Editor’s Note: The following is a guest blog from David Gustin, the editor and co-founder of Trade Financing Matters, providing insights on trade credit and business finance issues. David joined Kyriba recently for a webinar entitled, “Why Treasury and Procurement Should Collaborate for a Successful Supply Chain Finance Program.”
Treasurers are typically more concerned with raising capital for normal operations than trying to figure out how to finance suppliers. So, when the opportunity to increase cash free cash flow or raise capital presents itself through supply chain finance (SCF), a treasurer should ask at least these five questions:
1. Is this a good use of my scarce credit?
To implement SCF, companies need to set up a credit line with their funding provider(s). There is no free lunch. It’s important to realize that bank-led supply chain finance, or what we sometimes call reverse factoring, involves your credit. Any bank setting up a program must set up an unsecured facility. Companies need credit lines for all kinds of purposes, including company revolvers, FX trades, pcards, letter of credits, etc. Most treasurers have a limited amount of capital they can tap, so the program merits must be strong, which leads us into the second question.
2. What are the programs objective(s) and how will they be measured?
Are you looking just to extend terms to improve your DSO, or do you see supply chain finance as a way to allow your suppliers access to early payment on their receivables to do one or more of the following:
- Manage your supplier diversity program
- Reduce cost of goods sold by providing suppliers cheaper funding than alternatives such as factoring
- Improve suppliers cash flow to lower supplier financial risk
- Provide your suppliers with tools to enhance their cash flow forecasting
Measuring the above benefits is not always straightforward. For example, supplier costs is a purchasing function and there are many dynamics that come into play with supplier contract negotiations, but providing suppliers an option for lower cost funding does provide leverage to the procurement team.
3. How should my SCF program be funded?
The first big issue to deal with is to determine what is the most appropriate funding model.
- Do you want to self-fund some or all of your suppliers’ receivables?
- Do you want to work with a single relationship bank?
- Or do you want to have a few relationship banks involved?
- Do you want an agnostic funding model or one managed by a platform provider (who can work with your relationship banks)?
Going with your house bank may make sense for some companies for very simple and straightforward programs. The reason for choosing a bank-agnostic financing model is that companies want to ensure there is always sufficient liquidity for the program and that it is not exposed to any risk of individual banks choosing to exit the program. Single bank balance sheet lending can restrict program capacity due to changes in limits, supplier exclusions, Basel III constraints, etc.
Working with a few relationship banks usually involves a lead platform bank that manages a program, usually under a pricing band guided by the company. A participating bank who is not interested in doing any credit work can still be a funding source.
From our discussions, there are three additional issues to be aware with funding:
- Given SCF is an uncommitted credit product, how do you manage if funding partners suddenly change their credit policies and limits?
- How do you ensure enough capacity for the future if you want to grow the program with more suppliers or different business units or geographies?
- Do funders have the ability to handle large key suppliers in the countries and currencies you need support?
4. What are the accounting risks?
Since 2003, when the SEC first commented on these programs, the debate around threatening re-classification of the payables on the buyer’s balance sheet is real. Why this matters is that if a corporate is required to reclassify $500 million of trade payable debt to bank debt, it impacts their loan covenants, their leverage and their access to additional credit.
The crux of the issue is if the buyer is confirming to the financial institution that it will pay at maturity of the invoice regardless of trade disputes or other rights of offset it may have against the supplier, then it is giving a higher commitment to pay to the financial institution than it owes to the supplier. This may be construed as a bank financing and not a trade payable on its books.
Unfortunately, there is no clear guidance from the IFRS in regards to reclassification of trade payables to debt. This is something of paramount importance, and your program needs both internal auditor and external auditor vetting.
5. How do I assess how much credit I need?
A counterparty analysis should be done that helps segment suppliers into different categories to tailor solutions and a model needs to be built to forecast supplier demand. Predictive analytics can be used to look at historical supplier data to forecast take-up of early payment opportunities.
David can be reached at [email protected] or visit http://azulpartners.com/publications/trade-financing-matters/
Link to webinar playback: Why Treasury and Procurement Should Collaborate for a Successful Supply Chain Finance Program