Financial liquidity in business is critical so this means businesses need working capital and many businesses need funding to trade internationally.

Working Capital Lines

Put simply, working capital is the money that the business needs to use so they can undertake day-to-day trading operations. For accountants it can be defined as current assets minus current liabilities. So, working capital is defined as:

• Cash at bank, and near cash such as an overdraft
• Accounts Receivable
• stock ready for sale
• less Accounts Payable (wages and bills)

A big part of the company’s treasury operations is managing and forecasting the cash available and the cash needed to manage the business.

In finance, working capital is generally thought of as the credit or cash you need to run the business from time to time. Working capital lines adds the extra concept that you need to have different amounts of cash at different times. In business things don’t happen at certain times despite what we like to do. Many companies choose to have payroll dates often midmonth, and bill payment dates commonly the 23^rd day of each month. Despite these good intentions some people need to be paid on different dates and cash flows can be erratic because a client may pay when you expect to be paid.

Some vendors or suppliers will insist on being paid before the goods leave, on delivery or net seven days. Quite often if you haven’t paid on time you won’t get a second delivery

Most companies have some sort of financial accommodation (e.g.; credit line) with their bank. The most common of these is an overdraft.

Working capital lines, such as an overdraft, allow companies to buy and pay for things knowing that after they process them, they can sell them and sometime later they will be paid. Effectively, the company is borrowing money to provide a good or a service to another organisation which will pay for it into the future.

Some clients perennially pay slow but is generally accepted they will pay in 60 or 90 days. To get cash back in a company with a receivable it will sell it often under a program to a factoring company. Basically, they buy the debt and hold it until it is paid. They know for example a company like Woolworths or Coles will pay probably under the terms you had no choice but to accept. By paying later these companies effectively give themselves a discount as the supplier is helping fund their working capital.

One of Projects RH is clients produces confectionery. They purchase their inputs from a number of suppliers and generally have to pay within seven days. They maintain in their warehouse some of each of these goods for special orders. They are generally producing confectionery and sending it to the warehouse and when sold it is on 30 days terms, and when dealing with the major retailers perhaps a lot longer. They need to recycle their money or borrow some so they can continue to purchase and sell.

The bank recognises their clients have good clients themselves and that their receivables will be received. They lend money based on security over assets including those receivables. Woolworths and Coles are generally seen as good credits and can be factored.

Trade Finance

Trade finance is a wonderfully exciting world filled with its own language and its language has precise meanings. It is in fact working capital for international trade. It is first important for the parties to agree what the contract represents. How the goods are to be packaged and when they become payable. When you get paid is the most important issue.

Trade finance is a general term which is used to describe a group of financial instruments and products used by companies to facilitate international trade and commerce. Another way to think of it is everything that is not on open account. Trading on open account is like dealing with company next door you know and you don’t take any credit insurance on. International trade raises other issues and risks.

The financing of trade is generally provided through

• Banks
• specialist trade finance companies
• import export companies
• insurers
• export credit agencies such as EFIC which are effectively government supported trade facilitators.

Each of these reduces the risk of dealing with a trading partner.

Dealing internationally has issues which do not occur internally. Currencies can move, trade can be impacted because of intergovernmental relationships, changes in policy, foreign currency shortages or quotas. It is the unknowns which leads trading partners to appoint intermediaries to either accept and/or manage those risks.

It is possibly best explained by way of an example. A Japanese restaurant chain decides to buy Australian beef. Its functional currency is Japanese yen and is buying from an Australian farmer whose functional currency is Australian dollars. The restaurant agrees to buy one container for 25,000 kg of beef to be delivered to the Port of Tokyo. The farmer arranges for the cattle to go to the abattoir with the beef is prepared for export, packaged as per instructions, and loaded into a container.

The first question is how much does the Japanese purchase of pay and when.

The farmer has offered the Japanese buyer, and the buyer has accepted, the average price by Meat and Livestock Australia (MLA) for the day before the kill of the day and the day after the kill. This price is agreed in US dollars.

The next issue is when is the farmer paid and when is the beef transferred to the Japanese restaurant. The restaurant wants the beef delivered and its costs to include insurance and freight. Under this scenario the farmer arranges the insurance and freight and pays for it.

Alternatively, the restaurant could take responsibility for the beef either at the abattoir after it is packed into a container (FOR – Free on rail), at the port and after it is loaded on the ship (FOB – Free on board) or when it is received in Japan (FIS – free in-store – traditionally a bonded warehouse at the port). A farmer who provides a FIS contract is generally also responsible for arranging the freight, insurance and transport to the storage at the other end.

