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Advisors, Private Equity

In Supplier Finance, the Importance of Early Payment Programs

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In the world of trade finance, we are seeing a recent trend for implementing supplier finance schemes. Large corporates like Proctor and Gamble use vendor finance programs for increased cash flow but more importantly to strengthen the financial health of their most important stakeholders; their vendors.

Recent developments in technology have allowed for greater transparency in the supply chain. Platforms like GT Nexus are used by buyers and sellers alike to track shipments and obtain financing against export bills. The old way of global trade through use of instruments like a letter of credit is becoming quite antiquated. The reality is that large creditworthy buyers in the developed world are demanding open account terms from vendors. The use of documentary letters of credit can be onerous and costly, especially when we consider the likelihood of discrepancies. The use of these instruments have had their benefits; specifically allowing the supplier to monetize the L/C and obtain packing credits from a local lender. Now with supplier finance programs, suppliers are able to “borrow” both pre and post shipment against open account orders.

Factor Chain International estimates that 70% of Chinese export is on open account. This development has spawned from global demand for a less cumbersome execution of sale – US and European retailers, MNC’s and other large importers being the driving force for change. Corporations like Proctor & Gamble implemented vendor finance programs to alleviate their own cash flow constraints by extending the days outstanding on payables; this is crucial during a period of expansion. “P&G has developed its own Supply Chain Financing (SCF) program…and it makes this a win-win for P&G and our suppliers. As part of our SCF program, P&G’s external business partners are able to leverage P&G’s AA credit rating and obtain financing at a much reduced rate than they otherwise could. In this case, suppliers actually get paid at a much faster rate of 15 days or less.”

There has been a recent trend for large MNCs to support their smaller vendors because they rely on having a reliable source of goods and strong supply chain network.

These programs are also available for the SME importer, specifically for regional retailers that rely on a strong supply chain network. Cash flow is a two sided equation; accelerate receivables while increasing the payables outstanding. In this scheme a financial institution facilitates this arrangement. These programs allow SME Suppliers to obtain favorable financing by leveraging the credit of the overseas buyer at the same time allows them to extend favorable terms to these buyers. Buyers benefit from a decreased cash conversion cycle by increasing payables outstanding.

Under early payment programs, the supplier is able to extend open credit terms to their buyers but is paid at sight by the financial institution. The importer or retailer benefits from the longer payment terms from suppliers.

In many cases, the importer uses their existing credit line to make purchases for periods where an influx of inventory is necessary. Through these programs the importer is not forced to tie up their existing credit facility to make these purchases. When structuring these programs, the institution underwrites the obligor and assesses the ability of the buyer to service the trade debt based on liquidity and cash flow.

 

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