Pre-shipment finance can be a useful tool for businesses that need to secure financing to complete a production run or meet customer demand but need more cash on hand.
It can help businesses to manage their cash flow and ensure that they have the necessary funds to complete their production and delivery schedules. Read more to get an in-depth knowledge of pre-shipment finance.
Meaning of Pre-Shipment Finance
Pre-shipment finance is a type of financing solution that is provided to a business before the goods or products have been shipped to the customer.
It is typically used to cover the costs of production, such as raw materials, labour, and transportation, as well as any other expenses incurred before the goods are ready to be shipped.
Pre-shipment finance can be provided by banks, financial institutions, or other lenders and is typically secured by the goods being produced or by a letter of credit from the customer.
It is usually provided for a short period, typically around 30 to 90 days, and is intended to help the business bridge the gap between the time the goods are produced and the time the customer pays for them.
What are the Types Of Pre-Shipment Finance?
The prominent types of pre-shipment finance include:
Extended Packing Credit Loan
Extended packing credit loan is a type of pre-shipment finance provided to businesses to cover the costs of production and packing of goods being exported.
It is typically provided by banks or other financial institutions and secured by the goods being produced or by a letter of credit from the customer.
The loan is intended to help the business cover production costs, including the purchase of raw materials, labour, and transportation, as well as the costs of packing the goods for export.
Packing Credit Loan (Pledge)
A packing credit loan (pledge) is a type of pre-shipment finance provided to businesses to cover the costs of production and packing of goods being exported.
It is typically provided by banks or other financial institutions and secured by a pledge of the goods being produced or by a letter of credit from the customer.
A pledge is a legal agreement in which a borrower gives the lender the right to seize and sell certain assets if the borrower fails to repay the loan.
In the case of a packing credit loan (pledge), the goods being produced or exported are used as collateral for the loan.
Packing Credit Loan (Hypothecation)
The loan is typically extended by a bank or financial institution and secured by a hypothecation agreement, which is a legal document that allows the lender to seize the goods being financed if the borrower defaults on the loan.
The lender may also require collateral, such as real estate or other assets, to secure the loan.
Advances Against Red Clause L/C
An advance against a red clause letter of credit (L/C) is a type of loan that is extended to a business based on the strength of a red clause letter of credit issued by a bank.
A red clause letter of credit is a special type of L/C that allows the beneficiary (usually the seller of goods or services) to request an advance payment before the goods or services are shipped.
The advance payment is typically made by the bank issuing the red clause L/C and secured by the L/C itself.
Pre-Shipment Credit in Foreign Currency (PCFC)
In India, pre-shipment credit in foreign currency (PCFC) is a type of short-term loan that banks and financial institutions extend to businesses to finance the purchase and transportation of goods or services that are being exported.
The loan is typically secured by the goods or services being exported and denominated in the importing country's currency.
PCFC loans are typically used to cover the cost of purchasing raw materials, transportation and other related expenses.
They are often used by businesses to finance the export of goods or services to foreign countries and typically offered to businesses that have a good credit history and a proven track record of exporting.
What are the 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.
What is the 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.
What are the 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.
What are the 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.
