Cash flow challenges from increasing open account trade

Due in large to the ongoing development of global supply chains, many multinational companies now prefer to offer open account terms to their suppliers in an effort to speed up production cycles, improve margins, free up cash flow and save costs.

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Many multinational companies now prefer to offer open account terms to their suppliers in an effort to speed up production cycles, improve margins, free up cash flow and save costs. However, in an increasingly competitive environment characterised by a heightened aversion to credit risk, this move can increase pressure on the cash flows of their suppliers. Sriram Muthukrishnan, Regional Head of Business Development, Global Trade & Receivables Finance, Asia-Pacific with HSBC, shares how some of the region’s leading companies are alleviating the strain.


Key insights

  • The pressure to meet buyer payment terms is greater than ever before
  • An increasing number of suppliers are agreeing to open account terms in order to seal the deal
  • This benefits buyers in several key ways, most notably by extending payment terms by up to 90 days
  • Open account trade is considerably more agile than traditional methods of trade finance such as letters of credit
  • Many companies are engaging in accounts receivable factoring, which enables the business to sell its accounts receivables to a third party
  • Bank collection services can also alleviate back office strain without the need for traditional borrowing
  • Through supply-chain financing, the seller can leverage the buyer’s credit rating and ability to pay for the goods or services at a later time in order to access funds up front
  • With the right banking partner, open trade account terms can benefit both the buyer and the seller

The process of buying and selling goods and services is almost as old as man himself, however in today’s global marketplace, the way in which companies do business has become increasingly complex. Not only are organisations now competing on a much larger stage than ever before, an ever-growing number of distribution channels and fundamental advancements in logistics and shipping have led to a search for new banking products that help enable international trade quickly and easily.

In the past, tools such as letters of credit have been used. However today more and more organisations are implementing open account trade terms in an effort to increase sales and gain a competitive edge. According to the World Trade Organisation’s International Finance Corporation, more than 80 per cent of global trade is now transacted using open account terms.

When it comes to either local or international trade, an open account transaction is a sale in which the goods or services are delivered before payment is due, in some cases even after they have been sold to the end user. While this was not always the case, the rise of the global or regional buying centres within large corporations has resulted in a fundamental shift in power in favour of the buyer, which means purchase terms are increasingly aligned to the buyer’s working capital optimisation objectives. And because payment is often not required until after the goods or services have been delivered, buyers benefit from an additional source of free cash flow for up to 90 days or more, and are therefore encouraging suppliers to sign up to these extended open account terms, rewarding them with ‘preferred supplier’ status.

In today’s fiercely competitive market, the pressure to meet buyer payment terms is greater than ever before, and as a result more and more exporters are looking to this practice in order to seal the proverbial deal. Exporters who are reluctant to extend credit to their buyers may lose the sale, especially if their competition is willing to do so. Moreover, open account trade is considerably more agile than traditional methods such as letters of credit, which are both cumbersome and costly.

However, this also leads to some obvious concerns on the part of the seller. Exporters must be thorough in their assessment of the political and economic risk, and be fully aware of any local legislation that could stand in their way. They must also be absolutely sure that the customer will accept delivery of the goods and pay at the agreed time before they enter into any open account transaction. While these risks can by and large be managed using a range of trade finance tools such as trade credit insurance and forfaiting for example, the greatest impact of open account trade lies in the lengthening of the cash conversion cycle. Without cash up front or even a partial down payment, it can be extremely difficult for exporters to cover the costs of manufacturing (or to secure funding to help ease the burden of paying for it in advance).

So how do companies go about ensuring they receive these benefits while mitigating the risks associated with open account trade? The good news is there are several banking solutions that can deliver.


The changing face of supply-chain financing

There are several supply-chain financing methods that companies are now using to free up working capital and improve company cash flow while still offering open account terms. Smart organisations are increasingly looking to accounts receivable factoring, which enables the business to sell its accounts receivables to a third party, giving them access to cash more quickly than if they had to wait until the invoice had been cleared. The terms and nature of factoring differs depending on the banking partner, however companies can access up to 100 per cent of the value of their invoices quickly and easily using this practice. Many banks also offer collection services, which can help eliminate back office strain, and because this isn’t a loan it offers considerably more flexibility than traditional borrowing. These structures help both large and small buyers arbitrage risk and improve liquidity.

