The Role of Trade Finance in Working Capital Manage risk.
As well as managing liquidity risk, the
treasurer will also want to manage the
associated trade risks. The use of a
letter of credit facility or supplier finance
programme will help to both finance trade
and reduce counterparty risk. Linking
funding to particular assets also helps in
understanding changing counterparty risk
exposure, as the funding stream and the
receivable are directly related. Finally, the
choice of currency when raising funds can
also help to manage foreign exchange risk.
Enhance sales.
On one level, reduced funding costs will
mean the company’s end product should
be cheaper. However, treasurers may also
be able to consider funding that allows
their sales teams to offer better payment
terms to their customers, either in the
form of early payment discounts or as an
extension to payment terms.
Evaluation of different techniques
There is a range of different funding tools
available to companies seeking to finance
their trade transactions and wider working
capital. The particular tools will vary between
companies, depending on their local markets,
size, activities and available assets. Larger
group entities will typically have more tools
available, although they may also have
greater funding requirements.
Broadly speaking, a company will need to
identify, first, what tools are available, before
evaluating which tool, or combination of
tools, to use. There are a number of variables
which will help the treasurer identify the best
course of action.
Working capital funding gap.
At the heart of any funding decision there
is a requirement to identify precisely
what needs to be funded. Aside from
a degree of precautionary or backstop
credit lines, treasurers will usually want to
avoid raising unnecessary working capital
funding from external sources.
Internal funding.
For this reason treasurers will look
internally to identify sources of working
capital funding. Restructuring a group’s
cash and liquidity management activities
may offer the opportunity for cash-rich
group entities to fund the working capital
requirements of sister companies. This
can be a complex, time-consuming and
expensive process, so care should be
taken before embarking on such a policy. It
is most likely to be possible in groups which
have a range of products at different stages
in their respective product life cycles.
Change in business approach.
More generally, companies may be able to
restructure their business activities to free
working capital. This may include adopting
a more streamlined approach to inventory
management, changing suppliers or
making accounts payable and receivable
departments more efficient.
General or specific funding.
A critical question is for the treasurer to
determine whether funding should be
arranged for general working capital
purposes (perhaps through a bank line of
credit or a commercial paper programme)
or for specific activities targeted at
financing a particular stage of the
production process (pre-shipment finance
or invoice discounting, for example).
Short, medium or longer term.
Depending on the company’s cash
forecasts, the funding can be put in place
with different maturities. A temporary peak
borrowing requirement, such as financing
stock in a retail business just before
Christmas, may only need a short-term
facility. Funding a longer-term investment
with the return generated over many years
requires longer-term finance.
Other funding arrangements.
This decision needs to be taken in the
context of the company’s wider funding
arrangements. A highly leveraged
company, with a high ratio of debt to
equity, will find it harder to arrange
additional debt funding than a less
leveraged company of the same size.
The treasurer will need to identify which
assets may be available for sale and for
use as security for financing, especially if