Inventory Purchase Financing – The Flip Side of Funding Trade Payables

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

In today’s Supply Chain Finance “charts”, one of today’s big hits is providing early funding at a discount to suppliers of buyer approved invoices. But the flip side of this tune – Inventory Purchase Funding – can also be harmonious to companies with a high weighted average cost of capital (WACC).

By definition, confirmed trade payables represent the buyer’s liability to pay for goods purchased and delivered from suppliers.  As such, these goods – inventory – are held as an asset on the buyer’s balance sheet and consume substantial amounts of capital.  Given the choice, many buyers might prefer not to clutter their balance sheet with inventory in the first place.

Inventory Purchase Funding is the purchase by a lender for cash of inventory from a supplier and the management and control of that inventory until the buyer is contractually committed to take ownership of and pay for it.  In this way, buyers can improve liquidity and balance sheet metrics by delaying ownership of inventory while simultaneously ensuring that suppliers are relieved of the need to tie up scarce (and expense) capital in holding goods.

With post-crisis leverage now back to more conservative levels, the preservation of capital has become imperative.  It’s no surprise, therefore, that buyers increasingly adopt Just-in-Time or “lean” inventory practices – in other words, postponing ownership of inventory until it’s needed for consumption (in production) or resale (in wholesale/retail trade).

But there’s no “free lunch” for buyers who lean on trade suppliers – either by pushing out payment terms or requiring suppliers to hold inventory for long periods.  Often the supplier’s cost of finance and logistics is higher that the buyer’s – and these costs are baked into the supplier’s price of goods sold.  Optimal Supply Chain Finance requires buyers to understand these costs and to replace them with more competitive finding costs whenever possible.

So finding a lender to purchase goods from a supplier at a cost of finance lower that the buyer’s WACC can produce off-balance sheet advantages for both buyer and supplier when compared to Trade Payable Finance.

As with Trade Payable Finance, considerable care must be taken when structuring such facilities to ensure that they don’t qualify as Product Financing to the buyer in accordance with Statement of Financial Accounting Standard No. 49, Accounting for Product Financing Arrangements, and require the buyer to record the inventory and loan debt on its books at the order date.

So far as this writer knows, only two large banks – Standard Chartered and BNP Paribas (see Stepping Out of the Box – One Bank assists with Inventory Finance) – offer Inventory Purchase Financing to their best investment grade buyer clients for products ranging from raw materials and commodities to hi-tech components part.  This leaves a large audience potentially ready to dance to a different tune from Trade Payable Finance.

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Voices (3)

  1. Gaurav Bhatnagar:

    Very good article.

  2. Gaurav Bhatnagar:

    Very good article. A simple alternative to this will be for bank to purchase the receivables from supliers of large buyers ….this will take care of the balance sheet impact on buyer.

    Yes for supplier , it might still mean a worse current ratio…but dont think that people care too much about current ratio now a days.

  3. George Benedict:

    Terrific and timely article Tony. Thanks for the nuts and bolts and your insights .

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