Inventory finance - SCF upgrade
Stock on the balance sheet, whether raw materials or finished goods, is a dead weight. It pushes up both assets and liabilities, but does not contribute to financial results.
Inventory finance takes stock off the balance sheet together with its corresponding funding. This reduces the balance sheet size and moves key financing ratios in the right direction, improving cash flow.
You can combine inventory finance with digital supply chain finance. These are naturally compatible.
How does this work, what are the advantages for corporates and financiers?
Inventory finance: why?
Most corporate treasurers and CFOs pay close attention to their ratios. For example, key ratios are "debt to equity" and "interest cover".
As mentioned above, stock on the balance sheet is a dead weight - especially if the stock is not readily usable. For example, if you (as a business) allow suppliers to invoice you as they ship, then the stock is on your balance sheet whilst it is in transit. You, the buyer, cannot use this stock - it is on a truck or ship somewhere. But it adds to your assets and liabilities.
Taking that stock off your balance sheet, particularly if you don't need it or cannot access it, means that your assets go down but also your debt goes down.
This reduces your leverage and improves your interest cover - and you can use the process to improve your operating cash flow.
There are lots of types of inventory finance, some very complicated. Also the Incoterms (FOB, DDP etc) that apply to the supply will influence when stock comes on your balance sheet and what might make sense in terms of finance.
This blog, and the inventory structure proposed here, focus on a simple and common situation: suppliers invoice as they ship, and this is when the products ordinarily come onto the buyer balance sheet.
Essential capabilities of your SCF platform
Adding inventory finance is typically not a capability of legacy supply chain finance platforms. There are a two key features of modern digital SCF platforms (like PrimaTrade) which are essential:
Supplier data: Digital SCF platforms are powered by supplier data - so this means financing transactions can start at shipment because the platform operates in real-time. If your SCF platform is powered by data from your ERP (accounting system), it simply won't be updated quickly enough for inventory finance to be effective.
Real-time documents: Digital SCF platforms can generate documents in real-time at shipment, enabling suppliers to sell their products to a financier shipment-by-shipment. This is both automated and effective using integrations with e-signing systems like Docusign.
These are inherent features of digital supply chain finance platforms that use "cash against data" technology - see more here the ICC paper on how this works.
How do I upgrade SCF with inventory finance?
From the buyer point of view, the arrangements have no impact on daily accounting and finance processes. Everything happens on the digital SCF platform:
Financier buys the product from the supplier
Each time a supplier ships, a real-time document is generated transferring ownership of the product to a financier. The financier pays the supplier. The platform manages this for you.
At the same time as the financier purchases the goods, control of the goods is also moved to the financier via the transport document (eg: via an automated switch of an eBL).
Financier sells the product to the buyer
Now the financier both owns and controls the goods - and retains that ownership and control until the time when the corporate buyer needs the goods.
When the buyer takes the goods, more real-time paperwork is generated automatically on the platform transferring ownership and control over the goods to the buyer and invoicing the buyer (the financier invoices the buyer, also managed via the digital SCF platform).
The buyer pays later based on terms agreed with the financier, either via a payment term on the invoice or potentially even later via a digital bill of exchange (which can also be automatically generated and executed).
Step 2 - when the buyer takes the goods from the financier - is a discussion about what's best and easiest. Buyers will prefer to take the goods as late as possible. On the other hand, if financiers have to land the goods and manage customs filings, it can be better if title moves to the buyer as the goods are landed. There are choices here and plenty of flexibility to optimise the outcomes for the buyer.
What are the benefits of inventory finance?
For the corporate buyer, removing stock from the balance sheet can be a big win.
This reduces assets and liabilities and means that the key corporate ratios move in the right direction:
Debt to equity is lower
Interest cover is higher
Operating cash flow can be boosted
Inventory finance can be combined with a supply chain finance program without upsetting the buyer accounting, finance processes and financial controls. There are administrative steps involved, but these can all be incorporated into the usual flow of activity associated with the supply chain finance program.
Who provides inventory finance like this?
Financiers like the structure that digital SCF platforms support.
This is because the goods involved are bought directly from the supplier rather than sold to the buyer first and then re-purchased. This makes the structure much more resilient from a legal, credit and accounting perspective.
Banks are usually reluctant to take ownership of goods for regulatory reasons. Typically an inventory financing will use a separate corporate structure that acts as the owner of the goods. Digital SCF platforms like PrimaTrade can provide and operate the corporate structure involved as a natural part of their platform delivery; this is built into the arrangements rather than an extra process.
PrimaTrade's investor panel also has a number of specialist funders (non-bank) that specialise in inventory financing - we can introduce them if required.
What next?
Adding an inventory financing leg on top of a supply chain finance program is not difficult to do - especially given new digital SCF platforms available to support the transactions at scale.
Why not talk to us about reducing the stock on your balance sheet, boosting your operating cash flows and even generating some P&L wins in the process?
We have a strong interest in this area, a strong panel of inventory financing specialists that can quickly execute transactions, and we can bring the infrastructure to make this work if your bank would like to take a look.
Contact us here: call us.