How Pre-Shipment Finance Can Help Your Business Meet Export Demands?

Managing finances is a crucial aspect of running a business, especially when it comes to fulfilling large orders or completing production before customers make payments. Pre-shipment finance can provide an effective solution for businesses facing cash flow issues while trying to meet demand or ramp up production. It ensures that companies have the necessary funds to manufacture, package, and deliver goods on time.

This article explains the concept of pre-shipment finance, how it works, the various types available, and the key benefits and risks involved.

What is Pre-Shipment Finance?

Pre-shipment finance is a type of financial assistance provided to businesses before their goods are shipped to customers. The primary purpose is to help businesses cover the costs of production, including raw materials, labor, and transportation. It is a short-term financing option usually provided by banks or financial institutions and is typically secured by the goods being produced or a letter of credit from the buyer.

Pre-shipment finance is usually offered for a brief period, ranging between 30 and 90 days. This type of financing bridges the gap between when goods are produced and when the business receives payment from the customer.

How Does Pre-Shipment Finance Work?

The process of securing pre-shipment finance follows these steps:

• Letter of Credit or Purchase Order: The buyer arranges a letter of credit or provides a purchase order.
• Request for Finance: The seller requests pre-shipment finance from a bank or financial institution.
• Invoice Financing: The financier provides a significant portion of the invoice amount to the seller upfront.
• Shipment of Goods: Once the goods are shipped, the sales order is considered fulfilled.
• Repayment: On the agreed maturity or payment date, the financier deducts the principal and any interest from the seller’s account.

Financial institutions typically impose strict eligibility criteria for pre-shipment finance and may charge a notable fee. They carefully evaluate the creditworthiness of both the buyer and seller before approving the loan.

Types of Pre-Shipment Finance

There are several types of pre-shipment finance options that businesses can explore, depending on their specific needs and circumstances:

1. Extended Packing Credit Loan

An extended packing credit loan provides businesses with funds to cover production and packing costs for goods intended for export. This loan is typically secured by the goods being produced or by a letter of credit. The funds are used to purchase raw materials, pay labor, and cover transportation and packaging expenses.

2. Packing Credit Loan (Pledge)

In a packing credit loan based on a pledge, the goods being produced serve as collateral for the loan. The business provides the lender with the right to seize and sell the goods if it fails to repay the loan. This type of loan is also secured by a letter of credit from the buyer and helps the seller cover production costs.

3. Packing Credit Loan (Hypothecation)

This loan is similar to the packing credit loan (pledge), but it involves a hypothecation agreement. The goods being produced are used as collateral, and if the borrower defaults, the lender has the right to seize the assets. Sometimes, additional collateral, such as real estate, may also be required to secure the loan.

4. Advances Against Red Clause Letter of Credit (L/C)

A red clause letter of credit allows the seller to receive an advance payment before goods are shipped. This type of loan is extended based on the letter of credit issued by a bank and helps the seller finance production costs.

5. Pre-Shipment Credit in Foreign Currency (PCFC)

Pre-shipment credit in foreign currency (PCFC) is a short-term loan offered to businesses in India to finance exports. It covers the cost of raw materials, labor, transportation, and other production-related expenses. The loan is provided in the importing country’s currency, helping businesses reduce foreign exchange risk.

Documents Required for Pre-Shipment Finance

To obtain pre-shipment finance in India, businesses need to submit specific documents to financial institutions. These typically include:

• Export Contract: The agreement between the buyer and seller, outlining the terms of the export transaction.
• Proforma Invoice: An estimated invoice for the total cost of the goods being exported.
• Letter of Credit: A bank guarantee from the buyer, ensuring payment to the exporter once goods are shipped.
• Shipping Documents: Includes the bill of lading (receipt for the shipped goods) and the commercial invoice (a list of the goods and associated costs).
• Insurance Documents: Provides protection against any damage or loss to goods during transit.
• Certificates of Origin: These certify the country of origin of the exported goods and are sometimes required for international trade.

Pre-Shipment Finance Procedure

The process of obtaining pre-shipment finance typically involves the following steps:

• Assess Financial Needs: Businesses determine whether they need pre-shipment finance to cover production and shipping costs.
• Research Lenders: Businesses compare options from various financial institutions to find the best loan terms.
• Submit Loan Application: The business submits an application with all relevant information and documents.
• Negotiate Terms: Once the application is reviewed, both parties discuss and agree on loan terms such as interest rates and repayment schedules.
• Sign Loan Agreement: After agreeing on terms, the business and lender sign the agreement.
• Receive Loan: The lender disburses the loan, which the business can use for production and export purposes.

Benefits of Pre-Shipment Finance

Pre-shipment finance offers several benefits to businesses:

• Improved Cash Flow: It helps businesses maintain steady cash flow by providing upfront funds for production and shipping.
• Enhanced Competitiveness: Businesses can take advantage of export opportunities without being constrained by cash flow issues.
• Increased Flexibility: Pre-shipment finance gives businesses the flexibility to fulfill customer orders and manage production efficiently.
• Reduced Risk: By providing funds before shipping, businesses can minimize financial risks and ensure the timely completion of orders.
• Strengthened Supplier Relationships: Timely payments to suppliers can lead to better terms and improve supplier relationships.

Risks of Pre-Shipment Finance

Despite its advantages, pre-shipment finance comes with some risks:

• Credit Risk: The risk that the buyer will not be able to make the required payments due to financial difficulties or bankruptcy.
• Political Risk: Political instability or trade restrictions in the buyer’s country can lead to delays or non-payment.
• Exchange Rate Risk: Fluctuations in foreign exchange rates can affect the final payment amount in the seller’s local currency.
• Shipping Risk: Goods can be damaged, lost, or delayed during transit.
• Documentation Risk: Incorrect or incomplete documents can delay payment or affect the loan approval process.
• Fraud Risk: There is always a risk of fraudulent activities by buyers or intermediaries in the transaction.

Conclusion

Pre-shipment finance provides businesses with a valuable solution to meet production and export demands while managing their cash flow effectively. By securing funds before shipping, businesses can enhance their competitiveness, reduce risks, and strengthen supplier relationships. However, it’s important to be aware of the risks involved and take necessary precautions, such as obtaining credit insurance and thoroughly vetting buyers.
Also Read: Pre-Shipment vs Post-Shipment Finance