Approaching Trade Finance From The Payables Side

Trade finance is a critical tool in supporting global trade for both buyers and sellers, particularly smaller businesses.

Yet these financing products aren’t without their risks and drawbacks, and today, criticism continues to mount for certain invoice financing tactics in particular.

High-profile corporate collapses and questionable invoice discounting programs run by major conglomerates has led financial officials in the U.K., U.S., Australia and beyond to take a closer look at products like factoring and supply chain finance.

Yet when used responsibly, supply chain finance — a process in which financing is approached from a buyer’s accounts payable (AP) side, not from the supplier’s accounts receivable (AR) side — can be effective at promoting healthy cash flow for both ends of a B2B trade transaction.

Raul Esqueda, president of supply chain financing company 1st Commercial Credit, recently spoke with PYMNTS to explore the benefit of financing corporates’ payables at a time when invoice factoring on the receivables side remains the go-to trade financing strategy for many businesses today.

An Alternative To Factoring

Factoring can be a helpful cash flow management tool for suppliers, although it’s not without its own criticisms. Opponents argue factoring and other invoice financing solutions perpetuate the ability for a corporate buyer to extend payment terms and delay payments, forcing a vendor to turn to a third party to finance unpaid receivables.

Increasingly, Esqueda said, he’s also seeing more B2B vendors unable to participate in factoring programs.

“We’re running into a lot of suppliers that already have lines of credit at a bank, and they’ve already pledged their receivables to that bank, so they can’t go to an invoice factoring company,” he said. “Now you have a perfectly good supplier capped out with their line of credit, and they have a buyer that doesn’t really want to accelerate payment on their behalf.”

Not every corporate buyer can pay an invoice early, even with an early payment discount, he added.

Factoring also runs significant risk for financiers in instances like chargebacks, trade disputes, fraud, returns and more: a supplier who accidentally delivers the wrong product may have already obtained financing on an unpaid invoice, but thanks to the mistake, that vendor won’t be getting paid anytime soon — or perhaps ever — leaving that financier to face losses.

Re-Shifting The Risk

Supply chain finance programs face the same risks that invoice financing initiatives do. Esqueda likened a trade payables financing program to that of a credit card: If a buyer finances a payables, but an order is wrong, that buyer is still on the hook to repay the financier.

While risk is mitigated somewhat in that supply chain finance requires buyers to authorize the release of payment to a vendor (much like a buyer will still have to pay a credit card bill even if something goes wrong with their purchase), Esqueda also noted that there are ways financiers can further limit their exposure to mishaps and financial losses.

Much of the controversy surrounding supply chain financing today stems from the critique that banks can sometimes finance payables for a corporate buyer that is cash-strapped and unable to pay the bills. Esqueda emphasized the importance of financiers only working with companies that use payables financing as a cash flow management tool, and not a way to fill in cash flow gaps.

“They need to have sufficient cash, they need to be financially strong,” he said. “You can’t be doing this with buyers struggling to pay their bills. A lot of supply chain finance companies are getting in trouble because they are financing buyers that need money.”

The mindset behind this tactic, he said, is that many financiers rely too heavily on trade credit insurance products, assuming that if a buyer is unable to pay up, insurance will pay out. But in times of market disruption, trade credit insurance providers will eventually drop policyholders as the instance of deals that fall through grows more frequent.

Removing The Friction

Esqueda said he’s seeing trade credit insurance providers pulling back from the oil industry as travel restrictions and coronavirus fears suppress demand and dampen prices. It’s only one example of the broad-reaching implications of the coronavirus on B2B trade and corporates’ cash flow management strategies, while certain industries like retail are facing their own particularly volatile moments in history.

As such, financiers must be especially stringent in their due diligence and underwriting processes. But if approached responsibly, supply chain finance programs can play a significant role in helping businesses endure market disruptions.

In addition to proper underwriting processes, Esqueda also noted that supply chain financing firms must also do everything they can to remove friction for all parties involved. That means ensuring buyers actually have vendors willing to offer discounts on their invoices, limiting the amount of paperwork parties must complete, and integrating into buyers’ existing AP workflows and suppliers’ invoice data without the need for clients to build their own application programming interfaces (APIs).

“You have to simplify the process,” he said.