Many SME businesses get caught in a Cash Trap because they don’t understand how the Working Capital in their business ebbs and flows, and how chronic Working Capital shortages can create a highly stressful Cash Gap in their business. (Read more in this introduction to Trade Finance)
There are three main Working Capital tools that I use to help my SME customers defeat the Cash Flow pressures they face from unrecognised business Cash Gaps. These are:
- Invoice (Debtor) Finance
- Trade (Purchasing) Finance
- Unsecured Business Loans
This post explains Tool #2 – Trade Finance (sometimes also called Purchase Order Finance). Other posts cover Invoice Finance and Unsecured Loans.
So here we go…
How Trade Finance works
Trade Finance loans you the money to pay your suppliers on time, giving you more time to turn your inputs into products or services and bill your customers for your work.
It’s a little more complex than Invoice Finance – but it can be a powerful financing tool to help many small business escape the Cash Trap .
It’s particularly useful for retail businesses with seasonal purchasing peaks.
How Trade Finance is secured
Trade finance lenders typically lend based on the strength of your business’ balance sheet and the risk of your supply chain transactions, NOT on your personal assets. They look at your business’s performance and order values in order to set your credit limit.
Trade finance makes it easier to scale your business – because as your transaction values and profitability grow, so does your funding access.
Benefits of Trade Finance
Trade finance gives you longer to pay invoices, reducing stressful Cash Gaps.
Trade finance ALSO enables you to take advantage of Early Payment discounts and Bulk Order discounts – which can be a net gain even despite interest payments.
The nitty gritty of Trade Finance processing
You raise a purchase order, and the supplier processes your order ships the goods. In this example, let’s say you’ve got “30 days from receipt” terms from your supplier.
At 30 days from the invoice due date – in this case the delivery date – the Trade Finance provider will give you a loan to pay your supplier’s invoice. That will give you – let’s say – an extra 90 days to pay for the goods at your agreed interest rate.
This will mean that you’ve extended the overall payment terms to 120 days and – for many businesses with significant “build” periods – solved a cash gap problem, because you have 120 days instead of 30 days to pay the supplier invoice (plus interest).
That gives you 90 extra days to take those goods, use them (or sell them if you’re in retail) and bill your customers for the result. That’s significant extra production and invoicing time.
Costs of Trade Finance
At time of writing, Trade Finance is sitting at 16%. In monthly terms – and I look at business as a month-to-month cash flow process – of around 1.25% a month.
These aren’t large amounts – and they only apply for the period that you USE their funding.
Which Trade Finance is right for your business?
As with any financing tool, there are costs to using trade finance. That means you need to understand your profit margins and expenses so that you can build the finance fees into your pricing policy.
There is a growing range of technology-enabled Trade Finance tools in the market – with some super-powerful features.
The “right” one to use is one that meets your business needs with a minimum of administrative overheads. That’s why you need to put a Working Capital Strategy in place before you go shopping for financing tools.
Luca Pay is one current example that’s helping several of my customers.
Luca Pay – simple, accessible trade finance
Luca Pay – from a company called Luca Plus – is financing tool that looks at your accounting system and decides how you’re trading.
They provide trade credit for your purchases – but they provide trade credit in a simple, easy way – a bit like paying off your credit card.
Firstly, their costs are incredibly reasonable. Let’s say you drew down $100,000 in trade credit. With Luca Pay, you would pay back four monthly payments of $25,000 each, and the interest rate (at time of writing) is a very reasonable 1% per month.
So basically, you’ve got $100,000 and you pay back $25,000 a month plus 1% (which is $250). So you’ve extended your terms for a total of four months while those funds are being paid back, but you have the additional liquidity that Luca Plus provides.
Whether it’s “costly” depends what you DO with that $100,000 of purchases – like accessing bulk buy discounts or EOFY specials. Or investing in business efficiency tools that make your people more productive.
Luca Pay is a very new, very flexible tool based on decades-old trade finance processing. It’s one that works on the inputs side of the cash gap problem, the purchasing side.
So it’s a very effective way to obtain finance and a relatively simple process to obtain ongoing funds.
Any business financing strategy needs to be matched to your business needs
Which business financing tools are best for your business? That depends on your business and it’s specific situation.
For many SMEs, trade finance tools are used in conjunction with debtor finance – but they don’t have to be.
Take a moment to look up the value of your current supplier invoices that you raised in the past 60 days. Write down the total.
Ask yourself if 80% of that amount – in your bank account today – would let you run your business better today?
If the answer is “yes” then book a strategy review with Cash Flow Strategist Martin Cattach today.
