The world has come a long way since the days of the cheque book; we can move cash in an instant. Conversely it still takes time to make, import, export, and sell goods.
Have you wondered how you might control the time between that instant you pay for goods and the instant you are paid for goods?
Does this sound familiar?
You need to buy more stock from overseas – your supplier requires 30% deposit up front, another 20% once shipped (one month later) and the balance of 50% on arrival (another month later). All of this cash out, despite it still being another month before you sell the goods and get the cash in from the sale.
This is your cash cycle;
- 30% of cash at use for 3 months
- 20% for 2 months
- 50% for one month.
Say you’re purchasing $100,000 of goods per month. The cash cycle means that at any one time, you have $180,000 of funds paid to suppliers on goods you haven’t sold. $180,000 which you could have in your business.
Your cash cycle could be stifling growth, creating pressure with your bank, as well as stress around how you’re going to meet your payments.
Good news! This doesn’t need to be the case.
Banks specialise in Trade Finance (Import and Export) facilities and can help you significantly shorten your cash cycle putting money back in your pocket to pay staff, rent, marketing, research and other core costs.
Trade Finance Facilities allow you to manage your cash cycle from Purchase of Inventory to Sale of Goods. These facilities may allow you to turn that 3 month period from payment to your supplier, to receipt of payment from your customer into as little as 1 day.
There are many different types of facilities available across the banks but I will focus on two.
Letter of Credit (LOC)
A Letter of Credit is commonly used by importers to defer payment for goods. The LOC is essentially a Guarantee from your bank to pay your supplier at a set point in time if you default.
Suppliers like LOC’s because they provide surety over full payment as default risk lies with the Bank.
This allows you to negotiate terms on payment with the supplier to perhaps one month after shipment (as opposed to 30% up front and 20% once shipped). Once the term is up you make the payment and the LOC is cancelled.
The supplier is also aware that if you fail to pay, they can raise a request from the Bank and the Bank MUST pay the FULL amount.
Occasionally a supplier may request a deposit as they require funds to make or source goods for delivery. An LOC can solve this problem. Often a supplier can take the LOC to their Bank and raise funds against the surety of payment to secure those goods and pay those bills.
Utilising the example above, the cash flow cycle shortens to one month (as opposed to three) and the cash utilised drops to $100,000.00 as opposed to $180,000.00.
Trade Finance Loans (TFL’s)
Trade Finance Loans are short term loans matched to a business’s payment for goods and expected receipt for sale of those goods.
An example of this is importing vehicles. The business would arrange for the purchase of Car X for say NZD$50,000.00 which will take two months to deliver to NZ. There will then be a further month to get the car registered in NZ and complete the sale.
Without a TFL, a business would be required to pay the $50,000 for the car up front without seeing any money back until the sale is made (3 months).
But with a TFL raised at the point of payment for the term until the sale is expected (say 3 months including delivery, registration and sale), the business hasn’t paid any money until the sale. They’ve instead raised debt which they can repay when they receive the cash from the sale.
A couple other neat things to note with Trade Finance Loans;
- Often being short term and for a specific purpose, they’re cheaper than Overdraft Facilities
- They can be drawn in foreign currency to hedge Foreign Exchange Risk (note that this is only really appropriate when your receipts are also in that foreign currency).
Both the facilities above are aimed at supporting a business trade and allow business effective use of their cash. Even better, both facilities can be used together. You can raise an LOC to negotiate payment terms, then once those goods are on the ship and it’s time for you to pay, you can raise a TFL to make that payment – due when you have sold the goods and received your payment. In this case, you’ll have $0.00 of your own cash invested in the activity (excl. fees & interest costs) for the entire cycle.
Make the most of these options
It’s important to note that to make use of these facilities, the banks will want to see proof of your business performance. (We can help with presenting this to them). And if you’re an Importer or Exporter, you should be managing both your import and export cash flow but also your Foreign Exchange Risk.
Good news though, Banks can accommodate for this also.
If you’re importing or exporting and want to improve your cash cycle or want to better use form your precious cash, give us a call, and a Squirrel Commercial Adviser will be happy to help.