Pre-Shipment Finance: a Worked Example

An exporter with a large order pays for materials, labour and packing months before the buyer pays for the goods. A general overdraft can carry that gap for a small order; a large one can outgrow it. Pre-shipment finance is the loan written for the gap, tied to one order or a set of orders, and sized and timed to the costs of filling them. The name packing credit is most familiar from Indian and other Asian banking; elsewhere the same lending is often booked as a trade loan or an export working capital facility.

Its repayment source is unusual. Most working capital lines are repaid from cash the business already generates. This one is repaid from a receivable that comes into existence only once the exporter has performed. Until the goods ship, the bank's risk is the exporter's ability to make them, to specification, by the date the contract or the credit demands. Only after shipment does it become the risk that the buyer, or the buyer's bank, will not pay.

The advance rate is set file by file, and is usually pitched to leave some of the cost and all of the margin with the exporter; the cap stops the bank funding a profit before it is earned. Drawings are often made against supplier invoices or payroll rather than in one sum, so the loan grows as the goods take shape. The term follows the order's timetable to the expected date of payment.

The controls are what make it lendable. Proceeds are routed through the lending bank. Where the order is backed by a letter of credit, the credit is often advised through that bank, and some files take an assignment of its proceeds, a right UCP 600 leaves to the applicable law even when the credit is not transferable. General security catches the stock and work in progress. Where the bank's appetite falls short, a government agency can share the risk: UK Export Finance's Export Working Capital Scheme can guarantee up to 80% of a lender's risk on a facility used before and after shipment, and Export Finance Australia guarantees bank finance, pre- and post-shipment, for eligible exporters that cannot raise the full amount without it.

A maker of insulated cool-store panels, constructed for this page like every figure in it, wins an export order worth US$1.8m, payable by a sight letter of credit with a latest shipment date four months away. Its bank offers pre-shipment finance at 60% of the order value, capped at the cost of filling it. The exporter funds the rest of the cost itself. The rate, the cap and the interest are the example's, not a market norm.

That is the version in which everything works. The credit file is written for the other one. A supplier's delay pushes production two weeks past the latest shipment date. A bill of lading dated after it is a discrepancy, and the credit can be amended only with the agreement of the issuing bank, any confirming bank and the exporter, and the buyer has to ask for it. A buyer that now holds the leverage may ask for a discount, or have found the panels cheaper elsewhere. If it walks away, the bank is repaid from stock:

The panels were made to one buyer's drawings and sell to anyone else at a heavy discount. The 30% is the example's assumption. The point is that it is low for made-to-order goods and higher for a commodity another buyer could take at a market price.

The two are links in one chain, and the shipping documents are the hinge. Before shipment, the bank lends against an order and the exporter's ability to fill it. After shipment, post-shipment finance lends against a receivable that exists: documents presented under a credit, a bill sent on collection, or an invoice. The risk moves from performance to payment, and the price usually falls with it. Many facilities run the two as one line, the pre-shipment loan repaid by a post-shipment advance on the day the documents go in.

It also differs from a red clause letter of credit, under which the advance before shipment is made under the buyer's own credit, and from a general overdraft, which funds the business as a whole and is repaid from its cash flow rather than from one order's proceeds.

DEFINED IN ONE PARAGRAPH → · POST-SHIPMENT FINANCE → · PRODUCT FILE: TRADE LOAN →

A pre-shipment credit paper answers questions an ordinary working capital paper can skip. Has this exporter made this product at this scale before, and shipped on time? What happens to the timetable if a key supplier is late? Is the order firm, and does the credit's latest shipment date leave room for the production plan? What would the stock fetch if the buyer walked away? Who carries the goods between the factory and the ship under the contract's Incoterms, and are they insured for it?

A strong buyer does not answer those questions. A bank that relies on the buyer's name alone has lent against a receivable that does not yet exist. The decision usually turns on the exporter's record, the share of the cost it funds itself, and whether export credit agency cover takes part of the performance risk off the bank.

HOW BANKS READ EXPORTERS → · WORKING CAPITAL REQUESTS → · EXPORT CREDIT AGENCY COVER →