India, for example, will seriously impact the company s cash flow due to the long shipping times involved. The second is how does the importer reduce the risks of paying for goods in advance? These two challenges are mainly resolved by the importer s bank or independent trade finance provider providing a letter of credit to the exporter, or the exporter s bank, guaranteeing payment upon presentation of certain documents, such as a bill of lading. The exporter/manufacturer can also benefit as his bank may then make a loan to the exporter/manufacturer on the basis of this letter of credit so that manufacturing costs can also be covered from their point of view. Both sides benefit, the importer s cash flow is not seriously harmed by paying in advance and the exporter can begin manufacturing without cash flow difficulties. Please be aware that trade finance can also be arranged not only for importers but also in those instances where the manufacturer is situated in the UK. The illustration below describes a typical trade finance transaction. But remember each transaction is unique so no two solutions may be the same. 1. Customer places order with UK trading company 2. The trading company sources a supplier to fulfill the order 3. The trading company secures trade finance to pay supplier 4. Trade finance house either provides a loan to the trading company or makes payment to the supplier or provides guarantees such as a letter of credit 5. The supplier delivers the goods 6. The customer pays the trading company for the goods. Payment may be after delivery if invoice discounting or factoring is also used. 7. The trading company fulfils the order 8. The trading company settles the trade finance facility / the guarantee expires 3 P a g e

4 2. Letters of Credit Explained It s important to be aware of the additional costs involved in using a letter of credit. Banks make charges for providing them, so it s sensible to weigh up the costs against the security benefits. If an exporter you should be aware that you will only receive payment if you keep to the strict terms of the letter of credit. You will need to give documentary proof that you have supplied exactly what you contracted to supply. Using a letter of credit can sometimes cause delays and other administrative problems. When to use a letter of credit Although letters of credit can be useful, it s often best to avoid using one for a transaction. They can sometimes result in expensive delays, bureaucracy and unexpected costs. As a general rule you should probably only consider opening a letter of credit as an importer if: Your supplier insists on it Your bank insists on it National exchange controls require it An alternative is to just use telegraphic transfers. Exporters - deciding whether to ask for a letter of credit Think carefully about whether or not you need to ask an overseas customer for a letter of credit. Some important things to consider include: Legal matters - does the country you are exporting to require one? Costs - does the value of the order justify the bank charges and extra costs involved, and who pays these costs? The customer s creditworthiness - do they have a track record with you? Risks associated with the country you are exporting to - is it politically stable with a good reputation as an international trading partner? Normal trading practices - is it standard practice for exporters to use letters of credit when trading with that country, and/or in that particular commodity? Available advice and guidance - banks may recommend using a letter of credit in certain trading situations regardless of other factors, while credit insurers sometimes insist on it. Give some thought to alternative arrangements, such as credit insurance, export factoring or cash in advance terms. If you do decide that a letter of credit is the best option you will need to consider which type of letter to use. A confirmed and irrevocable letter of credit is the most secure type. It s wise to have a clear policy in your business about when to consider using a letter of credit. Reviewing your policy on a regular basis will help you avoid using them unnecessarily and possibly putting off would-be customers. Types of letter of credit There are five commonly used types of letter of credit. Each has different features and some are more secure than others. The most common types are: irrevocable revocable unconfirmed 4 P a g e

5 confirmed transferable Other types include: standby revolving back-to-back Sometimes a letter of credit may combine two types, such as confirmed and irrevocable. Irrevocable and revocable letters of credit A revocable letter of credit can be changed or cancelled by the bank that issued it at any time and for any reason. An irrevocable letter of credit cannot be changed or cancelled unless everyone involved agrees. Irrevocable letters of credit provide more security than revocable ones. Confirmed and unconfirmed letters of credit When a buyer arranges a letter of credit they usually do so with their own bank, known as the issuing bank. The seller will usually want a bank in their country to check that the letter of credit is valid. For extra security, the seller may require the letter of credit to be confirmed by the bank that checks it. By confirming the letter of credit, the second bank agrees to guarantee payment even if the issuing bank fails to make it. So a confirmed letter of credit provides more security than an unconfirmed one. Transferable letters of credit A transferable letter of credit can be passed from one beneficiary (person receiving payment) to others. They are commonly used when intermediaries are involved in a transaction. Standby letters of credit A standby letter of credit is an assurance from a bank that a buyer is able to pay a seller. The seller doesn t expect to have to draw on the letter of credit to get paid. Revolving letters of credit A single revolving letter of credit can cover several transactions between the same buyer and seller. Back-to-back letters of credit Back-to-back letters of credit may be used when an intermediary is involved but a transferable letter of credit is unsuitable 5 P a g e

