Using Supply Chain Finance as a Risk Management Tool

Think about if for a minute. Why would a company want to take early pay finance offers from its own Customers.  There could be a myriad of reasons:

  • The pricing could be much better than it gets on its ABL lending facility
  • The pricing may not be as great as its factoring deal, but there are no transaction fees, which can be significant in factoring.
  • Of course there are those quarter end and year end window dressing issues where companies want to clean up their books.
  • And the most dominate reason is one of predictable cash flow (or in accounting terms, managing your Days Sales Outstandings). We know that opting in to early pay programs and receiving your funds via ACH provides certain cash versus waiting for the customer to pay in 45 or 60 days, hoping your invoice isn’t diluted, and losing an extra few days because you miss a payment file cut-off (because your customer makes bi-weekly payments).

But another reason that cropped up over the years according to a recent survey by Taulia of their own suppliers is large companies taking early pay on buyers who have low credit risk, even though the funding costs are higher than their weighted average cost of capital, to manage their customer exposures.

As children, most of us had certain fears that came out in the dark.  Mine was clowns.  I didn't trust them because I couldnt see beyond the mask.  Yours could have been vampires, ghosts, a noise in the house or maybe an old uncle or aunt that just looked funny.  Credit risk is one of those things that can go bump in the night, an unknown that can cause great fear.

Every sale made by a company of any reasonable size that is done on some extended payment terms is a credit decision.   Whether a company has a dedicated process for credit lines with their buyers or does it in some haphazard fashion, the receivables are exposed, particularly the longer the sales terms.  It’s not rocket science that payment terms can be used as a carrot to induce a sale (ie, extend terms for buyers to induce the sale) but it comes with extended Days Sales Outstanding (not good for your Treasury KPIs) and potential higher receivable losses.

Companies spend a great deal of time and resources focusing on bank credit which is certainly an activity to spend time on.  But when you consider inter-enterprise credit is five times more than the total volume of short-term bank credit, using early pay or supply chain finance as a risk management tool to manage buyer limits is not such a bad idea.  You see, with the economy long in the tooth on a ten year recovery, a customer default is certainly something that can impact your balance sheet and go bump in the night.

Am I saying that Early Pay finance solves this?  Of course not, that’s naive.  Large corporates have professional risk management teams that manage their customer portfolio credit risk.  And receivables, because of their short duration and favorable structural issues that can be used for financing and capital raising initiatives such as securitizations, asset based lending structures, bank revolvers, capital market debt issuance, etc

But according to Taulia, supply chain finance is being used by large companies for this purpose.  While trade credit insurance provides protection for bankruptcy of a customer, becoming insolvent can be very different than “failure to pay”.  As programs become more popular and widespread, early pay finance becomes another risk management tool in the toolkit of a CFO.

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