Cash & Liquidity ManagementCash ManagementPracticeShort-term Financing: Don’t Get Stuck in the Middle

Short-term Financing: Don't Get Stuck in the Middle

During the financial crisis – and the slow recovery period – many corporates have experienced very painful moments and through these have gained a deeper insight into their working capital processes. One revelation has been that a company can easily get stuck in the middle, squeezed by both customers and suppliers. This puts greater stress on working capital, much of which is already tied up within the company. As a result many companies are facing an increased need for short-term financing.

Today the key question that corporates are asking themselves is what can they do to avoid this situation, in good times as well as bad? What solutions do they need in their financing toolbox?

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 CPB 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 region. In addition, the more efficient and leaner 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 explode 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.

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 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 proportion almost doubles among those companies who said that treasury ‘owns’ the working capital function. 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.

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: counterparty 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 speed of change 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, 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 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. The purchaser will make a pre-payment to a producer and receive an advanced payment guarantee in return from the producer’s bank. This (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 ‘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 high- 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.

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 finance cannot 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 consent being 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 the buyer has perhaps 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.


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 essential 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.

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