6 3. Am I eligible for Trade Finance? All Trade Finance providers will insist that any company looking for trade finance must already be in possession of a firm order for the goods that need to be financed. It is also important that the company ordering those goods from you must have an acceptably high credit rating so that the risks to the funder are greatly reduced. The thinking behind this is that the trade finance provider will want the security of knowing that if your company goes out of business while the goods are in transit, they can still deliver the goods direct to your client and recover their money that way. Your end user client must also be credit insurable. If you require this type of funding but not all the goods have been pre-ordered from you, but the majority have been, then some trade funding providers will still provide their services to you as long as approximately 80% of the goods have been pre-ordered. Other eligibility criteria you need to keep in mind are: The goods must not be perishable They must be as completely manufactured as possible. It is much more difficult to get this sort of finance if the goods have to be assembled before they can be delivered to the end user. If there is to be a minimum amount of assembly then each part has to be numbered and easily identified. Most providers, but not all, will insist that the goods end up in the UK. Your company must have a good trading history as well as a good credit rating. Most trade finance providers will also insist that you use their invoice discounting or factoring services so that they are assured of getting their money back as quickly as possible. However, there are one or two that, although still insisting that invoice discounting or factoring be used, will allow you to use alternative providers as long as that provider agrees to pay the trade funder directly for the invoices relating to the goods that they have financed. Some providers will also insist on controlling the actual physical goods themselves and will want the goods to be delivered directly to their own warehouse until they are delivered to the end user. 4. Who do I approach for Trade Finance? High Street Banks The main high street banks will be the least expensive but they can also often be the most inflexible and will have stricter requirements concerning your own company s credit record as well as that of your end user client. They may also have more stringent requirements for personal guarantees and all asset debentures. Decision times can also be quite lengthy. The banks can put restrictions on the type of goods they will finance. I have just had trade finance turned down for a company that supplies the Ministry of Defense with empty ammunition boxes. The bank classified these empty steel boxes as munitions and therefore would not finance the transaction. Naturally, an independent provider of trade finance was very keen to supply the funding. But where do you go if your own bank will not undertake Trade Finance for you? 6 P a g e

7 Independent Trade Finance Providers Smaller Banks The smaller off high street banks, such as Clydesdale, Bank of Cyprus, Handlesbanken are worth considering but they will often require you to transfer all your banking requirements to them as well. You will also have to ask yourself the question about the likelihood of them taking on a client when your own bank has already turned you down. Specialist Trade Finance Organisations These come in all shapes and sizes from the very large to the very small. There is one that will only provide trade finance to those companies supplying the major supermarkets and another that will only provide trade finance for deals of up to a maximum of 30,000. Most of the independent providers offer very similar terms: An arrangement fee of between 1% and 2% A monthly interest rate of between 2.5% and 3.5% for the time the money is borrowed. Please note this is a monthly rate and not annual and that it is per month or part thereof. Additional fees will also be charged for documentation and issuing the letter of credit and for any legal work required. If credit insurance is a requirement this will also involve a monthly charge. Please note that if the trade finance provider also requires you to use invoice discounting or factoring then these charges must also be taken into account. Invoice Discounting and Factoring Organisations A few, but not many, of the independent invoice discounting and factoring organizations will offer trade finance facilities to their existing clients. Their trade finance charges are broadly in line with those quoted above. Trade Finance is not inexpensive and if your profit margins are less than 20% to 25% most providers will turn you down. Most Managing Directors look at Trade Finance as an unfortunate but necessary extra cost of sales. It is better to have less profit than no profit at all. You need to arrange the best trading terms that you can with your manufacturers so that the period of time that the funding is required for is cut to the minimum. If an irrevocable letter of credit is issued, then the manufacturer knows that he is guaranteed payment and you may be able to get them to agree better payment terms than before. If you can negotiate so that they are not paid until the goods arrive in the UK and you then immediately make delivery to your client and issue an invoice that then gets paid by using invoice discounting or factoring, the period of time that you need the trade finance for is kept to the minimum and so are the charges. 7 P a g e

