The Role of Trade Finance in Working CapitalCompanies may also be able to arrange
additional external financing, whether from
banks (in the form of a loan or an overdraft
facility), the money or bond markets or from
the sale of equity. If successful, all of these
would improve the company’s liquidity position.
However, these choices are dependent on
market appetite, and funding rates will be
determined by the individual company’s
credit rating. Because lender appetite can
be changeable, companies tend to take
advantage of receptive funding markets, even
if it means carrying surplus cash for a period.
Managing risk
To manage risk effectively, the treasurer’s
first job is to understand the risks to which the
company is exposed. Having understood this,
the treasurer then needs to decide how best
to manage that risk.
Counterparty risk
In most cases the most reliable information a
company can have on its counterparties is that
which it can build up itself over time. Trends
(on, for example, the time each counterparty
takes to pay) will become apparent over
time, as long as the company has the tools
to capture that information. ERP and sales
management systems can be set up to report
statistics on individual counterparties. These
reports can indicate developing problems and
the need to change the company’s approach
to that counterparty. However, this technique
only works for established trading partners.
To assess counterparty risk for both
existing and prospective trading partners, it
can help to develop an internal credit-scoring
model to help to assess counterparty risk.
There are a number of different factors to
consider when evaluating the strength of a
counterparty, including:
the company’s name and location, any
publicly available annual reports or other
filings, and the ultimate beneficial owners
of the company, including the use of any
central treasury or shared services centre;
the likely or agreed payment terms, the
currency of payment, the use of any trade
instruments or techniques (factoring etc.),
and the nature of the counterparty’s other
trading relationships; and
any established payment track record.
For prospective customers, it may be
appropriate to seek references.
Together this information can be used to
assess and monitor current and potential
trading partners. It is always important
that any changes in metrics are fully
understood. For example, a counterparty
could show an increased DPO value
(days payable outstanding), which might
suggest a weakening credit. However, if it
is participating in a supplier finance scheme
operated by its main customer, this figure
might be misleading.
As well as assessing counterparty risk
internally, there are a number of different
entities providing risk management
services, including credit rating and credit
checking agencies.Credit rating agencies
Credit ratings can help in managing
counterparty risk, as they provide an indication
of likely credit default. Credit ratings provide
a measure of the likelihood of default and
the severity of loss on financial obligations.
They are an opinion on the relative ability
of a financial obligor to meet its financial
commitments, such as interest, repayment
of principal, insurance claims or counterparty
obligations. Ratings are intended to be easily
understood measures that differentiate
between debt instruments on the basis of their
underlying credit quality.
Credit ratings can help a company to
assess the creditworthiness of a particular
counterparty. However, it is important to
recognise their limitations. The ratings
process has come under a lot of criticism
in recent years, especially since its failure
to predict the credit contraction and the
associated collapse of a number of banks,
notably Lehman Brothers and three Icelandic
banks in 2008, as well as the difficulties which
AIG, for instance, experienced. The agencies
have also been criticised for being slow to
identify problems with corporate entities –
Enron was a well-publicised example of this.
When treasurers use credit ratings to support
their evaluation of credit risk in a transaction,
such cases highlight the importance of