Trade finance and letters of credit: secure the deal before funding the shipment

International trade can force a business to pay suppliers, manufacture goods or ship products weeks before receiving customer cash. Trade finance is designed to bridge that timing and reduce payment risk, but every structure depends on documents, counterparties and conditions being handled correctly.

Map the gap between paying for the order and receiving customer cash

The British Business Bank describes trade finance as a way to manage cash-flow and payment risk in international trade. Start by mapping one export or import cycle. Include deposits to suppliers, production, freight, customs, insurance and the expected customer-payment date.

An exporter might spend £180,000 manufacturing an order during January and February, ship in March and receive payment in May. The commercial deal can be profitable while the business funds several months of working capital. Trade finance should be judged by how well it supports that gap, not only by the interest rate on one facility.

Understand what a letter of credit actually promises

Business.gov.uk explains that a letter of credit is a bank-backed payment arrangement used where the exporter wants greater certainty that it will be paid. The buyer's bank agrees to make payment when the exporter presents the documents required by the credit and complies with the stated terms.

This can reduce buyer-payment risk, especially where the buyer and seller do not know each other well or trade in higher-risk markets. It does not eliminate operational risk. If the documents do not match the letter of credit requirements, payment can be delayed or refused even when the goods themselves were shipped correctly.

Treat document accuracy as part of the payment process

Business.gov.uk emphasises that letters of credit require strict document compliance. Invoices, transport documents, customs papers and other required evidence must match the wording and timing specified in the credit. A small discrepancy can become a payment problem rather than an administrative detail.

Assign one person to own the document checklist and involve the bank or trade-finance adviser before shipment where the transaction is material. Do not wait until goods are already on the water to discover that the bill of lading, invoice description or shipment date does not meet the credit terms.

Compare letters of credit with collections, guarantees and receivables finance

Trade finance includes more than letters of credit. The British Business Bank also describes export factoring, bonds and guarantees, while business.gov.uk explains documentary collections where banks handle documents against payment or acceptance. The right method depends on buyer trust, contract value, destination and bargaining power.

A long-established customer in a stable market may accept open-account terms with credit insurance or receivables finance. A new buyer placing a high-value first order may justify stronger bank-backed payment protection. Use the least complicated structure that gives the business an acceptable level of payment and performance risk.

Know when UK Export Finance support may improve access to facilities

UK Export Finance's General Export Facility can provide guarantees to participating lenders to help UK exporters access working-capital and contingent facilities such as trade loans, bonds and letter-of-credit lines. UKEF says the scheme can support facilities typically up to around £25 million, subject to eligibility and lender approval.

The guarantee does not mean the exporter automatically receives finance. The participating lender still assesses creditworthiness and retains part of the risk. For a business with strong export orders but limited collateral or working-capital headroom, UKEF support can be worth discussing with the bank or an Export Finance Manager before turning down an order.

Compare the full transaction economics, not only the finance fee

Add facility interest, letter-of-credit issuance and amendment fees, confirmation fees where relevant, document handling, FX, correspondent-bank charges, insurance and staff time. A structure that costs more can still be sensible if it materially reduces non-payment risk on a large order.

For example, paying £6,000 of total trade-finance and insurance cost on a £400,000 order may be commercially reasonable if the gross margin is £80,000 and the alternative is unsecured exposure to an unfamiliar overseas buyer. The comparison should be between protected margin and unprotected risk, not between £6,000 and zero.

Also compare the internal workload. Letters of credit can require careful document checking, amendments and coordination with freight and customs teams. On a small low-risk order, that administration may outweigh the benefit. On a large first order to a new buyer, the same workload can be entirely justified because one non-payment would materially damage the business.