What to do about longer credit terms?

The demand by the large corporate groups, in particular the large supermarket groups, for longer payment terms is having a problematic domino effect in the market.

Those not able to persuade their suppliers to also accept longer credit terms have a much higher level of working capital to fund. This can be difficult to achieve and where they succeed it can be expensive. This is particularly the case with unlisted companies. They not only need to find additional capital, they also need to pay the investors a handsome return for that capital. Where capital is reallocated within the business to fund the higher working capital needs, there is invariably a high opportunity cost in that the capital could otherwise have been invested in projects with a relatively high expected return.

There is a funding solution to this, one that is considerably cheaper than the cost of equity and does not result in shareholder dilution. It involves a combination of two products that together significantly reduce the amount of working capital required, potentially even eliminating the need for any working capital.

One of those products is an invoice-by-invoice debtor finance facility. The traditional debtor finance facilities in Australia are ‘whole-of-book’, which generally enable a supplier to borrow an amount of up to 85% of ‘eligible receivables’ less this and that and generally exclude relatively large debtors. As a result the effective loan-to-value ratios under these ‘whole-of-book’ facilities are invariably well below 85%. Under an ‘invoice-by-invoice’ debtor finance facility the company would receive 100% of the invoice amount less the interest cost associated with the payment term. A simple example to illustrate the point: Let’s assume a 3-month credit term and a cost of 1% per month. Under the traditional debtor finance facility the company would receive $85 and be required to pay interest over the 3-month period, so a net receipt of $82.45. Under the invoice-by-invoice facility, the company would receive $97.

The other product is a supply chain facility, one where the suppliers can either wait until the expiration of the credit term for payment or get paid immediately by in effect selling the invoice to another party. Under such a facility the company’s suppliers should have no objection to a lengthening of the credit terms – provided the supplier is compensated for the interest cost associated with the increase in the credit term. From the company’s point of view, it is not a loan to the company, does not impose additional indebtedness on the company, does not require the support of personal guarantees from directors or shareholders and is off its balance sheet.

So with these two products one can turn a situation where one’s company is facing difficulties funding working capital to one where the company has both surplus cash (having received the sale proceeds months before having to pay its suppliers) and happy suppliers (as they have received payment shortly after completed the supply).

There is however a challenge for a company to overcome. It is finding an ‘invoice-by-invoice’ debtor finance facility at a respectable cost. The well-established providers of debtor finance in the Australian market either do not offer such a facility or charge an ‘arm and a leg’ for it. I tend to think one would have a much higher prospect of securing a facility at reasonable rates by approaching both the providers of supply chain finance as well as one’s corporate customers. In the case of the latter, one’s corporate customers, one would encourage them to provide a supply chain finance facility and compensate one (e.g. by agreeing to accept a higher sale price) for the finance cost associated with the longer credit term. These corporate customers should be able to offer a supply chain finance facility at minimal (if any) cost to it and as indicated above do so without having to borrower money, without imposing any additional indebtedness it and without the requirement for personal guarantees from directors or shareholders. The facility should also be off its balance sheet.

Implementing a supply chain finance facilities should be a ‘no-brainer’ for large companies. The upside potential for them far outweighs the downside. So it astounds me that so few appear to have done so.

In an article to follow (at some stage) I will argue that one can – by adding ‘bells and whistles’ to a supply chain finance facility – sigtnificantly increase the return one would otherwise have earned on money in bank accounts, on term deposits or other ‘cash equivalents’.


By Mark Morris (July 2017)