Supplier Credit vs Bank Financing for Imports from China

There are three core ways that importers can finance purchases from suppliers, each of them meant to address one or both of the key challenges faced by import businesses: cash flow and trust.

The default pay-in-advance model means importers can have their working capital tied up in existing orders for prolonged periods of time, limiting the business’ ability to scale.

Suppliers demand payment in advance because of the trust problem. This is especially relevant for suppliers in China, many of whom deal with large numbers of buyers all over the world, and don’t have the resources to investigate each individual buyer.

To address these problems, importers can turn to one or a combination of three options:

Letter of credit

A letter of credit is a guarantee of payment from the importer’s bank for a particular order. Typically, such a letter guarantees payment to the supplier once an order has been shipped.

It solves the trust problem for both supplier and buyer. The supplier is assured of payment once delivery has been made, and the buyer is assured they will not have to pay for an order that is never delivered.

A letter of credit typically requires collateral: The buyer will have to put up the cash value of the order, or place a certain tranche of their credit limit towards the letter. The buyer also pays a bank fee for the service, typically a percentage of the invoice value.

While a letter of credit is not a financing instrument per se, it can be combined with a bank loan or line of credit.

Bank loan/line of credit

This is direct funding from a financial institution, enabling the buyer to pay for an order on fixed repayment terms, for instance 60 days or 180 days.

This mechanism solves the buyer’s cash flow problem. It allows the buyer to put their existing working capital into future orders, rather than having it tied up in current orders.

Obtaining a bank loan or line of credit for orders typically requires the buyer to put up collateral (some part of the buyer’s business assets) and comes with a cost in the form of interest charged on the loan or the used part of a line of credit.

Supplier credit

This is financing provided directly by the supplier, in the form of deferred payment terms. A supplier will agree to payment a set period after shipment, for example 30 days or 90 days.

This mechanism solves the buyer’s cash flow problem – but it is only available after the trust problem has been solved. Typically, a supplier will only offer deferred payment once a strong, long-term relationship has been established with the buyer, or if the buyer’s order is insured through trade credit insurance.

For Chinese suppliers, the main trade credit insurer is China Export & Credit Insurance Corporation (SINOSURE). Importers looking for trade credit terms from their suppliers can register with SINOSURE and be assigned a credit limit – the maximum value of orders from that buyer that SINOSURE will insure.

With supplier credit, no collateral is involved, but there may still be a cost to the buyer in the form of a slightly higher per-unit cost.

When is each of these options the preferred solution?

A letter of credit is an importer’s best option when supplier credit is not available and mitigating risk is a greater priority than cash flow. The importer will have to set aside a certain amount of cash, essentially tying it up in a similar to way to prepayment, but the letter ensures that the cash is not released to the supplier until the order has been shipped.

A bank loan or line of credit is an importer’s best option when supplier credit is not available and freeing up working capital is a priority. The importer takes on a loan to pay for the order, freeing up existing cash flow for future orders. It can then repay the loan, with interest, from sales revenue.

Supplier credit is often the best option: it requires no collateral, and the additional cost is minimal (no bank fees or interest is paid). However, this option is only available when the trust problem between supplier and buyer has been solved, either through the establishment of a long-term successful relationship, or through trade credit insurance that covers the risk of non-payment to the supplier.

For importers buying from China, trade credit insurance may help facilitate supplier credit arrangements. Importers may also choose to work with independent consultants to better understand the process and coordinate with their Chinese suppliers.

Axton Global is an independent international trade finance consultancy that assists importers with matters related to supplier credit from China.

How can these tools be combined?

Letter-of-credit to bank loan flip

A letter of credit can be combined with a bank loan/line of credit to solve both the trust problem and the cash flow problem when supplier credit is not available. The letter of credit assures the supplier of payment, and the loan frees up the buyer’s working capital.

This is best employed when working with a new supplier that is hesitant to offer credit, and when the importer’s domestic sales cycle is slow.

Usance letter of credit + supplier credit

A letter of credit can be combined with supplier financing, such that the buyer issues a usance letter of credit in which the buyer’s bank guarantees payment a set period of time after the order has been shipped. At the same time, the supplier will offer trade credit terms, enabling payment after shipment.

This is best employed when the buyer has a semi-established relationship with the supplier. The supplier will be willing to extend credit to the buyer, knowing that they have a guarantee of payment from the buyer’s bank.

Split payment

The importer can negotiate split payment terms with the supplier, for instance paying 30% down with the remaining 70% to be paid after shipment under trade credit terms with the supplier. The importer can use a bank loan or line of credit to cover the 30% deposit, thus preserving working capital.

This is best employed when making large orders from a trusted supplier. Not only does it protect the buyer from a cash flow squeeze, it also reduces pressure on their line of credit, allowing for future orders.

“Understanding which financing tools are available to you, and when to use each one, can be crucial to growing an import business,” says Igor Sokolov, Managing Director at Axton Global. “It’s often the case that importers don’t take full advantage of the instruments available to them, limiting their growth and exposing their business to unnecessary risks.”

A comparison of financing tools available to importers