What’s in Store?
Running a business necessitates effective fund management especially in circumstances like meeting urgent operational requirements or delivering bulk orders to clients before receipt of payments. Thus, businesses who lack adequate working capital but wish to fulfill orders on time while managing daily operations could benefit from attractive financing options such as Pre-shipment finance.
Pre-shipment finance guarantees access to funds organizations manufacture and deliver goods on time as per the agreement between parties. Keep reading to find out what Pre-shipment finance is, its pros and cons, documents required and procedure to avail this credit facility.
Pre-shipment Finance- Meaning and Purpose
Pre-shipment finance is a short-term financing facility offered to businesses by lending institutions to fulfil production requirements before the goods are shipped to buyers. It allows businesses to fulfil their working capital requirements during the pre-export phase, enabling them to purchase raw materials, pay staff wages, cover manufacturing expenses, and prepare goods for shipment. It is a part of supply chain finance.
Financial institutions generally secure repayment through pledging goods produced as collateral or via issue of financial instruments like Letter of Credit from the buyer.Typically, pre-shipment financing is available for only a brief time frame i.e. 30 days to 90 days at most.
Pre-shipment financing is usually subject to stringent eligibility requirements and may incur certain fee expenses from financial institutions. Lenders meticulously assess the buyer and seller’s creditworthiness before final loan acceptance.
Working Capital for Exporters
Features of Pre-Shipment Finance:
Some important features of pre-shipment finance include:
Short-Term Financing Facility-
Pre-Finance credit is often a short-term debt that is repaid based on the export cycle. This minimizes long-term debt implications by allowing exporters to swiftly refinance the credit after receiving payments from customers.
Reasonable Interest Rates-
The interest rates charged by lending institutions for pre-shipment financing are generally lower. However, the lending rates might differ slightly for every borrower entity owing to factors like current market rates, lender policy, and the credit history of the organization.
Flexible Terms of Repayment-
Pre-shipment finance facilities generally offer attractive and accommodating repayment terms for the borrower entity.
How does Pre-Shipment Finance Work?
In a typical pre-shipment financing transaction, the purchaser of goods first arranges a letter of credit or provides a purchase order to the seller. Following that, the seller approaches a lending institution to seek pre-shipment financing. Once approved, the lender pays an upfront payment for a substantial portion of the invoice amount. Once the goods are delivered, the sales transaction is deemed fulfilled. The financier transfers the principal and interest out of the seller’s account on the specified maturity or payment date.
Types of Pre-Shipment Finance
Businesses might look into a variety of pre-shipment finance options based on their particular needs and circumstances:
Extended packing credit loan (EPC)
Exporter businesses who are in need of working capital to meet costs associated with preparing goods for export seek Extended packing credit facility. The loan amount is normally determined by the exporter’s creditworthiness, preceding export performance, and the size of the export order.
Packing credit loan (Pledging)
In this type of pre-shipment financing, businesses requesting working capital must pledge goods or inventories. The lender takes such assets into its possession until export proceeds are received. The exporter repays the loan and releases the collateral once the export revenues are received.
Packing credit loan (Hypothecation)
A packaging credit loan is a financing arrangement that seeks either goods or inventory to secure loan repayment on fulfilling the export transaction. However, dissimilar to packing credit (pledging) credit facility, the exporter is not obligated to lose possession or control of the collateral to secure repayment.
Advances against red/green clause letter of credit
Advance against red clause letter of credit is a type of pre-shipment facility which comes with a specific provision enabling lenders to make advance payments to the exporter entity even before presentation of any shipment related document. The advance amount is intended to be utilized to meet production or shipment costs with instructions from the concerned importer. Once the exporter receives payment from the buyer, the issuer deducts such advance payment along with other applicable costs.
An advance against green clause letter of credit, on the other hand, is a financial facility that provides funds to cover costs associated with goods storage at the port. In India, the government’s prior approval is essential for the issue of this kind of letter of credit.
Pre-Shipment Credit in Foreign Currency (PCFC)
Pre-shipment credit in foreign currency (PCFC) is a temporary loan facility that Indian business entities could use to finance their export related costs. It helps businesses to lower the risk of foreign currency fluctuation as it is provided in the currency of the importing nation.
Benefits of Pre-Shipment Finance
Improved Cash Flow-
Generally exporters need to incur substantial costs to export their goods globally i.e. production costs, wages, storage and shipment costs. Such costs are to be expended before receipt of payment from the buyer which could affect business cash flows. Hence, pre-shipment finance aids businesses to sustain steady cash flows through upfront credit access to fulfil production and logistics purposes.
Optimizing working capital-
Pre-shipment financing bridges the financial gap between the time production starts up till the exporter receives sales revenue from the buyer. In this way, exporters are able to fulfil their financial obligations, invest funds for expansion as well as maintain adequate liquidity for day-to-day business.
Gives Edge over competitors-
Exporters who are able to secure pre-shipment finance facilities are naturally able to fulfil timely orders and achieve effective operational management. It gives them an edge over their competitors in the global marketplace. Also, timely access to resources to meet production and shipping functions also helps them to avoid penalties or loss of growth opportunities.
Improved supplier relationships-
Pre-shipment finance encourages and strengthens business relationships by ensuring access to adequate liquidity essential to fulfil export of goods. Other than this, it enables businesses to negotiate favourable terms and conditions with the suppliers which saves costs and boosts business profits.
Reduced risk-
Pre-shipment finance also alleviates the risk of incurring financial losses by helping to manage risks against events such as delayed payments, buyer defaults or any other unexpected events.
