How Your Suppliers Borrow Money: Understanding Relationship vs. Transactional Lending

From a procurement perspective, we often think little about what it takes for our suppliers to run their operations. Our risk analyses (think Altman Z) are cursory at best. But just as important as understanding supplier capability and simplistic balance sheet health (and being able to read an income statement) is unearthing how a supplier can access cash to run its business.

Understanding how suppliers borrow money is essential to appreciating not just the opportunity for new types of receivables and payables financing programs (e.g., invoice discounting) but also managing supply risk. In his analysis, “On-Demand, Event Triggered Finance With Network Models – A Game Changer?,” my colleague David Gustin explains how suppliers can actually borrow money today. Unless you’re a banker, you’re probably not aware of all the nuances and options.

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David suggests that “much is written about supplier perspectives in the supply chain, but we often observe one supplier’s perspective that’s missing: that of the banker (or financier, more broadly). The banker’s ultimate question is: “What can I lend against with a reasonable expectation of repayment – and what should the risk-adjusted financing rate be?”

Lenders can collateralize loans in a number of ways as David notes:

  • Use the suppliers’ personal liquid assets as collateral for the business loan. A small business owner borrows money personally, and lends it to the company.
  • Buy credit insurance on receivables. Suppliers wait at least 90 days with protracted default before a claim can be made. There are 2 kinds of defaults: an actual event, such as bankruptcy, or “protracted default,” which is technical jargon for late payments or non- payment before bankruptcy (i.e., “the check is in the mail”).
  • Use factoring agents. Factoring is the collection of proceeds of invoices by a (factoring) company other than the seller. It’s subject to a number of issues, not the least of which are merchandise disputes, charge backs and buyer-controlled payment dates regardless of previous agreements.
  • Acquire some type of government loan guarantee on a business loan. The guarantee only pays off the bank when the borrower is declared “in default.” This means that the bank may have to wait for a long time to get the guaranteed percentage share of the loan.

Yet these approaches (in an historical lending context) all present a different set of challenges including high loan origination cost. As our analysis and reporting on David’s recent paper continue, we’ll explore these – and new options for P2P and supplier network driven financing – in more detail.

Curious? Download the full paper: here. We also encourage you to investigate our deep, subscription coverage of trade financing, invoicing discount and P2P on Spend Matters PRO.

In addition to Spend Matters PRO research, David and Jason offer workshops, lectures and advisory services to corporations, banks, private funds, consultancies and technology providers that want to learn more about the trade financing ecosystem and its intersections with new technology products and platforms. Contact them directly to learn more: jbusch (at) spendmatters (dot) com or dgustin (at) tradefinancingmatters (dot) com.

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