Generally, the farms all ask for a letter of credit (known as an “LC”) which covers the costs and which will be payable once the bill of lading has been accepted either by the trucking company or the ship’s captain. The letter of credit will allow the farmer to get his money. If the farmer has to wait until the ship arrives in Japan and the beef is cleared the farmer may well ask his bank to discount the letter of credit and pay him now. The farmer needs to manage his cash invested in the processing of the beef and its transport plus insurance costs. By discounting the letter of credit, the bank or trade finance organisation receiving it acts like a factoring house.

If receipt of the beef by the restaurant is subject to its acceptance after it has been checked by Japanese officials, then the farmer would probably ensure against rejection.

Well-established payment points are

• at factory gate
• FOR
• FOB
• FIS (simply delivery to the port)
• FIS including freight and insurance

if you are not paid at the factory gate critical are the issues of insurance and negotiations of freight rates. Also, if you’re not paid at the factory gate often there is a requirement for an independent inspection and a risk that the independent inspector will either reject the goods for say they are not of the quality standards. This can lead to expensive legal issues in a foreign jurisdiction. All So, it’s important to say where the contract is going to be interpreted and under whose laws.

The trading houses and financial institutions act to descend to mediate the risk so that the Japanese restaurant can deal with his local bank and the farmer with his, leaving the banks to deal with each other. Professionals in trade finance work daily in this area and tend to know their counterparts across the world. This knowledge and day-to-day practice tend to reduce the risk of dealing foreign countries. Moving to open account tends to be something that large organisations to often because they contract and deal with the same party. An example of this may be an Australian coal supplier who does not want to pay his bank 1.5% every time the company sends coal and it knows that the purchase of the other end needs the coal to run his power station. After a few deals they may learn to trust each other and deal direct. Inevitably, the exporter will want to remove the charge from the bank. This is achieved by going on open account. In doing this they take the credit risk.

In documents not only may we see a letter of credit but also a standby letter of credit. If you are an importer the bank may well require you to cash collateralise the letter of credit they issue on your behalf.

Invariably a document will be issued by an independent party (who will need to be paid) to verify that the goods as specified were loaded on the ship or plane, or picked up by a truck and taken to a port or airport.

Projects RH role

Projects RH act like a company member or hired CFO/Treasurer, and where appropriate supported by a strategic partner, prepare the support documents, and assist the directors with their applications. If we have prepared the support documents a typical application would include financials, company/trust/director details and background, collateral, why the deal makes sense.

In the case of working capital, we sit down with our clients and understand their cash flows and how much money they actually need with the reasonable buffer in case things don’t go as they expect and life does not run according to budgets. We then assist them to prepare their proposal for a financial institution. We then engage with an appropriate party has a credit AFSL or credit licence to speak to the banks and other providers including finance companies, factoring houses and insurers on their behalf.

It is not uncommon for our clients to approach us and say “we are looking an opportunity to either import or export”, can you assist? We work with the client to understand the transaction and the risks. We then write down the process and the cash flow. We work with our client to ensure that their bank or trade finance provider understands the transaction has priced it appropriately

2020

This year has changed the market. It will be a time we will remember we took easy solutions and wants to conserve capital. We have all heard the stories of how the banks are moving slowly simply because there are people are impacted by Covid-19 too.

2020 will be long remembered as the year many organisations needed to improve their working capital lines and found that they needed to look to new markets which meant export and that these needed to be funded.

Conclusion

At Projects RH work with our clients to achieve their goal. We are seeing the companies are looking to expand their working capital base as a take on new opportunities associated with the post Covid-19 world. Many of these opportunities not only require domestic working capital but they need trade finance because we need to export to achieve economies of scale. Many businesses see this as a challenge but it is truly the opportunity.

For the clients of Projects RH there continues to be a positive energy in dealing with business opportunities that may be over the horizon. This needs planning in advance and if you’re going to go expand your business including going into trade it requires proper documentation including business plans, financial models and cash flow management. Working with our clients and their advisers we are seeing they are ready to respond to this challenge.

Paul Raftery – 15 July, 2020

Projects RH works with its clients, and our strategic partners, to introduce potential investors or lenders to exciting projects and opportunities. Projects RH’s core business is to link projects with money. Our work extends across national borders because we seek, for our clients, investors who will assist with the business as well as invest.