1. Short-term Financing: Don’t Get Stuck in the Middle
Authors: Niclas Osmund and Lars Hagne, SEB
Before exploring available solutions, it is worth looking at some of the fundamental
features of the current global trade environment:
• Despite the fact that global trade has been relatively slow over recent months,
the long-term trend is of stable growth and it is now beginning to pick up
again as the global economy moves out of crisis mode. According to the
Netherlands Bureau for Economic Policy Analysis (CPB), global trade
volumes in the first three months of this year were 5.3% higher than in the
previous quarter, representing slightly slower growth than in recent months
but still a healthy rebound from the crisis. World trade in March was 4%
below the peak reached in April 2008 but 21% above the trough seen in May
2009. An interesting development is that trade growth is now strongest in the
emerging economies and regions, such as Asia and Latin America.
• Large manufacturing companies are sourcing increasingly complex
components from new suppliers in new markets.
• Corporates are also selling their products and services to new customers in
new markets with a different set of prerequisites than they are used to.
• During the past few years, multinational manufacturing companies have put a
lot of effort into making the physical supply chain as efficient as possible - for
example production, sourcing, logistics, warehousing, etc.
• On the other hand, the financial supply chain has not been able to attract as
much attention as the physical one and therefore, in the majority of cases, they
are not aligned.
All of these factors add complexity, vulnerability and new risk elements to the global
trade environment. The risk increases exponentially with every new customer,
supplier and geography. In addition, the more efficient and lean the physical value
chain becomes the more pressure is put on the financial value chain.
Aligning the Financial and Physical Supply Chains
During a sharp economic downturn, working capital comes under tremendous
pressure as sales decline, key suppliers demand pre-payment and warehouses are
exploding from within. Naturally, therefore, working capital management receives a
lot of attention during the bad times. The challenge for corporates is to avoid the trap
of taking action with only short-term goals in mind. To keep up the momentum in the
good times, a corporate needs to establish a long-term strategy for its financial supply
chain, making step-by-step improvements and ensuring that these improvements are
sustainable.

2. To do this, a company needs to have a holistic view of its funding - both internal and
external - and understand that there is no one simple solution readily at hand. The
overall objective is to align the financial supply chain with the physical supply chain,
to make them synchronised and work in harmony. When the physical supply chain
changes, its financial twin needs to do the same. But this alignment is not happening,
in large part due to corporate treasury’s lack of ownership over working capital.
This was borne out in two surveys - one on cash management and one on trade
finance - carried out by gtnews, in association with SEB. Both surveys highlighted
interesting findings related to working capital management, which in turn impacts the
need for short-term financing.
In the Cash Management Survey 2009, only 30% of respondents said that treasury has
ownership over the working capital function. Although this was a 6% increase from
2008, still the majority (60%) confirmed that treasury still merely monitors working
capital.
The majority of respondents described the quality of their purchase-to-pay (P2P),
order-to-cash (O2C) and inventory cycle processes as either average or good. Less
than 10% of the respondents considered their P2P process (8%), O2C cycle (8%) and
inventory cycle (7%) to be best practice. However, the results from just those
companies who said that treasury ‘owns’ the working capital function, the proportion
that said the quality of their working capital processes is best practice almost doubles.
There is also a significant proportional increase in the number of respondents who
describe their processes as ‘good’.
This is a clear indication that if treasury does take a leading role in the management of
working capital processes, substantial improvements can be made.
The Trade Finance Survey 2010 found similar results - only 36% of respondents
claimed that treasury has ownership over working capital.
The percentage of companies trying to enhance working capital levels by
manipulating their day's payables outstanding (DPO) or their day's sales outstanding
(DSO) was 53%, the same percentage as in 2008.
The tough economic markets of the past year have sent treasurers rushing to protect
their equity, rather than taking a holistic view of working capital throughout the value
chain. While there has been some progress in integrating trade finance into the cash
management function, far more remains to be done to get treasury in the driving seat
when it comes to working capital.

3. How to Free Up Working Capital with Short-term Financing Solutions
The starting point for a short-term financing solution must be a holistic one,
encompassing the total supply chain of a company. Along the path of the physical
supply chain, financial solutions in the form of different financing options can act as
mitigating factors to make the engine run smoother - similar to oil in a machine. A
step-by-step approach could look something like this:
Sourcing: counter party and market risk assessment
In order to reduce the risk associated with sourcing materials, buying entities need to
have a due diligence process in place, particularly when sourcing new supply
partners. One way is to approach the supplier’s bank and ask for a commitment based
on their relationship. If the supplier’s bank refuses, then that serves as a warning to
the buyer.
Corporates can look to rating agencies and export credit agencies (ECAs), who often
work close together cross-border. However, the rating agencies have been largely
discredited during the recent crisis mainly due to the fast changes in the market
environment. A corporate treasurer can also turn to credit and risk management
specialists, some of which provide a broad range of services such as debt collection,
credit reports, insurance, credit risk management, due diligence, security services, risk
management, brand protection, fraud investigation, background investigation, etc.
Perhaps the best due diligence is a visit to the supplier but, for obvious reasons, this is
not a viable option for all companies. One avenue opening up is around new social
media/networking internet forums, such as www.theBenche.com, which can be used
as another source for market risk assessment, either by reading country reports or
posting questions for forum participants. A corporate still has to do its own due
diligence, but such a community can provide insights into different markets and
market practices.
Trade contract: negotiating the terms
Many large buyers can use their dominant market position to impose trade terms on
their suppliers. However, if a purchaser doesn’t consider its supplier - e.g. whether it
is located in a higher interest rate market, its working capital needs, etc - then it can
create a situation in which the supplier fails. Therefore, a buyer must look at the
resilience of the whole supply chain and should try to make the trade contract
advantageous for all parties concerned, from a DPO, DSO, cash flow, or cash
conversion perspective.
In some industries, the supplier holds the power and market participants have to abide
by the standard terms of the industry. For example in long-term projects, suppliers can
demand (a) pre-payment(s) from the buyer. From a pure cash management

