Mid-Market Banking

Supply chain finance and trade finance tools support global relationships during crisis

7 Minute Read

The global pandemic has created both unforeseen challenges and opportunities for U.S. companies engaged in international trade, and sustaining success in this environment has required careful shepherding of trade relationships. In response, many mid-sized businesses are leaning on traditional trade finance instruments like letters of credit, and increasingly on a tool historically used primarily by large corporations — supply chain finance.

The COVID disruption

Supply chains rely on healthy and secure relationships between buyers and suppliers. While the pandemic has led to the expansion of certain industries — such as the video conferencing, housewares and toy businesses, just to name a few — for many U.S. importers and exporters it’s been a disruptive force and has placed an enormous strain on their relationships with critical trading partners.

Factory shutdowns have created supply chain and production delays for importers that rely on parts or finished products from overseas vendors. Pandemic-induced logistical difficulties such as a lack of containers, freight booking obstacles and delays at ports due to a reduced workforce have also made importing more onerous.

U.S. exporters supplying foreign customers are facing these same issues, in addition to concerns about if and when they will get paid once they ship their product. What’s more, during this period, the strong U.S. dollar has made U.S. goods more expensive and less competitive, adding friction to relationships with overseas buyers.

Commercial letters of credit aid buyers

Indeed, these conditions have altered the dynamic of trading relationships. Whereas previously open account terms had been widely used, in the pandemic era companies have had to re-examine practices to address supply chain stability. Buyers with slower sales have responded by requesting longer payment terms to preserve cash flow, and many buyers and suppliers are returning to traditional trade finance services as a way to mitigate supply chain risks or negotiate temporary changes in the process.

For instance, more U.S. importers are using commercial letters of credit (LCs) to avoid heavy down payments. An LC can act as collateral. A buyer can often bring an LC to its local bank to secure prefunding in the form of packing credits or pre-export finance loans.

In this time of uncertainty, buyers are also using LCs to assure suppliers that after they ship goods they will get paid. As a legal instrument, an LC says if the supplier ships the goods and meets all terms and conditions in the LC, the bank assures payment to the supplier.

Industries in which many importers are using LCs for these purposes run the gamut — from apparel and seafood to auto parts and raw materials.

LCs as a solution for exporters

At the same time, many U.S. exporters are using commercial LCs to assure payment from their trading partners, and as a working capital financing tool. To effect the latter, a supplier might, for instance, shift from LC terms requiring payment on sight to terms allowing the buyer to pay in 30 or 60 days and hold on to its cash longer to maximize its working capital.

To enhance its own working capital situation, the supplier can choose to discount the LC without recourse, enabling it to monetize the trade receivable, receive early payment, and deploy these funds to the rest of the business — for instance, to manage day-to-day operations or to purchase new materials to support increased production.

Supply chain finance

The use of supply chain finance to support the trade relationships of U.S. middle-market companies has accelerated in the pandemic era as a way to both stabilize supply chains and improve working capital management for both buyers and suppliers.

In supply chain finance arrangements, buyers send approved invoices from participating suppliers to a bank, and based on the buyer’s strong credit rating, the bank can make an early payment to the supplier at a discount. The buyer can also, in many cases, negotiate extended terms from the supplier.

Buyers hold on to their cash longer, increasing their days payable outstanding (DPO), and suppliers get paid faster and take advantage of financing rates that are typically better than what they could receive on their own. Additionally, supply chain finance enables suppliers to obtain working capital without using their own lines of credit or other credit facilities.

Small foreign suppliers hit hard by the pandemic are often eager to participate in supply chain finance programs with U.S. buyers.

Supply chain finance can be a perfect fit for a U.S. importer looking for a way to ease the liquidity challenges of its foreign suppliers while extending its own payment terms and boosting its working capital metrics.

Don’t overlook traditional or unfamiliar tools

If your company is engaged in international trade, talk to your banks’ trade specialists to learn about tools you can use to manage the various risks of working with overseas buyers and suppliers.

Companies sometimes make the mistake of overlooking traditional trade payment tools like commercial LCs because they perceive them as cumbersome. However, your bankers can explain how LCs can be structured to meet the mutual needs of buyers and sellers.

Similarly, supply chain finance is a product that is not as familiar to middle market companies but is increasingly being used to enhance trade relationships. A shorter cash conversion cycle is typically a goal for most businesses.

Trading partner relationships are key in the procurement and sales process. Trade finance and supply chain finance solutions can help you retain and secure those relationships through the pandemic until the market becomes more stable. And once you become comfortable with these financing programs with certain trading partners, you might want to continue or expand them.

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