Best practices for improving working capital through trade finance

Best practices for trade finance

Interest rates are on the rise, and there is talk about “normalizing,” leaving finance teams to figure out just what “normal” looks like nearly a decade post-recession.

For some, normal means a new strategy altogether: a shift away from holding large amounts of cash on the balance sheet to investing in growth strategies. Identifying the right growth strategy is the hard part.

Trade finance is worth consideration. It offers a return on low-risk investment and protection for your supply chain. But not all trade finance options are equal. And not all are a fit for your company’s unique needs. However, there are a few best practices for trade finance that are universal.

Trade finance as a growth strategy

“Financing costs are going to rise in 2017, as the economy recovers and grows more than 1.5 percent,” explains Sean Van Gundy, Managing Director, Working Capital Advisory for fintech company, C2FO. “As a result, companies need to prioritize investments in real growth initiatives in the years ahead.”

Previously, Van Gundy led the implementation of Walmart’s supply chain finance program that served over $4 billion in spend and generated cash flow exceeding $400 million.

Trade finance, says Van Gundy, is an initiative worth considering.

Trade finance helps multinationals put cash to work in each geography rather than remain “trapped.” It also supports your supply chain and helps you respond to increasing fulfillment pressures.

“In the last five-to-ten years, there’s been a lot of supply chain transformation,” says Jordan Novak, Managing Director of C2FO. Before joining C2FO, Novak was based in Singapore as a key finance leader for Dell, Inc.

“Twenty years ago,” Novak continues, “Dell’s just-in-time fulfillment model was the golden standard. Now everything has moved from just-in-time to an on-demand fulfillment model. That move puts a lot of financial strain on ordering systems and procurement infrastructure whether you are a B2B or B2C business. Having finance linked into those conversations is a new requirement for CFOs.”

Key trends in trade finance:

  • No-risk, you are receiving a discount on money you already guaranteed to pay your suppliers
  • Global, puts cash trapped on a balance sheet to work in each geography
  • Improved margins, adds value to an asset earning little in interest — with little effort

The most “bang for your buck” is in accounts payable

Many organizations focus strategy on managing operating expenses. However, accounts payable offers the best opportunity for your bottom line. For AP, that value lies in both process improvements and leveraging trade finance.

Regarding savings and efficiencies, automating the AP process reduces bottlenecks from reliance on paper documentation. It also shortens invoice cycle times.

AP automation requires not only investment, but significant process change — for both you and your suppliers. A common misconception is that your AP process should be automated before you consider trade finance. This approach leaves value on the table.

“As an example, even if your terms are net 30 and it takes you fifteen days to approve an invoice, you’ve still got fifteen days of value to accelerate payment and earn a discount, or you can get a rebate with a p-card program,” explains Van Gundy.

Unlocking value from AP

  • AP automation standardizes your process, reduces the manual effort required to process invoices, and provides greater visibility of payables.
  • Launched first, a trade finance solution that offers early payment for discounts increases your margin and helps fund AP process improvement.
  • With both programs in place, there is an increased window of opportunity for value from discounting.

Aim for long-term value over short-term metrics

Since 2008, companies have been managing to the cash conversion cycle (CCC) metric through days payable outstanding (DPO). As a result, payment terms across industries and regions have extended significantly. Finance executives are incentivized to improve cash conversion cycle even as it puts pressure on their supply chains.

“Many publicly traded companies target working capital metrics, which can be very short-sighted,” says Kerri Thurston, CFO at C2FO. “I have seen companies fall short of their revenue guidance due to lack of raw materials, which could have been avoided had they been more focused on supplier health and less focused on working capital metrics. At the end of the day, if the company doesn’t make more money each year and grow, then having great metrics doesn’t matter.”

“As finance professionals, we need to push ourselves to do the right thing for our shareholders and our companies even when we have a misguided target,” adds Van Gundy. “As broader leaders of an organization, how hard would we want to hold people accountable to those metrics if DSO took a dip, but we generated a $5 million worth of income through early payment discounts?”

How to gain value in the long-term:

  • For companies in a good position, understand that a dollar of EBITDA is more important to investors than a dollar of cash on the balance sheet.
  • Be less obsessed with cash conservation.
  • Expand your strategy to put the cash on the balance sheet to work in ways that offer a return on investment and strengthen supply chain health.

The innovation and opportunity of trade finance

Trade finance is a broad term. Technically, it covers any time a third party facilitates the transaction in trading goods and services. Historically, trade finance meant a letter of credit,
p-cards or supply chain finance. The third party would have been a bank.

Today, innovation in trade finance is through tech companies, not banks. The change is as much a shift in mindset as it is technology, by viewing a receivable as a form of currency and figuring out how to monetize it. Tech companies offer trade finance alternatives from invoice discounting and invoice sales, to purchase order finance and factoring.

Think strategy first, then solution

The trade finance option you choose is not a strategy in and of itself. To succeed, you must set your strategy and prioritize your goals for payment terms, supply chain health, and return on investment. Once you have a strategy, then find the right “working capital mix” of trade finance that supports your goals and the full spectrum of your supply chain.

For example, supply chain finance doesn’t provide value for you as a return. The value is in terms standardization or terms extension and support for your largest suppliers.

Best practices to consider as you develop your strategy:

  • Prioritize the liquidity of suppliers.
  • Use banks to build cash, while using the balance sheet as much as possible to boost margins.
  • Consider a mix of trade finance solutions to fit needs across the full spectrum of your supply chain.
  • Limit your reliance on a bank or single entity for your overall strategy.
  • Speeding up payments, whether on the receivables or payables side, always improves margins.
  • Shareholders always value margins and EBITDA over working capital.
  • You must protect your business and your supply chain regardless of what is happening in the market.
  • Suppliers often need a trade finance option but may be concerned about protecting their revenue stream and not be forthcoming about liquidity issues.

Trade finance and the evolution of treasury

“The role of a corporate treasurer is getting a little too interesting now,” Novak summarizes.

“As a multinational treasurer, you are now managing totally different companies within your parent company. You might be managing as a net borrower in the US, but also trying to squeeze out every basis point of yield in China or India. You need to work with multiple strategies across the globe daily. In many ways, this forces treasury out of their comfort zone.”

“As a result, tomorrow’s treasurers need to be more of a strategic leader and focus less on the tactical cash operations that once dominated their time. Treasurers must change their skill set to become more CFO-like and more open to new strategies,” he says.

How to succeed:

  • Own your strategy that aligns to your company’s overall goals, and then own the governance as well.
  • Be willing to use your balance sheet in a way that preserves the long-term health of your organization. Use it to help suppliers that may be stuck in high-interest-rate positions and not in able to achieve the type of fiscal health they need to be your best business partner.
  • Finally, there’s never going to be the best, right business cycle to do something. Every day you take 40 days to approve an invoice, it costs you value. Connect yourself to good partners who can help you get that value now.