Tim Nicolle

Supply Chain Trade Finance

Many of our exporter clients are poorly-served by supply chain finance programs implemented by their buyers. This short article explains:

  • how supply chain finance works,
  • what exporters need,
  • why supply chain finance often failsthem, and
  • how PrimaDollar’s trade finance addresses the gaps which emerge.

PrimaDollar provides business trade finance. We provide trade guarantees (letters of credit) and finance (cash at shipment) to support supply chains which run across international borders.

Adding a business trade finance capability (PrimaDollar) onto a supply chain finance program provides a much-needed solution to the gaps that arise.

1. Supply chain finance: how does it work?

A supply chain finance program inserts one or more banks into the supply chain of a corporate buyer.

This is to bridge the gap between:

  • when suppliers want to be paid, which is early if not upfront, and
  • when a buyer would like to pay, which is later, ideally after goods are sold.

Supply chain finance programs are arranged by buyers for their benefit, and for the benefit of their suppliers.

How supply chain finance typically works:

The business (let’s call it the “Buyer”) sets standard payment terms for all its suppliers (“Suppliers”), for example, invoices will be paid 60/90/120 days after goods are delivered.

Suppliers who want to be paid earlier than this backstop date are offered an ability to get paid earlier, but with a discount. This is implemented in an online system:

  • the Buyer uploads approved invoices into an online database connected to a bank
  • Suppliers can log in to this database to see the status of their invoices
  • Suppliers elect to get approved invoices paid early at a discount by checking a box
  • Suppliers who choose this early payment option get paid by the bank straightaway
  • the Buyer pays the bank later when the invoice is due

In accounting / legal terms, usually the bank pays cash upfront to the supplier in order to acquire the right to receive the deferred payment from the buyer under the invoice.

If the discount that the supplier agrees is higher than the funding charge from the bank, this creates an additional revenue source for the buyer.Sophisticated versions of this arrangement are integrated into the buyer’s accounting system with direct links to one or many funders on an auction basis.

2. What do exporters need?

Exporters, particularly in emerging markets often need to be paid at shipment, if not before.

The main reason is that banks who provide pre-shipment finance usually want to be repaid before goods leave the country of manufacture. Additionally, many governments in emerging markets have also implemented exchange control regimes that make it a criminal offence for banks and exporters to surrender control over goods without payment; this is to prevent foreign exchange fraud and ensure that export proceeds are properly remitted to the exporting country.

In practice, very strong suppliers working with very strong buyers find ways to manage the twin challenges of pre-shipment finance and foreign exchange controls. But many exporters are not in a position to solve these issues without assistance. This is where supply chain finance should come in and provide the solution.

But unfortunately there are gaps:

  • Early payment is not available to all suppliers
  • The money typically comes too late
  • Mid-sized buyers, where financial support and risk mitigation is really needed by suppliers, often do not have a supply chain finance program

3. Why do supply chain finance programs often fail exporters?

Taking these points in turn:

(a) Early payment is not available to everyone

A recent PwC industry survey found that 70% of supply chain finance programs involve less than 100 suppliers (click here).

When a multi-national corporate implements a supply chain finance program, aside from the IT and integrations, one of the biggest challenges is the on-boarding of suppliers. This is not just a practical question (training and information about the program) – it is mainly a question of compliance and cost.

  • Complianceis a process that is undertaken by the external funders of the program (banks), not by the corporate buyer itself.
    • It means that each supplier in the program is vetted and approved under applicable anti-money laundering regulations and the policies of the funder itself.
    • This is an expensive process which has to be repeated periodically.
    • Most funders are unwilling to delegate this process to a third party because of the potentially high cost of getting it wrong in terms of fines and regulatory penalties.
  • Costs arise because of the operation of the program itself.
    • The corporate benefitting from the supply chain finance program will want the lowest funding and operational costs.
    • This means that smaller volumes can be considered uneconomic because of processing costs.
    • Smaller, in this sense, can mean monthly billings of under US$1m or even US$10m – ruling out all but the largest suppliers.

A large part of a supply chain by outstanding amount of US$ can be brought within the program, but many suppliers in terms of numbers are left out; and these suppliers who are left out are usually the ones where the finance is most needed.

Moreover, the drive to reduce costs across the supply chain pushes buyers to locate suppliers in lower cost locations who are often smaller players in their markets.

These lower-cost locations, for example in South Asia, are exactly where the toughest foreign exchange control regimes operate, where local banks are most strict in requiring cash at shipment, and where compliance is hardest for lenders to achieve easily.

Those suppliers who need supply finance the most are the very suppliers who cannot easily receive it. The Asian Development Bank estimates the annual supply chain finance gap for Asian suppliers to be around US$1.7 trillion in 2017, up from US$1.4 trillion in 2016.

In summary:

  • Supply chain finance programs find it hard to provide finance to the suppliers who really need it
  • This is most acute for exporters in lower cost locations, particularly emerging markets, where compliance costs are highest and shipped volumes tend to be smaller.

(b) The money comes too late

As highlighted above, an emerging market exporter usuallyneeds the finance when the goods are shipped. But supply chain finance programs provide finance when invoices are“approved” for payment– which is usually after goods have arrived, been landed, inspected, and accepted – and the paperwork has made its way through the corporate system.

