There are many different types of financial products that facilitate international trade. The most common trade finance products can be broken up into products that affect the exporter's position before the shipment of goods and those that affect his position after shipment. These financial options include loans, guarantees, insurance and credit extensions.
One of the key difficulties with trade across international borders is the time it takes from when an importer places a sales order with an exporter and the actual receipt of goods. The shipping delay means that one party or the other has to absorb a heightened risk of non-performance: either of paying upfront under the risk that the order may never be delivered or sending product out on credit under the risk that payment may never be made. Trade finance products exist to ameliorate that risk and ensure exporters have enough working capital to be effective sellers in the international marketplace.
The two points in the international sales transaction when help from financial intermediaries is particularly important is pre-shipment, when the exporter decides to enter the global market or when an importer first expresses an interest in buying through a purchase order, and post-shipment, when the exporter has goods in transit and is waiting for payment upon delivery or upon sale. During pre-shipment, the exporter needs resources to produce the goods and cash flexibility so he can extend to the importer enough credit to be competitive against other exporters without tying up his cash in transit. After the goods ship, the exporter needs payment as quickly as possible so he can reinvest in more product.
The types of trade finance products that are used during pre-shipment include working capital loans, government guarantees and export credit insurance. Additionally, purchase order financing, factoring and a form of debt discounting called forfaiting are important during this time. Working capital loans and government guarantee programs are often offered as a matter of public policy, to enable businesses to enter the global marketplace by providing resources and working capital. Export credit insurance protects the exporter against nonpayment by the importer so the exporter can extend credit terms. Specialized financial firms use purchase order financing, factoring and forfaiting to take over the collection of an exporter's anticipated receivables for a fee after an evaluation of the creditworthiness of the importer.
Post-shipment trade finance products include various types of letters of credit and documentary collections. Letters of credit are bank guarantees that a party will meet his obligations under an international sales transaction. The bank serves as a type of escrow agent to exchange the documents that will allow the goods to be picked up for the importer's payment. Letters of credit can be guaranteed or non-guaranteed, and can support multiple sales or open sales terms. Documentary collections work very much like letters of credit in that banks on both sides of the transaction handle the exchange of money for delivery documents.