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What is pre-shipment finance?

Pre-shipment finance is a form of financing that provides businesses with the necessary funds to fulfil their export orders. Learn more in this blog.

An important factor when planning business operations related to international trade is finance, especially in the pre-shipment stage. Exporters need to consider all relevant factors including their business goals, costs and other elements to plan in advance and run a smooth export business.

What is pre-shipment finance?

Pre-shipment finance is a form of financing that provides businesses with the necessary funds to fulfill their export orders and cover expenses during the pre-shipment phase of international trade. This usually addresses working capital requirements and cash flow challenges that may arise before shipment of goods.

Types of pre-shipment finance

Some of the popular types of pre-shipment finance are:

Extended packing credit loan

Extended packing credit loans offer exporters a line of credit based on their working capital requirements. The loan amount is typically determined by the exporter’s creditworthiness, past export performance, and value of the export order.

Packing credit loan

In this type of pre-shipment finance, exporters provide collateral, usually in the form of goods or inventory, to secure a loan. The collateral is pledged to the financial institution, until the export proceeds are realized. Once the export proceeds are received, the collateral is released.

Packing credit loan (hypothecation)

A packing credit loan (commonly known as hypothecation) is a financing arrangement where exporters offer goods or inventory as collateral. Unlike the packing credit loan option, in this case, the exporter retains possession and control over the collateral while using it to secure the loan.

Advances against red clause letter of credit

A red clause letter of credit (L/C) is a type of letter of credit that contains a special clause allowing the beneficiary (exporter) to receive an advance payment from the issuing bank before the shipment is made. The advance amount is usually a percentage of the total L/C value and is deducted from the payment the exporter receives upon submitting the required shipping documents.

What is the pre-shipment finance procedure?

While the process of pre-shipment finance may vary depending on the financial institution and type of pre-shipment finance, here is a general overview of the procedure:

Assess funding requirements:

Evaluate working capital needs for pre-shipment expenses.

Choose a financial institution:

Select a suitable lender based on reputation, rates, and terms.

Application submission:

Submit a finance application with exporter and transaction details.

Document verification and credit assessment:

Review and verify documents, assess creditworthiness.

Approval and offer:

Receive approval and finance offer from the institution.

Acceptance and agreement:

Formal acceptance by signing loan agreement and relevant contracts.

Utilization of funds:

Utilize funds for pre-shipment purposes as per agreed terms.

Reporting and monitoring:

Provide periodic updates on progress and fund utilization.

Repayment:

Repay the loan with interest and fees upon export proceeds realization or within the agreed period.

Benefits of pre-shipment finance

Pre-shipment finance offers many benefits to exporters involved in international trade. Here are some of the key advantages:

Smooth cash flow

Exporters often face significant expenses such as raw material procurement, production costs, packaging, and transportation before receiving payment from buyers. Pre-shipment finance provides the necessary funds to cover these expenses.

Working capital optimization

Pre-shipment finance helps bridge the gap between production and payment. By freeing up the working capital, exporters can allocate resources more efficiently, invest in growth opportunities and meet other financial obligations.

Competitive advantage

With pre-shipment finance, exporters can expedite their production and shipment processes, ensuring the timely delivery of goods.

Risk mitigation

By securing pre-shipment finance, exporters get relief from some of risks such as buyer defaults, payment delays, or unforeseen events.

Flexibility and customization

Financial institutions offer various types of pre-shipment finance with flexible terms and conditions. Exporters can choose a financing option that best suits their requirements.

Business growth and expansion

By securing the necessary funds for pre-shipment activities, exporters can take on larger export orders, explore new markets, and capitalize on emerging trade opportunities.

Risks involved in pre-shipment finance

While pre-shipment finance offers numerous benefits to exporters, it also carries certain risks that exporters should be aware of. Here are some key risks involved in pre-shipment finance:

Counterparty risk

Despite pre-shipment finance, there is always a possibility that the buyer may fail to make the payment, leading to financial losses for the exporter.

Market risk

Exporters who secure pre-shipment finance denominated in foreign currency are exposed to currency exchange rate fluctuations.

