Glossary
Trade Finance
Trade finance refers to the financial instruments and products used by companies to facilitate domestic and international trade transactions. It covers the mechanisms that bridge the gap between when a seller ships goods and when a buyer pays, managing the risk, timing, and liquidity challenges inherent in commercial trade.
What It Is
In any trade transaction, there is an inherent tension: the seller wants to be paid before or at shipment, while the buyer wants to pay after receiving and verifying the goods. Trade finance resolves this tension by providing instruments that give sellers confidence they will be paid and buyers the flexibility to pay on terms.
At its most fundamental level, trade finance is about three things: payment security, liquidity, and risk mitigation. It encompasses everything from simple payment terms and open account trading to complex structured instruments like letters of credit, bank guarantees, and documentary collections.
Supply chain finance sits within the broader trade finance landscape. Where traditional trade finance often involves banks and documentary instruments suited to large international transactions, SCF platforms offer digital solutions designed for ongoing buyer-supplier relationships.
Core Trade Finance Instruments
Open Account Trading
The most common form of trade in established buyer-supplier relationships. The seller ships goods and invoices the buyer, who pays within agreed terms (net-30, net-60, etc.). Simple and low-cost, but the seller carries all payment risk until the invoice is settled.
Letters of Credit (LC)
A bank-issued document guaranteeing that the seller will receive payment once agreed shipping and documentation conditions are met. The buyer’s bank issues the LC; the seller’s bank confirms it. Highly secure but slow, paper-intensive, and expensive, typically used for high-value international transactions with new counterparties.
Bank Guarantees
A bank’s commitment to cover the buyer’s payment obligations if the buyer defaults. Provides security to the seller without requiring upfront payment. Common in construction, infrastructure, and government contracts.
Documentary Collections
The seller’s bank forwards shipping documents to the buyer’s bank, which releases them to the buyer only upon payment or acceptance of a bill of exchange.