4. perspective, this arrangement aids the supplier but could be very cumbersome for the
buyer in terms of its cash position.
Order: pre-shipment financing
Certain industries use pre-export financing agreements, which effectively mirrors the
situation in the physical supply chain. Commodity trade finance is quite common in
the soft commodity industry: for example, a large purchaser might want to secure a
crop and will make a pre-payment to a producer and will receive an advanced
payment guarantee in return from the producer’s bank, which (somewhat simplified)
means that either the buyer receives the shipment as per the commercial contract or, if
something happens with the delivery, it will get the money back from the bank issuing
the guarantee.
There are of course a number of pre-shipment financing or payment vehicles and
solutions available from banks, some generic and some more ‘bank specific’. In
addition, such vehicles or solutions are often very closely related to and provided for
industries in which the trades are being done. Geographically one can also see certain
bank solutions that are not globally available – for example, Asia is highlighted as one
region where such geographical solutions are most common for short-term trade
financing solutions.
Supplier invoice: supplier financing
Supplier financing, often referred to as reverse factoring, is an emerging solution that
is based on the invoice sent by the supplier: when a buyer receives an invoice, it is
technically a payment obligation where the buyer promises to pay an amount by a
certain date and often after it receives the goods.
A bank or factoring company enters into a relationship with a buyer ‘initiating’ the
relationship with the supplier. The buyer presents the invoices to the bank or the
factoring company which purchases the invoices and pays the supplier shortly after.
The buyer, on the other hand, pays back the bank or factoring company within a
negotiated timeframe, which is usually longer than what it would potentially be under
a supplier’s credit scheme.
In today’s economic climate, most buyers are seeking to increase their DPO, while
their suppliers are trying to decrease their DSO. If the buyer has a better credit
standing than the supplier, the reverse factoring solution is appropriate as the buyer
can grant access to its quality balance sheet in order to finance itself and pay the
supplier early, while at the same time extending its DPO bilaterally with its bank.
Another positive effect seen from reverse factoring is that the relation between the
supplier and the buyer is often strengthened which is why, in addition to the pure
financial effects, buyers could be interested in introducing the solution to core
suppliers.

5. There are few drawbacks to be found in the set-up. True, there is a small discounting
cost on the part of the supplier but this is normally lower than a traditional working
capital financing cost. The buyer benefits from an extended DPO and hence improved
cash flow, but at the same time, of course, it is increasing its credit line liabilities with
its bank or factoring company.
Inventory financing
Importers, retailers or other companies with a large amount of capital trapped in
inventory, or companies with large seasonal variances in sales while production is
steady throughout the year, may want to look at inventory financing. This is when a
company pledges its inventory as collateral for a credit facility with its bank. The
inventory related to such a financing can not be controlled by the borrower but needs
to be under the full control of an ‘approved third party’, which for instance could be a
trusted forwarding company. In addition the pledged inventory needs to be
satisfactorily insured.
The ‘approved third party’ is obliged not to release any pledged inventory to the
borrower prior to a consent is given by the bank providing the inventory financing.
Consent is typically given when the borrower repays (a part of) the inventory
financing facility, or when goods of an equal or higher value are added to the
inventory.
Production: investment financing
This is classic financing where a company is seeking long-term funding for investing
in production equipment through either an ordinary bank loan or a leasing contract.
Distribution: post-shipment financing
Suppliers who seek to obtain cash shortly after goods are shipped (where perhaps the
buyer has been provided with a supplier’s credit which allowed the buyer to pay at a
later date) may explore a post-shipment financing solution to improve its working
capital. Post-shipment financing is commonly seen as the discounting of promissory
notes, bills of exchange, bank pre-payments under documentary collections and, of
course, (deferred payment) letters of credit (LCs), but also in terms of various export
factoring products and open account financing solutions.
The credit quality of post-shipment financing assets can be improved by credit
insurance schemes or, in the case of a LC, a confirmation granted by a bank.

6. Conclusion
Looking back on the financial crisis, when liquidity dried up in the banking industry
and market participants stopped trusting each other, many corporates were forced to
approach their banks with cash flow problems. Arguably this was just a temporary
situation, but they needed extra cash to get through the tough times.
By revealing its trade flow, a corporate can provide the information banks need in
order to feel more comfortable about providing short-term finance based on a
company’s business.
For that reason, companies need to broadcast their trade portfolio. Instead of the
traditional way of approaching banks with annual reports in hand, talking about what
happened last year, companies need to present their business case in up-to-date terms
- for example, a deal was done yesterday that will come to fruition in 90 days when
the company gets paid for an invoice from this rock-solid buyer, etc.
By taking this approach, companies won’t get stuck in the middle in the bad times and
they will be in a better position to take advantage of the good times. Although there is
a lot of focus on working capital today and corporates are working hard to free up as
much capital as possible, it is difficult to keep up the momentum in the good times.
Short-term financing tools are vital to have ready at hand in an economic downturn.
In addition, they could also enhance a company’s efficiency, transparency and
resilience during upturns, in order that it has the best possible cash flow and working
capital management situation.