What Is Pre shipment finance?
Pre shipment finance is a type of trade finance provided to an exporter or seller before the actual shipment of goods. This financing helps cover the costs incurred during the manufacturing, processing, or packaging of goods for export. It is essentially working capital extended to fulfill a purchase order from an overseas buyer, bridging the financial gap between receiving an order and getting paid after shipment. Pre shipment finance ensures that exporters have the necessary short-term loans to produce and prepare goods, facilitating international commerce. This financial tool is crucial for businesses, especially small and medium-sized enterprises (SMEs), that might lack sufficient cash flow to manage large export orders without external assistance.
History and Origin
The concept of financing trade activities has roots stretching back centuries, evolving with the complexity of international commerce. Early forms of trade credit and merchant financing laid the groundwork for modern export financing. As global trade expanded in the 20th century, particularly after World War II, the need for structured financial instruments to support production and export became more pronounced. Institutions like the Asian Development Bank (ADB) and various national export-import banks emerged to facilitate this growth, often providing guarantees and direct loans to support trade. The ADB, for instance, has actively supported trade finance programs, recognizing their role in economic development and stability in the Asia-Pacific region.4 Such initiatives helped formalize and expand access to facilities like pre shipment finance, enabling businesses to participate in global markets more readily. The establishment of global frameworks and rules by organizations like the International Chamber of Commerce (ICC) for instruments such as letters of credit further standardized and secured trade financing mechanisms.
Key Takeaways
- Pre shipment finance provides working capital to exporters to cover expenses before goods are shipped.
- It typically covers costs like raw materials, manufacturing, packaging, and transportation to the port.
- This financing is crucial for businesses, particularly SMEs, to fulfill large export orders without straining their cash flow.
- The financing is often secured by the export order itself or future receivables, and sometimes requires collateral.
- It helps mitigate liquidity challenges and enables timely execution of export contracts.
Interpreting Pre shipment finance
Pre shipment finance is interpreted as a vital liquidity injection for exporters during the production phase. The availability and terms of pre shipment finance indicate a bank's or financial institutions' assessment of the exporter's creditworthiness, the buyer's reliability, and the overall viability of the trade transaction. A lender's willingness to provide pre shipment finance often depends on the strength of the underlying export contract, the nature of the goods, and the credit risk associated with the buyer. This financial support confirms the commercial viability of an export deal, allowing the exporter to focus on production and logistics rather than immediate cash constraints. The structure of pre shipment finance, whether as a direct loan, advance against a purchase order, or packing credit, reflects the specific needs and risk profiles of the transaction.
Hypothetical Example
Consider "Global Garments Inc.," a textile manufacturer in Bangladesh, which secures an export order for 100,000 shirts from "Fashion Forward," a retail chain in Europe. The total value of the order is $500,000. Global Garments Inc. needs $200,000 to purchase fabric, threads, and pay for labor and other manufacturing costs before the shirts are ready for shipment.
Since Global Garments Inc. does not have all $200,000 immediately available in its working capital, it approaches its bank for pre shipment finance. The bank, after reviewing the purchase order from Fashion Forward (which is a reputable buyer) and the terms of the letter of credit issued by Fashion Forward's bank, agrees to provide a pre shipment loan of $180,000.
This $180,000 allows Global Garments Inc. to procure raw materials and begin production. Once the shirts are manufactured, packaged, and transported to the port, the shipping company issues a bill of lading. Global Garments Inc. then submits the required shipping documents, including the commercial invoice and the bill of lading, to its bank. The bank then processes the payment from Fashion Forward's bank, repays itself the $180,000 pre shipment finance amount plus interest, and remits the remaining balance to Global Garments Inc.
Practical Applications
Pre shipment finance is widely used in international trade to support exporters in various industries. Its applications include:
- Manufacturing and Procurement: Businesses use it to buy raw materials, components, and pay for manufacturing processes. For example, a furniture exporter might use pre shipment finance to purchase timber and pay for carpentry work.
