Inventory Finance and Balance Sheet Management– Pushing the Envelope

For a company like Starbucks, which has major spend categories such as coffee, cocoa, tea, sugar and dairy products, commodity price risk represents a primary market risk, generated by purchases of green coffee and dairy products, among other items. If someone could take the risk of holding that inventory off their balance sheet until they needed the products for conversion, that would be have tremendous balance sheet implications.

Companies are spending a lot of time on how to reduce inventory. Strategies that exist today include the following:

  • Use Copackers – A copacker is a contract packager that provides a turnkey service like filling and packaging its customers, mostly in the food and CPG industries
  • Multi-echelon Inventory Optimization - Managing inventory can be a daunting task for an enterprise with tens of thousands of products that are located in hundreds of locations. In multi-echelon networks, new product shipments are first stored at a regional or central facility which stocks internal suppliers in various tiers using software to ensure optimal stock levels for customer facing locations.
  • Vendor Managed Inventory (VMI) - Users of the inventory do not own it until they consume it. Inventory value and carrying cost reductions improve the balance sheet. Here, logistics companies play valuable services managing the collateral and providing the fulfillment and information. This has been well-established by contract manufacturers selling to brand companies.
  • Consignment Inventory – similar to VMI.

In the old days, traditional merchant banks would play a role in financing inventory. Today, very few banks play in this space. BNP Paribas has an Irish Trading company that is involved in financing inventory. Standard Chartered Bank has been rumored to shutter their operations. Mercuria just completed the acquisition of JP Morgan’s physical commodities business.

There are many reasons inventory finance by trading companies is hard work, and I can think of a few big ones:

  •  You need to understand things like the compliance issues around bill of materials. For example, you don’t want to buy filters for an auto client if there are asbestos in those filters and they are made in the states. Now that you are in the physical supply chain and you own the inventory, there are substantial risks that are undertaken in the chain of title.
  • The trick is the information about the inventory is powerful – what state it is in, who physically own, that information is not on a balance sheet. Balance sheets just show work in progress and finished inventory. You don’t know half is spoiled.
  •  The next issue becomes which supply chains as there can be rapid price degradation from the time a good gets made until it reaches the retailers shelf (i.e., technology goods)
  • Another challenge is around having the capabilities to warehouse products and keep them at the right specifications for the buyer. What happens if you fail to meet their specifications? This is where it becomes hard work and where risks come into play.

In addition, when programs get beyond niche, do the regulators come knocking? I still believe this is an area the logistics providers can exploit more. What do readers think?

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Voices (4)

  1. Craig:

    Hi David – this post has been over 3 years old now. Has anything changed over the past 3 years or its still status quo in the world of inventory financing off balance sheet? Any new players in the space? Thx.

  2. Tony Brown:

    You’re right, David, no one’s doing this in a scalable way. And certainly the banks are unlikely to be players. That leaves the logistics companies, non-bank lenders and IT platforms. Among the non-bank lenders, a fertile segment is industrial conglomerates that own funding, logistics, IT and manufacturing operations.

  3. Tony Brown:

    David, thanks for raising again the topic of inventory purchase finance ( I very much agree that this is an underexplored activity by both lenders and logisticians (acting in concert, preferably).

    It’s a continuing source of bewilderment to me that logistics companies (3rd Party Logistics providers or “3PLs”) aren’t more involved in this. Yes, I understand that they don’t want to clutter their balance sheets with clients’ inventory (since this will raise eyebrows among investment analysts) but there are compelling reasons for them to be in this space.

    1. It can win new business by offering more value.
    When I developed an inventory purchase program for a US commercial finance company we spoke at length to Schenkers (now part of Deutsche Bahn). They salivated over the idea of joining forces with a finance company to facilitate Vendor Managed Inventory business. In fact, most of the RFIs for new logistics business included an ability to finance inventory by taking ownership of it. Most logistics companies can’t find a way to accommodate such requests. Their clients would be thrilled if they did!

    2. Lenders can lend while logisticians move freight
    There’s no need for 3PLs to fund these deals themselves. Lenders (some bank and particularly non-bank) are ready to finance deals by taking title to goods. Of course, it helps for risk optics if the 3PL has skin in the (funding) game. And lenders don’t want to interfere with logistics arrangements – they want to leverage off of 3PLs’ networks and core competencies in moving freight (and safeguarding the lender’s collateral).

    3. IT platforms that track tracking inventory can be leveraged
    3PLs have invested considerable capital in creating platforms that provide their clients’ granular insight into the movement of inventory throughout the physical supply chain. This data is immensely valuable but becomes even more so to a lender when monetary unit values are attached to the goods managed by the 3PL. This facilitates tracking of the collateral value of the goods owned by the lender as they move through the supply chain.

    As for the lender risks you mentioned….

    Compliance of goods with buyer specifications and relevant regulations. This can be made a contractual requirement of the buyer and be made subject to 3rd party inspection, if appropriate. Clearly, due diligence of past track record is a key mitigant of non-performance risk.

    Product liability insurance is available to the inventory financier to mitigate the risk of being in the title chain.

    Damage to or loss of the goods can be covered through cargo insurance held by the inventory financier.

    “Importer of Record” responsibilities have to be clearly understood by any lender prepared to own inventory as it crosses borders. Due diligence on vendors, analysis of past trading experience, monitoring of anti-dumping activity, contractual recourse to the buyer for trade data retention are all part of the lender’s cost of entry into the market.

    Here’s lies the acid test: to have the stomach for inventory purchase finance, a lender has to have the mindset of a trader and the skills of a lender. Most don’t – but I see that there’s increasing interest in this space among lenders. Sadly, 3PLs don’t seem to be quite as venturesome!

    1. David Gustin:

      You bet Tony

      There is a lot of coulda, shoulda, here, but the fact is banks are retrenching and BNPs Irish Trading company could be closed down at a whim – see my Eurozone stress test post.
      Is anyone really doing this in any scalable way? I dont think so. Too much of a backward somersault with a 720 twist landing on one foot off the beam, if you know what I mean.


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