Suppliers in Asia usually ship by sea. This is a significant part of global trade in manufactured goods. Shipping times are often 30 days or more between South and East Asia and Europe / US.

So there are two issues:

  • In order to get the invoice approved, the supplier has to release the shipping documents to the buyer.
    • This allows the goods to be landed and delivered.
    • But releasing the shipping documents without payment is exactly what the local bank who may have financed the manufacture wants to avoid.
    • And this is also explicitly prohibited in the regulations that some South Asian countries apply.
  • It can take up to 45 days after shipment for the invoice to be approved.
    • For many suppliers, who have already financed the purchase of materials, manufacturing costs and wage costs, this simply creates a working capital requirement that they cannot cope with easily.
    • Many exporters are unable to finance this additional period from their local banks because the goods have left,
    • and so they resort to unsecured and expensive alternative sources of finance to bridge the gap, whilst also taking credit risk on distant buyers which they are ill-equipped to assess and manage.

Historically, these issues were solved using letters of credit and sending shipping documents through the banking system.

This covered the risks for the exporter and the exporter’s local bank. The shipping documents were not released without payment, whilst giving the buyer the chance to verify that the documentation matched their expectations. But supply chain finance programs do not extend their reach into this “transit period” – when goods have left the supplier but not yet reached the buyer – and so a significant and problematic gap emerges.

The “money comes too late” is one of the biggest challenges in supply chain finance.

In summary:

  • Supply chain finance programs usually provide cash against approved invoices, often 45 days or more after shipment.
  • But this invoice approval comes too late in practice to work properly for emerging market exporters and their local banks; post-shipment finance needs to be approved when the goods are shipped.

(c) Mid-sized buyers do not offer supply chain finance

Mid-sized buyers are usually the buyers where supply chain finance is most needed, but also the buyers where a program is not implemented.

The reasons are simply cost and complexity. A supply chain finance program typically requires the following topics to be addressed:

  • Digitization, automation and analysis of the payable function in the corporate buyer
  • Changes to paymentprocedures to create an invoice approval process for payment before due dates.
  • Enrolling Suppliers, which means agreeing the criteria to select which Suppliers will be eligible, and then completing the compliance checks and training them in the new system
  • Negotiatingwith one or more banks who will provide the finance, using credit lines that would otherwise be available to the corporate itself
  • Accountingpolicies and treatment for the funds used in the supply chain finance program have to be defined
  • Technologyimplementation to reflect all of the above in the purchase order, management reporting and accounting systems of the Buyer

These are large company projects, inevitably. The process of corralling finance providers, liaison with auditors and advisers, organizing the technology and setting up the Supplier on-boarding is expensive in terms of time and money.

In summary:

  • Mid-sized buyers, where credit and reliability is a higher concern of both emerging market exporters and their local banks,are unlikely to have a supply chain finance program.
  • Which makes itharder for emerging market exportersto supply them, especially from lower cost locations such as South Asia.

4. PrimaDollar: supply chain finance for exporters

PrimaDollar is a trade finance company.

With our business trade finance solutions:

  • The money does not come too late
  • Suppliers can be on-boarded, even with smaller volumes and in harder to manage locations
  • Zero set up means that finance can be available in 24 hours – so there is no obstacle to smaller and mid-sized buyers using our solution.

Our technology bridges exactly the gaps that supply chain finance programs have difficulty in addressing.

How PrimaDollar’s trade finance solution works:

The PrimaDollar trade finance system is simple:

  • Supplier and Buyer agree their purchase order.
  • We check with the Buyer and verify the order and the agreed arrangements.
  • We then provide a pre-shipment guarantee (either PrimaDollar LC a bank LC). The Buyer is not involved in this step. Our PrimaDollar LC provides the same benefits and protections as a bank LC but at a much lower cost.
  • At shipment, the guarantee pays cash to the Supplier; this cash is used to purchase the invoice.
  • On the invoice due date, the Buyer pays us.

These processes are automated by our systems. They are easy and convenient for all the parties involved.

Since we are not a bank, we can physically purchase and then collect the actual commercial invoice involved.

  • This means that there is no accounting risk associated with invoice – it is, and remains, a trade payable throughout.
  • There are no accounting questions arising.
  • Moreover, the credit that we provide is additive for the Buyer – we are not a relationship lender and we are not cannibalizing other credit lines to offer supply chain finance. The buyer’s lenders are not involved.

PrimaDollar supply chain trade finance really does work in practice

  • Via our local offices across South Asia, and with variable pricing models that allow us to cover our costs, we are able to accept smaller suppliers in lower cost locations. Our finance is available to all compliant suppliers.
  • By combining trade finance technology (letters of credit) with the approved invoice model, we providefinance at shipmentto exporters matching the requirements of their local banks . The money does not come too late.
  • With no IT costs, implemented in as little as 24 hours, no difficult accounting questions, and an ability to work trade-by-trade, our solutions are ideal for mid-sized corporates who do not want to go through the pain and cost of a supply chain finance program.

PrimaDollar’s supply chain trade finance helps finance programs to reach those important parts of the supply chain which otherwise are unsupported.

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