18 Oct 2016

A Crash in the Pound Will Affect your Profits

A Crash in the Pound Will Affect your Profits
by Raymond Moore

The Sterling has had its worst week since the Brexit vote falling by 6% against the dollar in 2 minutes on Friday. Can a Supply Chain Finance solution offset increases in the import price of goods due to the weakening pound? 

 As GBP continues to weaken, UK importers are increasingly exposed to "margin pinch”. Supply Chain Finance “SCF” could be potentially be a solution that allows some or all of this "pinch" to be recovered without the need to revise contracts with suppliers and create a 'win win' solution for both buyer and supplier.

How does it work? 

Basically it is an arbitrage play on the interest rate differential between the buyer's and supplier's relatively cost of borrowing, the buyer's typically being a lower cost. A financial institution whether it be a bank or a specialist trade finance house, sits in the middle of the buyer and supplier and makes available non-recourse finance to the supplier once the buyer has approved the invoices submitted to it by that supplier. Let's consider a simple example. 

A supplier submits and invoice to their buyer for $100,000 with 90 days terms. The supplier's cost of borrowing is 4% pa. Hence if it were to fund the invoice via a working capital line with one of it's partner banks it would get a discounted receivable of $99,014 against the invoice equating to a cost financing of $986.

Alternatively the buyer has a cost of borrowing of 2%. The $100,000 invoice is included in a SCF solution provided by a bank/trade house who on presentation of the invoice to them by the buyer make available non-recourse financing to the supplier. As it is non-recourse and the bank/trade house credit risk is with the buyer, the cost of borrowing is 2% (i.e. the buyers cost), the discounted receivable to the supplier against the invoice is is $99,507 equating to a cost of financing of $493. 

The difference in the cost of financing between the 2 scenarios of $493, and overall the solution provides a win for the supplier (reduced borrowing cost on its debtor position), a win for the buyer (ability to share in the interest rate differential and thus potentially offset some or all of the margin pinch) and lastly a win for the Bank or Trade Finance House providing the solution (it will have a potential annuity stream of income from the provision of a SCF solution and a very “sticky" client). 
How can we help?

 Implementing an SCF provision is not easy.  There are legal documentation and supplier on boarding problems to overcome together with ensuring the Trade credit Taken position on the buyers balance sheet remain undisturbed, i.e. there is no reclassification of Trade Credit Taken to Bank Debt. That said with the continued potential for margin pinch and the increasing differentiation between credit spreads/costs borrowing it is likely that the upward trend in the market for using this sort of solution will continue.

At BG we have recent hands on experience of developing and delivering SCF solutions for some of the world’s largest companies. Whether a bank, trade house or end-user, we can partner with you to devise solutions and identify other areas of working capital optimisation. 

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