Alternatively, supply-chain financing can also be used to help build a level of trust between the two parties and ensure strong contractual responsibilities are in place. With supply-chain financing, the bank allows the seller to leverage the buyer’s credit rating and ability to pay for the goods or services at a later time in order to access funds up front. Also known as supplier finance or reverse factoring, this enables the buyer to extend their payment terms without causing additional cash flow problems for the seller, minimising risk across the supply chain in the process. Meanwhile the buyer optimises working capital and the supplier generates additional operating cash flow, making this a win-win scenario for both parties. Some of the primary benefits include:

For the buyer:

  • The ability to extend payment terms with suppliers, generating free cash flow;
  • A potential reduction in the cost of goods sold, which stems from reduced financing charges for the supplier;
  • An opportunity to effectively optimise working capital metrics and create an economic value add;
  • Stronger relationships with suppliers, especially small-to-medium sized enterprises, as a part of ongoing Corporate Social Responsibility; and
  • Greater supply chain loyalty and sustainability to support top-line growth.

For the supplier:

  • Access to an additional source of financing, ideally at a relatively lower cost;
  • Easier management of financial metrics and credit standing thanks to the typical ‘without recourse’ nature of this financing;
  • Stronger relationships with buyers because it demonstrates support for their top-line growth strategies; and
  • A reduced need for debt, which can be focused on additional investments.

Other supply-chain financing alternatives that continue to be widely used include standard bill discounting, which is a short-term loan solution that enables companies to borrow money against their sales invoices before they have been paid. Meanwhile some companies favour import financing, which helps the seller meet any financial obligations associated with the manufacturing process while affording favourable payment terms to the buyer.

Obviously traditional trade finance tools such as letters of credit, standby letters of credit and guarantees will continue to be widespread for the foreseeable future, but smart companies are turning to these newer products to help alleviate the cash flow strain.


Conclusion

While at first glance, open account trade does in fact place an additional burden on the seller, there are several key benefits for both parties of any transaction that can help not only speed up the cash conversion cycle, but they can also foster corporate growth and encourage international trade. And with sellers under increasing pressure to offer these terms in order to secure a steady flow of trade, smart companies at both ends of the deal are looking to find the right banking partner in order to help them smooth the flow of goods and services and improve time to market, thereby making this an attractive option to all corporates, and not just buyers.


10 steps to alleviate cash flow challenges caused by increased open account trade

When trying to alleviate the additional burden placed on company cash flow caused by offering open account terms to buyers, there are several tried and tested best practices which companies should adhere to:

  1. Review the upsides in the internal company processes such as procure-to-pay, and order-to-cash for example. More often than not, you can find a week's worth of working capital trapped in the cash conversion cycle.
  2. Benchmark your working capital metrics against peers, customers and suppliers to ensure they are appropriate and effective. Define your target Days Payable Outstanding for working capital optimisation
  3. Properly understand the impact of your plans on your overall supply chain so that you can forecast potential risks
  4. Use appropriate structures for working capital needs that are financing specific in order to ensure more competitive and sustainable financing
  5. Identify potential sources of pressure on cash flow such as liquidity, counterparty, interest rate and FX rate for example, and actively manage those risks
  6. Standardise payment terms and credit terms, which will improve the predictability of your liquidity
  7. Agree an efficient dispute resolution process with suppliers and buyers in case problems arise further down the line
  8. Automate reconciliation of your bank statements, allowing your finance team to focus on preventing cash flow challenges rather than simply offering back office reactive support
  9. Look to outsource high volume, high touch processes such as documentary credits, invoice management and settlement to suitable vendors with clear service level agreements in place
  10. Constantly review progress on the previous nine steps and adapt

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