Trade finance and letters of credit: the basics for UK importers

Buying goods from an overseas supplier often means paying before you have seen, sold, or sometimes even received, the goods. Trade finance exists to manage that gap and the trust problem that sits behind it.

Summary

• Trade finance funds the purchase of goods, typically from overseas suppliers, bridging the gap between paying a supplier and being paid by your own customer.
• A letter of credit is a bank's formal guarantee of payment to a supplier, used where buyer and seller do not yet have an established trusted relationship.
• Costs include facility fees, document handling charges and sometimes interest if payment is deferred, so weigh them against the risk they remove.
• It suits importers and exporters with a repeatable buy-sell cycle more than one-off purchases.

What problem trade finance solves

International trade involves a basic trust problem: a supplier does not want to ship goods without confidence of payment, and a buyer does not want to pay before confidence the goods will actually arrive as agreed. Trade finance products exist to bridge that gap, using a bank or finance provider as a trusted intermediary, so both sides can trade with confidence even without an established relationship.

Letters of credit, explained simply

A letter of credit is a formal commitment, issued by a bank on the buyer's behalf, to pay the seller a specified amount, provided the seller presents the agreed documents, such as shipping and quality documents, proving the goods have been shipped as agreed. It shifts the payment risk away from "will this buyer actually pay" to "will this bank honour its commitment", which is usually a much stronger assurance for an overseas supplier. For the buyer, it means not having to pay upfront in full before goods are confirmed shipped, since payment is only released against the agreed documents.

How a letter of credit transaction typically runs

The buyer agrees terms with the supplier and applies to their bank or finance provider for a letter of credit, which is then issued to the supplier's bank. The supplier ships the goods and presents the required documents to their bank, which checks them against the letter of credit's terms. Once the documents are confirmed to match, payment is released to the supplier, and the buyer settles with their bank according to the agreed terms, sometimes immediately, sometimes with a short deferred period.

Import and export finance more broadly

Beyond letters of credit, trade finance includes import loans, which fund the cost of goods once they are purchased, often repaid once the goods are sold or against an invoice finance facility, and export finance, which can fund production or fulfilment of an overseas order before payment is received from the overseas buyer. Some facilities combine elements, funding the purchase of stock from an overseas supplier and then rolling into invoice finance once the goods are sold on to a UK customer.

What lenders and providers look at

Trade finance providers look closely at the underlying trade itself: who the supplier and buyer are, the track record of the trading relationship, the type of goods involved, and how readily they could be resold if something went wrong. They also look at your business's own trading history and, for larger facilities, the strength of your end customers, since in many structures repayment ultimately depends on that onward sale completing successfully.

Costs to expect

Pricing typically includes a facility or arrangement fee, document handling and checking charges, since letters of credit involve detailed paperwork that must be checked carefully, and interest if any element of the facility involves deferred payment. These costs should be weighed against the value of the certainty and trust the facility provides, particularly for a new supplier relationship where the alternative might be paying 100% upfront with no protection at all.

Who it suits

Trade finance suits importers bringing in goods from overseas suppliers, particularly new or less established supplier relationships, exporters fulfilling confirmed overseas orders who need working capital to produce or source goods first, and businesses with a repeatable, forecastable buy-sell cycle rather than a single one-off transaction, since the fixed costs of arranging a letter of credit are easier to justify when spread across regular trade.

Preparing to explore trade finance

Useful information includes details of the supplier or buyer relationship and trading history, the specific terms of the trade, including Incoterms, shipping method and timelines, and your own business's trading history and bank statements, as with most commercial finance.

Getting an indicative view

Lending Box works with lenders and providers across the trade finance market and can point you towards options suited to your specific trade. We are a broker, paid by the lender, not a lender ourselves, and figures given are indicative only, subject to assessment and approval.