What Is Pre-Shipment Finance and How Does It Work?

Pre-shipment finance serves as a financial bridge for businesses engaged in international trade. It addresses the working capital needs of exporters before goods are shipped and payment is received from the buyer. This type of financing is designed to cover various expenses incurred during the production and preparation phases of an export order, bridging the financial gap between the initiation of production and the eventual receipt of sales proceeds. It allows exporters to manage their cash flow efficiently.

Understanding Pre-Shipment Finance

Pre-shipment finance is a short-term financial solution provided to exporters to help them cover costs associated with fulfilling an export order prior to its actual shipment. This financing supports expenses such as procuring raw materials, manufacturing, processing, packaging, and storing goods until they are ready for dispatch. It is typically utilized in scenarios where an exporter has a confirmed export order, often supported by a letter of credit or a binding purchase order.

The primary purpose of this finance is to ensure that exporters possess the liquidity required to complete their production cycle. By providing funds upfront, it helps maintain an exporter’s operational cash flow, allowing them to pay suppliers, labor, and other overheads without waiting for the buyer’s payment, which often occurs much later. This financial mechanism helps exporters avoid delays in production due to insufficient capital, thereby facilitating timely delivery of goods. It contrasts with post-shipment finance, which addresses financial needs after goods have been shipped and while awaiting payment.

Common Forms of Pre-Shipment Finance

Several financial products fall under the umbrella of pre-shipment finance. These forms provide working capital at different stages of the export cycle.

Packing credit is a widely used form of pre-shipment finance, providing working capital for various stages of production and packaging. This short-term loan helps exporters finance the purchase of raw materials, processing, manufacturing, and packing of goods before shipment. It is often repaid once the exporter receives payment for the exported goods, typically upon submission of export documents to the bank. Packing credit can be extended in local currency or foreign currency, known as Pre-shipment Credit in Foreign Currency (PCFC).

Manufacturing or production finance includes expenses for labor, utilities, and other direct manufacturing overheads. Some forms, like a packing credit loan (hypothecation), treat the goods being produced as security for the loan, allowing the exporter to retain possession while using the goods as collateral. Another variation, a packing credit loan (pledge), involves the goods themselves being pledged to the financial institution as security.

Letter of Credit (LC) backed finance uses a confirmed Letter of Credit as a basis for pre-shipment funding. An LC serves as a bank guarantee of payment to the exporter upon fulfillment of specified conditions. Advances against a “Red Clause” Letter of Credit allow the exporter to receive an advance payment from the issuing bank before shipment, with the advance deducted from the final payment.

A revolving pre-shipment credit facility offers a standing credit line for multiple export orders within an approved limit. This facility benefits exporters with a consistent flow of orders, allowing them to draw funds without reapplying for each new order. Such facilities may be granted to exporters with a strong track record, sometimes without the immediate need for prior submission of each order or letter of credit.

Requirements and Application for Pre-Shipment Finance

Securing pre-shipment finance involves meeting specific requirements and following an application process. Financial institutions assess an exporter’s eligibility and the viability of the export transaction.

Exporters need confirmed export orders or contracts, which serve as proof of a legitimate transaction. Financial institutions also evaluate the exporter’s credit history, business experience, and the viability of their business plan. A strong track record in export operations can also be a significant factor.

Required documentation for an application includes:
Confirmed sales contract or purchase order, detailing the export deal.
Letter of Credit (LC) issued by the buyer’s bank, if applicable, providing a bank guarantee of payment.
Proforma invoice, an estimated invoice for the total cost.
Business financial statements.
Company registration documents and sometimes an Importer-Exporter Code (IEC) number, demonstrating financial health and legal standing.
These documents allow the financier to assess the transaction’s legitimacy and the exporter’s capacity to fulfill the order.

The procedural application process begins after all necessary information and documents have been gathered. The exporter starts with an initial inquiry to a financial institution that offers trade finance. A formal application package is submitted, including all prepared documents. The financial institution then conducts due diligence, reviewing the submitted documents, assessing the exporter’s creditworthiness, and evaluating the risk associated with the export transaction. Upon approval, loan agreements are signed, outlining the terms, interest rates, and repayment schedules.

The disbursement of funds may occur in a lump sum or in stages, depending on the exporter’s needs and the terms of the agreement. Repayment of the pre-shipment finance is expected upon receipt of the export proceeds from the buyer, often converting to post-shipment finance if payment is not immediate. The loan tenor for packing credit can range from 90 to 180 days, though extensions up to 360 days or more may be granted under specific circumstances.