Flexible and customised financing solutions for businesses-
Several lending institutions offer different types of pre-shipment finance options for businesses with flexible repayment terms. Accordingly, exporters could pick financing options as per their choice and requirements.
Risks involved with Pre-Shipment Finance
Documentation fraud risk-
It is imperative for exporter businesses to submit genuine authorized documents while applying for pre-shipment finance loans. However, there is a likelihood of acts of fraud, such as presentation of forged documents, submitting incorrect information, or misrepresenting facts, etc. on the part of buyers or transactional intermediaries. Thus, incomplete or inaccurate documentation could delay payments or impede the loan approval process.
Counter-party Risk-
Despite exporter availing pre-shipment finance facility, there could be instances where the buyer defaults to make payment which could increase financial strain for the exporter.
Market Risk-
Exporters avail pre-shipment finance facilities in foreign currency which exposes them to the risk of currency fluctuations in international markets.
Quality and Shipping Risk-
Pre-shipment funding is typically offered based on the export order value and product quality. However, there may be risks regarding situations where the goods delivered fall short of the requisite quality standards, or that the cargo will be delayed or destroyed in transit.
Regulatory and Compliance Risk-
Exporters need to comply with global trade compliances, satisfy export control procedures, and fulfill document requirements with respect to the transaction and the business. Failure to do so might have a huge impact including levy of penalties and cancellation of licenses.
Risk of Non-Delivery of Goods-
There is also a high possibility that the exporter business may fail to meet agreed-upon delivery terms, resulting in contractual violations and financial liabilities.
Political Risk-
Trade restrictions or political unrest in the buyer’s nation could give rise to risks such as delay in payments or even payment defaults. Further, exporters could be exposed to restrictions in trade, economic instability, change in regulations, etc. in certain areas. All of these factors may affect export transactions, payments, and everyday business activities.
Pre-Shipment Finance Documents Required
- Export Agreement- Copy of export agreement entered between seller and buyer which specifies terms of export transaction.
- Proforma Invoice- Copy of proforma invoice which offers a rough idea regarding total cost of goods being exported.
- Letter of Credit- Letter of credit which assures payment once goods are delivered.
- Shipping documents- Includes a copy of the bill of lading (receipt for items shipped) and the business invoice (list of products and associated charges).
- Insurance Documents- Includes insurance paperwork assuring protection against damages and loss of goods during transit.
- Certificates of Origin- These documents offer details regarding the country of origin of the goods exported normally required for cross-border trade.
Pre-Shipment Finance Process
- Determine Loan Amount- Businesses seeking funds shall determine the amount needed to be financed for covering export related costs.
- Research Lending Institutions- Next, businesses shall research different lending institutions to find out the best financing product and favourable lending terms.
- File loan application with preferred lender-After choosing pre-shipment finance product with favourable lending terms, the exporter business shall go ahead with submission of loan application with the lender.
- Application Review by the lender- On receipt of the loan application, the lender will review the creditworthiness of the applicant and export related details. Then, the lender and the exporter entity will negotiate lending terms and conditions including repayment terms and applicable interest rates.
- Signing the agreement and loan disbursal- Once the lending terms and conditions are agreed, both the parties will sign the loan agreement. Post which, the lender will disburse the loan amount which could utilize funds for manufacturing and shipping costs.
Difference between Pre-Shipment Finance and Post-Shipment Finance
Pre-Shipment Finance | Post Shipment Finance | |
| Meaning | Pre-shipment finance is a short-term financing arrangement which facilitates funds to fulfil export related requirements for a business. | Post-shipment finance is a short-term credit offered to business entities who have shipped goods to the buyer but haven’t received payment for the same. |
| Timing | Pre-shipment finance facility is provided prior to shipment of goods. | A pre-shipment finance facility is provided post goods are shipped to the buyer. |
| Purpose | facilitates the manufacturing and export-readying of goods assuring availability of funds for pre-export purposes. | Helps to manage business cash flows to allow exporters to manage financial obligations while waiting for payment from the buyer. |
| Security | The loan amount is backed against pledging or hypothecation of goods undergoing production and inventory. | The loan amount is secured against the trade receivables based on the borrower’s financial health and quality of goods. |
Conclusion
Therefore, pre-shipment finance is an essential financial instrument to fulfil goods production and shipping functions for export purposes while managing effective business cash flows. It helps businesses to secure funds to manage working capital while export of goods helps to gain an edge over their competitors.
With the advent and penetration of technology it is now becoming easier for the traders to access pre-shipment finance easily and quickly. They have funds to be able to meet their working capital needs. While banks have AI and centralised data driven technologies that reduces lengthy procedures and repeated paper work making lending easier.
Nevertheless, businesses should take adequate measures to minimize possible risks to review potential buyers and take insurance to protect against unanticipated losses. While managing their working capital or the loans the borrowers are advised to take help of advanced borrower driven softwares that take care of all the back-end jobs related to loans sanctions and renewals. BankKeeping is the only platform in India that helps borrowers manage their loans at one place. It also helps in negotiating, getting the projections and CMA report ready and also helps in regular interest checking. All this effectively reduces the borrowing cost for the SMEs and eases their day to day interactions with the banks, improving their overall business and credit ratings over the period. For more you may click here or get in touch with our experts.
FAQs
How can pre shipment finance help in working capital credit?
Pre-shipment finance provides short-term funding to exporters before goods are shipped, helping them meet their working capital needs.
Who is eligible for pre shipment finance?
If a trader is into exports and has an LC or a confirmed order from the foreign buyer, it is eligible to raise funds through pre shipment finance.
What is the tenure of pre shipment finance?
It is generally for 30-90 days depending on the export cycle.