The Role of Trade Finance in Working Capitalon one contract, but also the risk of a
consequent loss if a vital input into the
production process is not delivered.)- Raise invoice.
Once the goods have been delivered,
the company will also need to raise
the invoice. This may need to be
accompanied by a range of other
documentation, depending on the terms
of the transaction. - Collect payment.
The credit terms and any accompanying
documents will determine when payment
should be expected. The company
should ensure it has appropriate
procedures and structures in place
to make it as easy as possible for the
customer to pay. This may include having
bank accounts in the customer’s location,
appropriate processes for collecting
credit card payments, or being prepared
to negotiate accepted bills of exchange.
A process should exist to follow up on
overdue amounts. - Perform back office duties.
It is important at the end of the process
to fully reconcile and record the received
payment. This acts as a means to protect
the company against fraud, whilst also
providing the company with the tools to
evaluate a range of metrics, from the
counterparty risk to the efficiency of the
company’s order to cash cycle. Finally
it is a critical element in improving the
accuracy of the company’s cash flow
forecasting model.
The financial order to cash cycle
On the financial side there are four crucial
elements:
Negotiate price in response to sales
request. The scope for negotiation will vary
across industries and will be determined
by a range of factors, including the nature
of the relationship between the two parties,
any specific buyer requirements, as well
as overall market conditions. International
transactions may require taking a view on
foreign exchange movements, especially if
the contract is over a period of time or for
payment at a point in the future.
Agree credit terms. This will require
the company to know its internal costs of
production and to ensure that any discount or
credit terms are calculated using appropriate
interest rates, such that these costs are
adequately covered. Again, for international
transactions the company may consider
it necessary to hedge future cash inflows,
although this can be difficult as the precise
timing of the inflows may be uncertain.
Collect payment. The accounts
receivable function needs to be structured
in such a way that it is both convenient for
the customer to pay, and easy for the group
to direct cash into its liquidity management
structure. The core objective is for the seller
to be able to use the cash as quickly as
possible once it has been received. Again,
this will vary according to the location of the
company’s bank accounts. It may be simply
a case of diverting received cash into an
account paying higher interest. On the other
hand, it may mean repatriating the cash to
the home office as quickly as possible.
Use data to evaluate counterparties.
Using data that is generated by the order
to cash cycle is a critical function. Proper
recording of transactions, including
recognition of any delay in payment, or
the nature of any dispute, is a vital help
to improving the quality of the company’s
own internal review of counterparty
credit. In particular, awareness of any
slight lengthening of the time it takes
a counterparty to pay can indicate a
weakening of that party’s credit or trading
position. All companies should have internal
procedures to assess their counterparty’s
financial position.Order to delivery – inventory
The order to delivery cycle deals with the
company’s internal production process,
running from the forecast of demands, through
the production of the product, to the storage
and onward delivery of the final output.
The use of technology, especially ‘just-
in-time’ and similar production methods,
has opened the production process to wider
financial scrutiny, as production processes,
timelines and inputs can all be clearly
measured.