Pre-Shipment Finance

Pre-shipment Finance is a loan provided by a finance provider to a seller of

goods and/or services for the sourcing, manufacture or conversion of raw
materials or semi-finished goods into finished goods and/or services, which are
then delivered to a buyer. A purchase order from an acceptable buyer, or a
documentary or standby letter of credit or Bank Payment Obligation, issued on
behalf of the buyer, in favour of the seller is often a key ingredient in motivating
the finance in addition to the ability of the seller to perform under the
contract with the buyer.
Pre-Shipment Financing covers the working-capital needs of the seller,
including procurement of raw materials, labour, packing costs, and other
pre-shipment expenses in order to allow the seller to fulfil delivery to its
buyer(s). Pre-shipment Finance can be provided in any number of structural
variations. Financing can be provided against purchase orders (confirmed by
buyer or unconfirmed), demand forecasts or underlying commercial contracts.

Although Pre-shipment Financing is most commonly provided in an open

account situation, other sources of repayment from the buyer may also be the
proceeds of a Documentary Credit or standby letter of credit or a Bank Payment
Obligation. Pre-shipment Finance can be provided on a programmatic basis,
covering a series of transactions (typically for smaller sellers) or on a
transactional basis (typically for larger sellers).
The finance provider is likely to advance a certain percentage of the value of the
order, potentially disbursed in stages as the order is fulfilled. Maturity dates for
the financing are established between the seller and finance provider and are
often tied to the ultimate date on which the buyer will make payment.

Upon shipment, the finance provider may offer post-shipment financing using
techniques such as Receivables Discounting, or Payables Finance to cover the
period from shipment and the raising of the invoice until the final payment by
the buyer.

PARTIES
A typical Pre-shipment financing transaction involves two main parties: the
seller and the finance provider. The buyer is not a party to the financing
transaction but depending on the contractual arrangement with the finance
provider, the source of the repayment is usually the flow of sales proceeds from
the buyer. The history of the commercial relationship is a factor in determining
the probability of repayment. Bank and non-bank finance providers are active in
this type of financing particularly in Asia.
CONTRACTUAL RELATIONSHIPS AND DOCUMENTATION
The seller and finance provider enter into a financing agreement detailing terms
of the financing structure. This may but will not always include a security
agreement covering assignment of rights (transfer of title or a pledge) to the
underlying work in progress and finished goods prior to shipment. The finance
provider may require a security interest in the receivables following shipment.
The seller may grant inspection rights to the finance provider or its nominated
agent for the period of manufacture or conversion.

SECURITY
As described in the previous section, a security agreement will be executed
covering assignment of rights (transfer of title or a pledge) to the underlying
work in progress and finished goods prior to shipment and to the receivables
following shipment.

RISKS AND RISK MITIGATION

The primary risk is the performance risk of the seller as repayment is dependent
on the seller’s performance ability and reputation. Specifically, the seller’s
ability to perform against the purchase contract, and the buyer’s ability and
willingness to pay on delivery of the goods are the key risks. Mitigation of risk
is provided by the credentials of a creditworthy and reliable buyer and the
proven performance of the seller in a repeatable and predictable fashion.
Security over assets prior to shipment is an important control mechanism, but is
not the primary source of risk mitigation.
Documents Required for Pre-Shipment Finance?
In India, the documents required for pre-shipment finance will vary depending
on the specific circumstances of the export transaction and the type of financing
being used. However, some common documents that may be required include:

Export contract:
This is the main document outlining the terms and conditions of the export
transaction, including the goods being sold, the price, and the payment terms.

Proforma invoice:
This is a preliminary invoice that provides an estimate of the total cost of the
goods being exported. A proforma invoice may be used to obtain financing or as
a basis for the final invoice.
Letter of credit:
This is a financial instrument issued by a bank on behalf of the buyer, which
guarantees payment to the exporter once the goods have been shipped and the
required documents have been presented.

Shipping documents:
These documents include the bill of lading, which is a receipt for the goods
being shipped, and the commercial invoice, which is a detailed list of the goods
being exported and their associated costs.

Insurance documents: These documents, such as a marine insurance policy,

protect against the risk of damage or loss to the goods during shipping.

Certificates of origin:
The certificates of origin documents are essential to show that the exported
goods originate from a specific country and may be required for certain types of
goods or markets.

Pre-Shipment Finance Procedure

In India, the pre-shipment finance procedure typically involves the following
steps:

1. Identify the need for financing:

Businesses should first assess their financial needs and determine whether they
require pre-shipment finance to cover the costs of purchasing and transporting
goods or services for export.

2. Research and compare lenders: Businesses should research and compare

different lenders, including banks and financial institutions, to find the best
pre-shipment finance options for their needs.
3. Prepare and submit a loan application:
Businesses should prepare and submit a loan application to the lender of their
choice.

The application should include information about the business, the goods or
services being exported, the requested financing, and any collateral the business
is willing to provide.

4. Review and negotiate the loan terms:

Once the loan application has been received, the lender will review it and may
request additional information or documentation.

The business and the lender will then negotiate the loan terms, including the
interest rate, repayment schedule, and any fees or charges.

5. Sign the loan agreement:

If the business and the lender agree on the terms of the loan, they will sign a
loan agreement outlining the terms of the loan.

6. Obtain the loan:

Once the loan agreement has been signed, the lender will disburse the loan to
the business, which can then use the funds to purchase and transport the goods
or services for export.

Benefits of Pre-Shipment Finance

There are several benefits to using pre-shipment finance, including:

Improved cash flow:

Pre-shipment finance can help businesses to improve their cash flow by
providing the funds needed to purchase and transport goods or services for
export.

This can allow businesses to manage their financial resources better and reduce
the risk of financial difficulties.

Enhanced competitiveness:
Pre-shipment finance can enable businesses to better compete in international
markets by providing the funds needed to take advantage of export
opportunities.

Increased flexibility:
It can provide businesses with greater flexibility in their operations by allowing
them to finance the purchase and transportation of goods or services for export
as needed.
Reduced risk:
Pre-shipment finance allows businesses to reduce the risk of financial losses by
providing the funds needed to purchase and transport goods or services for
export.

This can help businesses to manage their risks better and increase their chances
of success in international markets.

Improved supplier relationships:

It can help businesses to strengthen their relationships with suppliers by
providing the funds needed to purchase goods or services for export on time.

This empowers businesses to secure better terms and conditions with their
suppliers, which can improve their competitiveness and profitability.

Risks of Pre-Shipment Finance

There are several risks involved in pre-shipment finance, including:

Credit risk:
Credit risk is the risk that the buyer will not be able to make the required
payments due to financial difficulties or bankruptcy.

Political risk:
This explores the risk that political events, such as revolutions, coups, or wars,
may disrupt trade or result in non-payment.

Exchange rate risk:

The risk includes the possibility of fluctuations in exchange rates that will affect
the value of the payment in the exporting company's domestic currency.

Shipping risk:
This is the threat of goods being damaged or lost during shipping.

Documentation risk:
This includes the risk that documents required for the export, such as letters of
credit or insurance documents, will be incorrect or incomplete.

Fraud risk:
It entails the danger that the buyer or intermediaries involved in the transaction
will commit fraud or engage in deceptive practices.

To mitigate these risks, exporters can use a variety of tools and strategies, such
as obtaining credit insurance, using letters of credit, and conducting thorough
due diligence on buyers.