UNDERSTANDING THE TRADE CYCLE & CREDIT TERM
This is the second article in a series of articles to be published by Anglo Cape Confirming (Pty) Ltd., which aims to focus on different aspects of trade finance in a simple to understand and practical manner.
In this article, we will deal with a simple, but often overlooked concept, which is at the heart of trade finance, namely the trade cycle.
The trade cycle is nothing more than a measurement of time, that is, the time between when a business has to pay for the goods it sells (or the materials necessary to manufacture them) and the time the business receives the money from the sale of the goods.
For example, let’s assume company X imports products from overseas, and sells them to company Y.
Company X places an order from, say, a Chinese supplier. Typically, a deposit would be required by the supplier, around 30% at the time the order is placed, with the balance payable on shipment.
Assuming the goods take around three weeks to arrive by sea freight, and a further week to clear and then distribute to company X’s customer/s, and assuming further that company Y will pay 60 days from delivery, we can see that company X’s trade cycle is 90 days, being 30 days in transit, and a further 60 days to wait for payment.
The question arises, which is a familiar one for most, if not all business enterprise, what is the optimal way to finance, or in simple terms, bridge, this 90 day gap between cash outlay and cash inflow.
The most obvious solution is to use an existing bank overdraft facility. But of course sometimes this may not be sufficient, because overdraft facilities must also be used to pay normal business expenses, such as rent, wages and salaries, vehicle expenses and so on.
It is in circumstances such as described above that a separate trade finance facility comes into its own. In simple terms, the trade finance facility is used to pay the Chinese supplier (in the above example, although of course the supplier could be anywhere in the world.) After the trade finance company pays the supplier, they draw an invoice on their client payable in 90 days. This gives company X sufficient time to receive and distribute its products, and receive payment from its customer/s in time to meet the trade finance company’s bill, in this case, Anglo Cape Confirming.
There are of course variations of this model, which will be discussed in part two of this article series.
Please feel free to contact us to find out more information on how our trade finance facility can be of benefit to your business.