Trade Finance Basics

🌍 Trade Finance Basics: The Story of Getting Paid When Selling Across Oceans

The Big Picture: A Simple Analogy

Imagine you’re selling lemonade. But here’s the twist: your customer lives in another country!

You can’t just hand them a cup and get coins. There’s an ocean between you. You’re nervous: “What if I send the lemonade and they never pay?” Your customer is nervous too: “What if I pay and the lemonade never arrives?”

Trade finance is like having a trusted grown-up in the middle who makes sure both sides play fair.

🧭 What is Trade Finance?

Trade finance is a set of tools, rules, and helpers that make buying and selling between countries safe and smooth.

Why Does It Exist?

When you trade with someone far away:

• You don’t know them personally
• Different countries have different rules
• Money travels in different currencies
• Ships take weeks to deliver goods

Trade finance solves all these problems!

Real-Life Example

A farmer in Brazil sells coffee beans to a shop in Germany. Trade finance helps:

• The farmer feel safe that payment will arrive
• The shop feel safe that beans will arrive
• Banks in both countries help move the money
• Documents prove everything happened correctly

💳 Trade Payment Methods: 5 Ways to Pay Across Borders

Think of these as different levels of trust between buyer and seller.

graph TD
    A["Trade Payment Methods"] --> B["Open Account"]
    A --> C["Cash in Advance"]
    A --> D["Documentary Collections"]
    A --> E["Letters of Credit"]
    A --> F["Consignment"]
    B --> B1["Most Trust in Buyer"]
    C --> C1["Most Trust in Seller"]
    D --> D1["Balanced Trust"]
    E --> E1["Bank Guarantee"]
    F --> F1["Pay When Sold"]

Each method shifts risk differently. Let’s explore the key ones!

📖 Open Account Terms: “I Trust You Completely”

What Is It?

The seller sends goods first. The buyer pays later (usually 30, 60, or 90 days after).

Simple Example

You send your friend a toy. They promise to give you money next month. You trust them!

Real Business Example

A clothing company in Vietnam ships T-shirts to a store in Canada. The store has 60 days to pay after receiving them.

Who Likes This?

• Buyers love it — they get goods before paying
• Sellers are nervous — what if the buyer doesn’t pay?

When Is It Used?

• When buyer and seller know each other well
• When the seller really wants the business
• Common in competitive markets

Key Points

💵 Cash in Advance: “Pay Me First!”

What Is It?

The buyer pays before the seller ships anything.

Simple Example

You want to buy a toy from an online store. You pay today. The toy arrives next week.

Real Business Example

A jewelry store in Dubai wants rare gems from a new supplier in South Africa. The supplier says: “Pay me first, then I’ll ship.”

Who Likes This?

• Sellers love it — money in hand before doing anything
• Buyers are nervous — what if the goods never arrive?

When Is It Used?

• When the seller doesn’t trust the buyer yet
• For small orders or new customers
• When demand is much higher than supply

Key Points

📄 Documentary Collections: “The Bank Delivers the Papers”

What Is It?

The seller uses their bank to send documents to the buyer’s bank. The buyer only gets the documents (to pick up goods) after paying or promising to pay.

Simple Example

Imagine sending a treasure map through a librarian. Your friend can only see the map after paying the librarian.

How It Works

graph TD
    A["Seller Ships Goods"] --> B["Seller Gives Documents to Bank"]
    B --> C["Seller's Bank Sends to Buyer's Bank"]
    C --> D{Buyer Pays or Signs Promise}
    D -->|Yes| E["Buyer Gets Documents"]
    D -->|No| F["Documents Return to Seller"]
    E --> G["Buyer Claims Goods"]

Two Types

1. Documents Against Payment (D/P): Pay now, get papers now
2. Documents Against Acceptance (D/A): Sign a promise to pay later, get papers now

Real Business Example

A machine manufacturer in Japan ships equipment to a factory in Mexico. Japan’s bank sends shipping documents to Mexico’s bank. The factory pays the bank to get the documents needed to pick up the machines from the port.

