Supply Chain Finance – a case study
The article by Carlos Bacigalupe in the last edition of Trade Brief highlighted the advantages of Supply Chain Finance (SCF) and in particular how new methods of funding trade via SCF and Trade Receivable programmes are greatly assisting the improvement in liquidity and working capital for both buyer and supplier alike. Whilst it is true that since its inception some ten years ago SCF is primarily used in developed countries, such is the growing popularity of SCF with key multinational buyers that many suppliers located in emerging markets are now beginning to benefit financially from the introduction of SCF programmes.
First, let us re-cap on the advantages of SCF for both buyer and supplier:-
Now let’s look at how this has actually worked in practise:
Last year a leading UK multiple was keen to expand its existing SCF programme to a major supplier of clothing located in Turkey. Existing terms of trade were 90days from shipment date. The Turkish supplier relied for its working capital on a local invoice financing facility with its domestic bank.
The high level of interest rate appertaining in Turkey (12%) plus the generous 5% margin charged by its bank with high arrangement fees meant the Turkish supplier was paying about 20% to fund its working capital & export trade to the UK. Furthermore, despite the strong credit rating of the UK buyer (a leading global brand) the Turkish bank would only advance 80% of the receivables due.
The UK buyer was aware that its Turkish supplier was unhappy with its local financing arrangements and consequently proposed a highly attractive deal whereby the buyer was prepared to extend the payment terms form 90 days to 180 days and provide 100% finance on submitted invoices. For its part the UK buyer was able to raise funds to finance the SCF facility with the Turkish supplier from its domestic UK bank at 1% over cost of funds, effectively circa 2% all in. A distinct contrast to the rate of 20% paid by the Turkish supplier to its local bank for only partial financing.
The buyer proposed to process the supplier’s invoices using the electronic platform in place with its London bank, to which the Turkish supplier was also given access. Using electronic invoicing meant that the buyer could approve the invoice and simultaneously instruct its bank to make payment. Thus, the Turkish supplier received its cash within seven days of shipment (see flow chart above).
The only caveat imposed by the UK buyerwas that in recompense for doubling the creditor days from 90 to 180 days and providing 100% immediate payment it required the Turkish supplier to give them a 3% discount on the price of the goods supplied. Such were the obvious interest cost savings and improvements in its cash flow / time value of money that the Turkish supplier readily agreed to the proposal.
In diagrammatic form the process can be shown as below.
The ability of a SME supplier located in a high interest rate jurisdiction to leverage off a major global buyer with a strong credit rating based in an economy with low interest rates was the key determinant to a successful SCF financing. Another key to success is the use of electronic platforms that did not exist a decade ago. This serves to highlight how the speed of technology in trade finance continues apace with invoicing through the medium of an electronic delivery channel now becoming part of every day trade.
The counter-party that has of course lost out in this case is the local Turkish bank. The supplier which is a valued client has now affectively re-financed itself via a SCF facility put in place by the buyer and the buyer’s bank, both based in the UK.
The obvious solution for the Turkish bank is to offer its client a 100% Trade Receivable facility in Sterling, but that pre-supposes that the bank concerned has ready access to Sterling funds at a competitive rate and is prepared to take a full 180 day credit risk on the UK buyer.
International Trade Receivable facilities are something we shall explore in the next issue.