The Role of Trade Finance in Working CapitalExtending finance beyond the
single company
Companies are increasingly looking to
improve not only their own operational
efficiency, but also that of their supply chain
partners. For example, companies recognise
that their own suppliers are critical to
operational efficiency, given that low-quality
raw materials will result in low-quality output,
and late receipt of raw materials will result
in delayed delivery of the output. On the
other side, if a supplier’s customer uses raw
materials inefficiently, the final product will be
unnecessarily expensive, ultimately resulting
in reduced orders for the supplier.
Large companies sometimes seek to
control the efficiency of the supply chain
by acquiring subsidiaries along its length.
Whilst superficially attractive, this can result
in significant managerial challenges, as
subsidiary entities typically still operate
independently. Other companies, especially
in the retail sector, try to impose strict terms,
conditions and controls on their suppliers,
seeing this as a technique which will ensure
stability of supply. Yet this model is more
one of the larger companies using their
financial muscle to impose their own will
on their suppliers. Smaller companies still
face the risk that the larger companies may
refuse to pay. Smaller companies also face
financial demands, as their larger customers
constantly put pressure on prices, whilst their
operating costs remain unchanged. Most
particularly, smaller companies have fewer
options for working capital finance, meaning
they often are forced to take what finance
they may be able to arrange, rather than
having a selection of funding alternatives
at rates the buyer may be able to access.
Ultimately these financial pressures on
smaller companies will and do put the larger
companies’ supply chains at risk, potentially
increasing the financial cost embedded in the
ultimate purchase price.
Instead of seeing each individual
participant along the supply chain as
separate, the participants should be seen as
interdependent. So as well as each company
operating its working capital as efficiently
as possible, the challenge is to operate
the whole supply chain as efficiently as
possible. From the treasurer’s perspective
there are two elements here. First, there are
all the inherent risks associated with every
transaction, ranging from foreign exchange
risk to the risk that the counterparty will
default. (However much the participants
along the supply chain cooperate, there is
still a risk that one of them will fail.) Second,
there is the cost of financing the supply
chain. Just as the treasurer in the standalone
company wants to minimise the cost of
external financing, so all the participants
along the supply chain will benefit from an
overall reduction in the cost of funds.
Trade finance techniques offer a
solution. Instead of viewing a supply
chain as a series of discrete transactions
and processes, it is possible to use trade
finance as the means to link a supply chain
together. If the supply chain as a whole
needs external financing, the entity with
the strongest credit may be able to arrange
at least some of that funding at the lowest
cost. Whilst other entities will not want to
become wholly dependent on the source of
stronger credit, careful use of trade finance
techniques, ranging from varying payment
terms to the use of guarantees, will allow
the stronger companies to finance the
weaker entities, to the ultimate benefit of the
overall supply chain.
The next two chapters look in more
detail at, first, the concept of working capital
finance and, second, the different forms of
trade finance.