Quality and shipment risk

Pre-shipment finance is often granted based on the value of the export order and the quality of the goods. However, there is a risk that the exported goods may not meet the required quality standards or that the shipment may be delayed or damaged during transit.

Regulatory and compliance risk

Exporters must comply with various international trade regulations, export control requirements, and documentation obligations when opting for various finance options.

Country and political risks

Exporting to certain countries or regions may expose exporters to political instability, economic crises, trade sanctions, or changes in government policies. These factors can impact the export transaction, payment, and overall business operations.

Non-delivery risk

There is a risk that the exporter may fail to deliver the goods as per the agreed terms and conditions, leading to contractual breaches and financial liabilities.

Fraud and documentation risks

Pre-shipment finance requires exporters to provide accurate and authentic documentation. However, there is a risk of fraudulent activities, such as forged documents, false information, or misrepresentation.

What are the documents required for pre-shipment finance?

While the specific requirements may vary depending on the financial institution and type of pre-shipment finance being sought, here are some commonly requested documents:

· Export Order
· Proforma invoice
· Purchase order
· Export license/ permits
· Insurance documents
· Bill of Lading/Airway Bill
· Export declaration

Pre-shipment vs post-shipment financing

Pre-shipment financing and post-shipment financing are two types of financing options. Here’s a comparison between the two:

Pre-shipment financing:

Timing:

Provided before shipment of goods, covering working capital needs during the pre-export phase.

Purpose:

Facilitates the production and preparation of goods for export, ensuring exporters have funds for procurement, production costs, packaging, and transportation expenses.

Security:

Often secured against export orders, raw materials, or the export goods themselves, with creditworthiness and viability of the export transaction assessed by the lender.

Repayment:

Repayment made after the shipment of goods, using proceeds from the sale of goods upon realization of export proceeds.

Post-shipment financing:

Timing:

Provided after shipment of goods, bridging the gap between shipment and receipt of payment.

Purpose:

Manages cash flow during the post-export phase, allowing exporters to meet financial obligations while awaiting payment from the buyer.

Security:

Often secured against export receivables or invoices, with the creditworthiness of the buyer and quality of the receivables considered by the lender.

Repayment:

Repayment made using export proceeds received from the buyer after payment is settled.

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Frequently Asked Questions

What is the pre-shipment inspection process?

Pre-shipment inspection process usually involves assessing the quality, quantity, and compliance of the goods before they are shipped.

What is the maximum period of pre-shipment finance?

The maximum period of pre-shipment finance varies depending on the financial institution and specific terms of the loan.

What is the amount of pre-shipment finance?

The amount of pre-shipment finance depends on various factors including the financial institution’s assessment of the exporter’s creditworthiness, viability of the export transaction, and working capital requirements.

Published on June 29, 2023.

Sources:
1. https://www.dripcapital.com/en-in/resources/finance-guides/pre-shipment-finance
2. https://www.kredx.com/supply-chain-finance/export-financing/pre-shipment-finance
3. https://connect2india.com/finance/trade-finance/types-of-pre-shipment-finance.html
4. https://www.idbibank.in/tradefinance-preshipment.aspx

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What is pre-shipment finance?

What is pre-shipment finance?

Types of pre-shipment finance

Extended packing credit loan

Packing credit loan

Packing credit loan (hypothecation)

Advances against red clause letter of credit

What is the pre-shipment finance procedure?

Assess funding requirements:

Choose a financial institution:

Application submission:

Document verification and credit assessment:

Approval and offer:

Acceptance and agreement:

Utilization of funds:

Reporting and monitoring:

Repayment:

Benefits of pre-shipment finance

Smooth cash flow

Working capital optimization

Competitive advantage

Risk mitigation

Flexibility and customization

Business growth and expansion

Risks involved in pre-shipment finance

Counterparty risk

Market risk

Quality and shipment risk

Regulatory and compliance risk

Country and political risks

Non-delivery risk

Fraud and documentation risks

What are the documents required for pre-shipment finance?

Pre-shipment vs post-shipment financing

Pre-shipment financing:

Timing:

Purpose:

Security:

Repayment:

Post-shipment financing:

Timing:

Purpose:

Security:

Repayment:

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Frequently Asked Questions

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