Key Points

📜 UCP 600 Rules: The Universal Rulebook

What Is It?

UCP 600 stands for “Uniform Customs and Practice for Documentary Credits, Revision 2007.”

It’s a rulebook that banks around the world follow when handling letters of credit.

Simple Example

When you play a board game with friends from different countries, you need one set of rules everyone agrees on. UCP 600 is that rulebook for international trade!

Why It Matters

• Created by the International Chamber of Commerce (ICC)
• Used in 175+ countries
• Makes trade predictable and fair
• Banks and businesses speak the same language

Key Rules in Simple Terms

Real Business Example

A tea company in Sri Lanka ships tea to the UK using a letter of credit. The UK bank follows UCP 600 to check all documents. Because everyone knows the rules, the process is smooth.

Fun Fact

UCP 600 replaced UCP 500 in 2007. The “600” doesn’t mean 600 pages — it’s just a version number!

🚢 Incoterms: Who Pays for What?

What Are They?

Incoterms (International Commercial Terms) are 3-letter codes that explain:

• Who pays for shipping?
• Who handles insurance?
• When does responsibility pass from seller to buyer?

Simple Example

When you buy something online, sometimes shipping is free (seller pays). Sometimes you pay extra for delivery. Incoterms make these rules clear for international trade!

Most Common Incoterms

graph TD
    A[Seller's Responsibility] --> B[EXW: Seller does minimum]
    A --> C[FOB: Seller loads onto ship]
    A --> D[CIF: Seller pays freight + insurance]
    A --> E[DDP: Seller does everything]
    B --> B1["Buyer takes over at factory"]
    C --> C1["Buyer owns it once on ship"]
    D --> D1["Buyer owns it once at destination"]
    E --> E1["Goods arrive at buyer's door, paid"]

Key Incoterms Explained

Real Business Example

A computer company in China sells laptops to a retailer in France.

• EXW Shenzhen: French buyer must arrange pickup from the factory and all shipping
• FOB Shanghai: Chinese seller delivers laptops to the Shanghai port. French buyer takes over from there
• CIF Le Havre: Chinese seller pays for shipping and insurance to the French port
• DDP Paris: Chinese seller handles everything — laptops arrive at the Paris warehouse, all duties paid

Why Incoterms Matter

• Clear expectations — no arguing about who pays for what
• Accurate pricing — sellers know their costs
• Less confusion — same codes work everywhere

🎯 Putting It All Together

Trade finance is like a safety net for international business. Here’s how all pieces connect:

graph TD
    A["Seller Has Goods"] --> B["Choose Payment Method"]
    B --> C{How Much Trust?}
    C -->|High Trust| D["Open Account"]
    C -->|Low Trust| E["Cash in Advance"]
    C -->|Medium Trust| F["Documentary Collection"]
    C -->|Want Bank Guarantee| G["Letter of Credit - uses UCP 600"]
    B --> H["Choose Incoterms"]
    H --> I["Define Who Pays for Shipping/Insurance"]
    D --> J["Trade Happens!"]
    E --> J
    F --> J
    G --> J
    I --> J

Quick Comparison

✨ Key Takeaways

1. Trade finance makes buying and selling across countries safe and predictable

2. Payment methods range from “trust the buyer” (open account) to “trust the seller” (cash in advance), with documentary collections in the middle

3. Open Account = Buyer pays after receiving goods (high seller risk)

4. Cash in Advance = Buyer pays before shipment (high buyer risk)

5. Documentary Collections = Banks act as messengers for documents

6. UCP 600 = The global rulebook for letters of credit that all banks follow

7. Incoterms = 3-letter codes that define who pays for shipping, insurance, and when ownership transfers

🌟 Remember This Story

Two friends across the ocean want to trade. They don’t fully trust each other yet. So they:

• Pick a payment method that feels fair
• Use Incoterms to decide who handles shipping
• Follow UCP 600 rules if banks get involved
• And everyone sleeps well at night knowing the rules are clear!

That’s trade finance in action! 🚀