Inventory Purchase Financing – The Flip Side of Funding Trade Payables (Part 2)

Tony Brown is principal of The Trade Advisory, a specialist international trade finance consultancy located in New York, NY.

In the first part of this post, we looked at the rationale for lenders purchasing goods from suppliers for cash and selling them to buyers as an alternative working capital solution to early funding of vendors’ approved trade payables.

Here, we shift the focus to consider what type and structure of transactions are a good fit for inventory purchase financing (IPF), what accounting considerations should be borne in mind to ensure a trade versus financing treatment, and what operating platform can ensure transactional management and scale.

For buyers attracted to IPF to improve liquidity and leverage ratios by keeping inventory off their balance sheet it’s important to ensure the optics are right.  Few CPAs will be convinced that a transaction is a trade deal if the purchase of goods is a bank!  That’s why banks like Standard Chartered (SC) and BNP Paribas (BNPP) and other non-banks transact such business through an offshore trading company subsidiary.

In terms of product eligibility, commodities and raw materials make sense since, if the buyer reneges on its purchase obligation, the goods should be relatively easy to liquidate.  Nevertheless, BNPP and others will look at consumer and manufactured goods if the deal makes sense.  The more the supplier has exclusive/preferred access to a product in limited supply the better.

FASB Accounting Standards Codification Topic 470-40 has replaced FAS 49 on the subject of Product Financing Arrangements.  It provides guidelines for determining whether a transaction involving the sale of inventory is in substance a financing arrangement. These state the deal is a financing if the buyer does any of the following:

a)    Sells the product to another entity (let’s call this the Inventory Purchase Company or IPC), and in a related transaction agrees to repurchase the product (or a substantially identical product) – in other words, a repo

b)    Arranges for the IPC to purchase the product on the buyer's behalf and, in a related transaction, agrees to purchase the product from the IPC

c)    Controls the disposition of the product that has been purchased by another entity in accordance with the arrangements described in either (a) or (b).

The key determinants to ensuring whether a transaction might qualify as a trade, not financing, transaction include the following:

•           The absence of any payment guarantee by the buyer to the IPC

•           The absence of documentation between the buyer and the IPC under which the IPC purchases goods on behalf of the buyer and the buyer agrees to hold the IPC harmless for product disputes, product price risk (in the event of resale), product liability, Customs/Import compliance liability and other commercial risks

•           The absence of a cost structure between the buyer and IPC under which the buyer agrees to cover the IPC’s physical and financial costs of importing and holding the goods until the buyer takes delivery of them

•           The IPC’s entity being a regular trading company, not a special purpose vehicle or “credit grantor”

•           The goods being stored by the IPC at the IPC’s or a third party warehouse until delivered to the buyer

Getting IPC deals signed-off by the buyer’s accountants as trade not financing is no easy task – sometimes it isn’t possible to hit 100% of the above bullets. But with the right structure, the IPC can purchase goods from the supplier that are presold to a creditworthy buyer.  The IPC can empower the supplier to accommodate “just-in-time” product deliveries while funding the transaction at a cost reflecting the buyer’s credit risk.

When it comes to operating platforms that execute and monitor transactions in granular detail it appears that none of the major players yet have the appetite to use a third party solution for this purpose.  They prefer a limited amount of products sold in large value shipments rather than have to worry about a huge volume of lower priced items shipped in dribs and drabs under a plethora of contracts.  In most cases, buyers will want the IPC to use the logistics service providers (freight forwarders, customs brokers and warehouse/distribution companies) the buyer presently uses.  Therein lies an opportunity for IPCs to piggy-back off of these service providers’ platforms.  Perhaps in due course, platforms like those of GT Nexus will provide a suitable platform for IPCs.

The heyday of lenders thinking like a trader but acting like a banker was several hundred years ago.  (They were called Merchant Bankers – remember them?)  With the advent of globalization, just-in-time/lean manufacturing, and the quest by buyers and suppliers to optimize the use of capital in trade transactions, perhaps Inventory Purchase Finance will make a comeback as an alternative to trade payable financing.

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