- Packaging and Logistics: It covers the costs associated with packaging the goods, labeling, and transporting them to the port or airport for loading.
- Quality Control and Certification: Funds can be used for necessary inspections, quality checks, and obtaining certificates required for export.
- Facilitating Export Financing: Government export credit agencies, such as the U.S. Export-Import Bank, often work with private lenders to provide guarantees and financing solutions that include pre shipment support for American exporters, particularly small and medium-sized businesses.3,2
This type of financing enables companies to take on larger orders than their existing cash flow might otherwise allow, thereby expanding their global market reach.
Limitations and Criticisms
Despite its benefits, pre shipment finance carries certain limitations and criticisms. A primary concern is the inherent risk for lenders, as the financing is provided before the goods are shipped and often before the final buyer’s payment is fully secured. If the exporter fails to produce the goods as per the contract, or if the goods are damaged or lost before shipment, the lender faces default risk. Additionally, inventory financing during the pre-shipment phase can tie up capital and introduce risk management challenges for both the exporter and the lender, especially with fluctuating commodity prices or perishable goods.
Broader challenges in the trade finance landscape, such as the persistent "trade finance gap," where small and medium-sized enterprises (SMEs) often face high rejection rates for their finance applications, can also limit access to pre shipment finance. The World Trade Organization (WTO) has highlighted this shortfall, noting that smaller businesses are significantly more likely to have their trade finance requests rejected compared to multinational corporations, often due to perceived lack of creditworthiness or insufficient documentation. T1his indicates that while pre shipment finance is a crucial tool, its accessibility is not uniform, particularly in developing economies. Furthermore, complex documentation requirements and compliance with international trade regulations can be burdensome for some exporters.
Pre shipment finance vs. Post shipment finance
Pre shipment finance and post shipment finance are both integral components of trade credit that support exporters, but they cover different stages of the export cycle. The key distinction lies in the timing of the financing relative to the shipment of goods.
| Feature | Pre Shipment Finance | Post Shipment Finance |
|---|---|---|
| Timing | Provided before goods are shipped. | Provided after goods are shipped. |
| Purpose | Covers costs of manufacturing, processing, procurement, and packaging. | Bridges the gap between shipment and receipt of payment from the buyer. |
| Typical Costs | Raw materials, labor, production, transportation to port. | Freight, insurance, marketing, administrative costs (until payment). |
| Collateral | Often the export order, letters of credit, or hypothecation of goods. | Export receivables, bills of exchange, or shipping documents. |
| Risk Focus | Production risk, performance risk, political risk (if production is impacted). | Buyer non-payment risk, country risk, delayed payment risk. |
Pre shipment finance ensures that the exporter has the necessary funds to prepare the goods for export, while post shipment finance provides liquidity once the goods are on their way, enabling the exporter to manage their cash flow until the importer pays. Both are critical for a seamless supply chain finance operation.
FAQs
What types of expenses does pre shipment finance cover?
Pre shipment finance primarily covers expenses directly related to preparing goods for export. This includes purchasing raw materials, manufacturing costs, labor wages, packaging, and transportation to the port of shipment. It ensures the exporter has sufficient working capital to fulfill the order.
Is pre shipment finance always secured?
While not universally absolute, pre shipment finance is typically secured. Lenders often take security against the export order itself, the underlying purchase order, a confirmed letter of credit from the buyer's bank, or the goods being produced. This reduces the risk for the financial institution providing the funds.
Who typically offers pre shipment finance?
Pre shipment finance is usually offered by commercial banks, export-import banks (like the U.S. EXIM Bank), and other financial institutions that specialize in trade finance. These institutions have the expertise to assess the specific risks involved in international trade transactions.
How does pre shipment finance benefit exporters?
Pre shipment finance allows exporters, especially those with limited cash flow, to accept and fulfill large international orders. It helps manage liquidity, ensures timely production, and reduces the financial burden of self-funding the manufacturing process. This support is vital for maintaining competitiveness in global markets.