Pre-Shipment Finance
Every business requires capital to keep its operational activities smooth and uninterrupted. With the help of trade finance, both exporters and importers can meet their financial requirements related to specific stages of trading. For instance, a pre-shipment finance option helps individuals take care of the expenses an international business is likely to incur during the pre-shipment phase of the venture. Read more
What Is Pre-Shipment Finance?
Pre-shipment finance is a credit option that financial institutions provide to an international business owner dealing in goods or services. As the name suggests, this financing option is availed before finished products are shipped for export. Fundamentally, it helps businesses to meet all their working capital requirements that precede shipment of goods.
For example, the funds availed through pre-shipment finance options are used to -
- Procure raw materials
- Meet manufacturing cost
- Meet the cost of packaging
- Pay for other pre-shipment expenses
- Pay wages and salaries to employees
Typically, exporters or suppliers of export goods can access funds through this financing option. Under normal circumstances, a purchase order of an acceptable buyer, a bank guarantee issued in favor of the seller, and a documentary or standby letter of credit prove useful to avail funds under this financing option.
Pre-shipment finance in India is also known as purchase order finance, packing credit, or contract monetization financing.
How Does Pre-Shipment Finance Work?
These following pointers highlight the step-by-step process of pre-shipment financing -
- The buyer arranges a Letter Of Credit or purchase order
- When in need of funding, the seller submits a request to avail pre-shipment finance
- A significant portion of the invoice is provided
- The sales order is met once the goods are shipped
- On the maturity or payment date, the financier debits the seller's (client) account
Typically, financial institutions lay down strict eligibility criteria, and levy a substantial fee on the principal amount. They are thorough about document verification and assess the creditworthiness of both buyer and seller to provide a loan.
Types of Pre-Shipment Finance
These are the most common types of pre-shipment finance
Extended Packing Loan
This funding option is provided to help businesses obtain funds immediately so that they can obtain raw materials at the earliest. Once goods are acquired, financial institutions convert this advance as a collateralized loan.
Advances Against Back-To-Back Letter Of Credit
Typically, under this financing option exporters request their banking institution to issue a letter of credit in favor of their suppliers. It allows suppliers to access funds to purchase raw materials or finished items from manufacturers quite conveniently. The said funding option depends on original credit and requires documents that serve as proof for the dispatch of goods mentioned in the same.
Red Or Green Clause Letter Of Credit
A red clause letter of credit allows the negotiating bank to provide a cash advance to a beneficiary so that he/she can purchase goods and deliver them to initiate export. Based on terms of payment and documents submitted, a red letter of credit offers either part or full payment.
A green clause letter of credit provides credit to store goods at the port. With the help of this instrument, the beneficiary will be able to avail of funds and use the storage facility as well. Notably, businesses must seek permission from the government to receive this letter of credit in India.
Secured Shipping Loans
Funds can be availed under this loan option once materials are converted into finished goods or exportable items. Also, the same must have been sent to transport operators for shipment. Mostly, the loan amount is sanctioned on rail receipts and lorry receipts, and exporters must use approved clearing or forwarding agents to transmit goods.
Advances Against Export Incentives
Cash advances are extended against export incentives and are approved after the goods are shipped. Funds are availed before shipment if the value of materials that need to be produced exceeds the free onboarding limit. Such advances are usually repaid by negotiating export bills and receipts of export invoices.
Packing Credit For Imports Against Entitlements Under Advance Licence
This credit facility can be availed by those who manufacture export goods. However, banking institutions forward this pre-shipment finance facility only if the letter of credit is produced within 60 days of providing the advance. Also, imported materials must be used to produce items that will be exported eventually.
Besides these, pre-shipment credit in foreign currency and advance against duty drawbacks are other noteworthy types of pre-shipment finance in India.
Difference Between Pre-Shipment And Post-Shipment Finance
The significant differences between the two forms of financing are given in the table below -
Parameters | Pre-Shipment Finance | Post-Shipment Finance |
Purpose | It helps to meet the working capital requirement before shipment of goods for export. | It helps to access funds immediately and allows meeting working capital requirements after the shipment of goods. |
Time Of Credit | Pre-shipment finance is obtained before goods are shipped. | Post-shipment finance is obtained after goods are shipped. |
Repayment | Occurs through the proceeds of the export once the goods are shipped | Repaid when the exporter receives payment from the buyer after the goods are delivered. |
Depending on their requirements, businesses can choose suitable pre-shipment finance without collateral. Subsequently, businesses can raise funds in the post-shipment phase of trading via invoice financing and meet the funding gap between shipment and payment.
Documents Required for Pre-Shipment Finance
To avail of this financing, there are specific documents that exporters must prepare and submit.
Export Order or Contract
This crucial document outlines the specifics of the export deal, including buyer details, product specifications, quantity, pricing, delivery terms, and payment conditions. It forms the basis of the transaction and is essential for lenders to assess the viability and legitimacy of the deal.
Letter of Credit
If the export is being made under a Letter of Credit, a copy of this document issued by the buyer's bank is needed. It acts as a financial guarantee that the payment will be made, specifying the terms under which the payment is secured.
Purchase Order
In transactions not covered by a Letter of Credit, the overseas buyer's purchase order is necessary. It serves as proof of a confirmed order, demonstrating the demand and validity of the export.
Proforma Invoice
This preliminary invoice is sent to buyers before delivery. It details the products to be sold and includes information like shipment weight and transport charges. This invoice is used for customs and funding purposes.
Export License (if required)
Certain goods or destinations may need an export license. This is a government-issued document that allows the export of specific items to certain locations, ensuring compliance with international trade regulations.
Insurance Certificate
This certifies that the goods are insured against loss or damage during transit. It's a critical document, especially for international shipments, as it assures potential risks.
Bills of Lading or Airway Bill
These are shipping documents that act as a receipt for the merchandise and detail the terms of the transport agreement. Bills of Lading are generally post-shipment documents but preparing them in advance can be beneficial.
Quality Inspection Certificates
For some goods, especially those with specific standards, a quality inspection certificate is necessary to confirm that the products meet the required criteria.
Export License or Regulatory Approvals
Certain products or destinations may require specific regulatory approvals or export licenses, which need to be presented.
Advantages of Pre-Shipment Finance
Here are five key advantages of pre-shipment finance:
Enhanced Cash Flow
Pre-shipment finance provides essential capital to exporters before they receive payment from their buyers. This influx of funds ensures that exporters have the necessary liquidity to cover the costs associated with producing, packing, and shipping goods, thus maintaining a healthy cash flow.
Facilitates Production and Growth
By availing of pre-shipment finance, businesses can afford to purchase raw materials, pay for labor, and cover other manufacturing costs. This financial support is especially crucial for small and medium enterprises (SMEs) that might not have substantial reserves, enabling them to take on larger orders and grow their business.
Reduces Financial Strain
Exporters often face a significant time gap between fulfilling an order and receiving payment. Pre-shipment finance relieves the financial strain during this period, allowing businesses to continue their operations without disruption or the need to deplete their working capital.
Increases Competitive Advantage
Access to pre-shipment finance can give exporters a competitive edge in the market. It enables them to accept more orders and potentially offer better payment terms to their buyers, making their business more attractive and reliable in international trade.
Flexibility in Operations
With the financial backing provided by pre-shipment finance, exporters can operate with greater flexibility. They can manage production schedules more effectively, negotiate better with suppliers, and optimize their supply chain, leading to more efficient and profitable operations.