What is Trade Finance?

Trade Finance provides short-term cash flow to businesses engaged in domestic or international trade. Because supply chains take time, there is often a massive gap between when a manufacturer has to pay their suppliers, and when they actually get paid by their end customer.

Instead of waiting 90 days for a customer to pay an invoice, a business can use Invoice Factoring or a Letter of Credit to get cash from a bank immediately. In exchange, the bank takes a cut of the invoice.

The Danger of "Flat Fees" in Short Term Finance

Trade finance companies often advertise their rates deceptively. A lender might say, "We will advance you the cash today for just a 2% flat fee."

To an untrained eye, 2% sounds incredibly cheap. However, if that invoice is due in just 30 days, you are paying 2% for one month of financing. When you annualize that rate (multiply by 12 months), your True Effective APR is actually 24%! This calculator instantly unmasks the true annualized cost of flat-fee financing.

Types of Trade Finance

• Invoice Factoring: You sell your outstanding B2B invoices to a third party (a Factor) at a discount. They give you ~80% of the cash today, and collect the 100% invoice from your customer later.
• Supply Chain Finance (Reverse Factoring): Your large corporate buyer arranges for a bank to pay your invoice early (minus a fee). This is common when selling to giants like Walmart or Amazon.
• Letter of Credit (LC): A guarantee from a bank that a buyer's payment to a seller will be received on time and for the correct amount. Highly common in international import/export.

When Does Factoring Make Sense?

Paying a 20%+ effective APR is mathematically painful, but it makes sense when the Opportunity Cost of not having cash is even worse. If having immediate cash allows you to buy more raw materials to fulfill a massive, highly-profitable purchase order that you otherwise would have had to reject, the expensive finance fee is easily justified by the net profit of the new order.