8 5. Stock Finance Stock finance is a revolving facility that enables you to raise additional working capital as a standalone facility or as part of an invoice finance facility. It is often described as a revolving facility because the finance is short term, when it comes to the end of the term it is rolled over to suit the needs of the borrower. The exact mix and amount of stock finance available against your stock will depend on the type of stock you have and the amount of finance you require. It is totally different to trade finance as no firm orders are required. It must be noted, however, that Stock Finance is one of the hardest types of finance to arrange as it is considered to be very risky. This is because often the nature of the goods means that they are highly transportable and sellable. The banks mainly offer this type of finance to clients that they have a long and happy relationship with. When is Stock Finance used? Stock finance is a way of generating additional funds for refinancing, restructuring, acquisitions, management buy-outs, and management buy-ins and business turnarounds. It can also be used where rapid growth is using a high proportion of working capital. The Benefits of Stock Finance Revolving facility available against stock (raw materials and finished goods) Confidential facility. Provides significant capital injection and on-going headroom. Can be used on a UK, pan European and global basis. It is, however, much more difficult and unusual to arrange stock finance if the stock is not located in the UK. Some stock finance providers will also insist that the stock is kept in their own warehouses or those of a trusted third party How Stock Finance works The provider will often need a third party stock valuation to be carried out to arrange a stock finance facility Once the stock finance facility is agreed, you provide the lender with your monthly or weekly stock listing. The lender provides you with funding based upon those stock values. Stock Finance Providers The Banks Once again your own bank should be your first port of call, but as said before this type of finance is considered very risky and so you will need to have a long and happy relationship with your bank before they will offer this type of facility. The smaller off high street banks are also a possibility but once again they will normally want you to transfer all your banking business to them. One bank that we know charges an arrangement fee of between 1% and 3.5% and an annual interest rate of between 2% and 5% above base. They will fund up to 75% of the value of the stock, but expect lower percentages and will also require the stock to be stored in a third party warehouse. 8 P a g e

9 Independent Stock Finance Providers These come in all shapes and sizes. One of the ones on our panel will only deal with stock values at over 500,000. It can be only 300,000 if linked to their invoice discounting and factoring services. They will finance the stock for up to 90 days and they charge an arrangement fee of 1% to 1.5% and then a monthly interest rate of 2% for the first month and then negotiable after that. They will only offer stock finance if the company requiring it is credit insurable. A smaller provider that is also on our panel charges a set up fee of 2% for a year and then an interest rate of 3.5% + per month or part thereof. Please Note: All quoted terms and conditions in this whitepaper are indicative prices only and are likely to vary at any time. Each individual case will be different and have unique levels of perceived risk, which the providers will price accordingly. Specialist Funding for all Types of Business and Stages of Growth The current global economic climate and the parlous position of the banking system are adding significantly to the pressure on UK businesses. However, at Pegasus Funding Resources, we pride ourselves on being able to deliver multiple solutions to meet the individual financial needs of companies. No matter where a company is in its own cycle, we have access to funding for start-ups, expansions, contractions, turnarounds and even companies which are no longer supported by their banks. Introductions can be made to over 650 different sources of funds, including equity, debt and asset backed finance. Probably the most immediate need for most SMEs is cash flow - we have the solution in terms of Invoice Discounting or Factoring with a panel of 47 funders. However, we adopt a competitive engagement (unlike most banks) thus providing transparent and cheaper options for business. For companies that require funding for only a limited period we offer short-term single or selective invoice discounting or factoring. These are but a few weapons in our armoury aimed at supporting UK business. Other options include Angel Funding, Trade Finance, Turnaround Finance, Leasing and HP including Sale and Lease Back and even IT Leasing, Commercial Mortgages, EFG and Commercial Loans. In addition to funding we offer comprehensive support and expertise to businesses by means of Business Planning and Mentoring. Our team has a wealth of practical business experience available to our clients. For further information look at our 'Profiles Section' on our website and then go to the 'Contacts Page' and call the regional consultant in your area. Services include: Business plan scoring, business plan creation and re-write, financial modelling, sales and marketing planning, due diligence responses, investor presentation creation, investor introductions and meetings and final investor negotiations. However small or large your need Pegasus Funding Resources can greatly enhance your chances of success. 9 P a g e

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