It costs money to borrow money. But a
lesser-known tactic called trade cycle
financing may allow companies to save on the cost of money.
If your company’s borrowing base is not
large enough to provide the money you
need now, you can fund each stage of a
trade transaction in exactly the amount
required for that stage, rather than the
amount your borrowing base allows. This
same model is used the world over to fund
international transactions.
“Most companies may not know about
trade cycle financing,” says Glenn Colville,
senior vice president and group manager,
Western Market, International Trade Finance for Comerica Bank.
“Trade cycle financing — a type of transactional financing — allows for more than
traditional availability of financing against
inventory.”
Smart Business talked to Colville to get
more specifics about trade cycle financing
and its benefits.
What exactly is trade cycle financing?
It’s a form of transactional financing that
provides a company with financing from
the beginning to the end of a sales transaction — from the time a customer places its
order until the receivable is liquidated.
Commercial banks generally lend against
a collateral pool of inventory and accounts
receivable, say, up to 40 percent on inventory and up to 80 percent on accounts
receivable. With trade cycle financing, the
bank examines the deal on an order-by-order basis. A company is not limited to the
traditional borrowing base percentages
against a pool of collateral.
Typically, banks are looking to finance
transactions that complete the trade cycle
within 180 days. In some scenarios, a bank
might be willing to go longer than that, but
the nature of the company’s business has
to justify the longer finance period.
What kind of companies can apply for trade
cycle financing?
Traditionally, it’s seen more in an import/export situation. But it can be brought onshore within the U.S. where there’s need
for larger-than-typical advances against
inventory.
Because you’re looking at transactional
financing as opposed to a traditional collateral pool, the banker has to be really
comfortable with the company applying
for the loan having been successful for a
number of years. The banker has to know
that the product is marketable and that
there’s a market for it — because that’s
where the liquidation value lies. Additionally, the company must be mature enough
to have experience with its vendors and its
customers.
All these factors dictate lending to a company that has demonstrated a successful
business model for a number of years, not
one that is less than tried-and-true.
What rate can a company expect to pay for
the money it’s borrowing?
Banks create a specific advance for a specific period of time. The rate could be
based on prime, LIBOR or Banker’s Acceptance, which is another form of fixed-rate, short-term financing. Banker’s Acceptance rates can be considerably less
than prime, which means a lower cost of
funds to the company.
How can a company benefit from this type of
financing?
As I just said, there’s the possibility of
lower-cost funding. In an environment with
a high potential for rising interest rates, the
ability to use fixed-rate, short-term financing is an advantage.
The other real benefit is the additional
financing against inventory. Trade cycle
financing allows up to 100 percent
advances against inventory as opposed to
20 percent to 40 percent against other
methods of financing.
What are the risks associated with this kind
of borrowing?
It’s neither more nor less risky than other
forms of financing. The fundamental risk
when any company borrows money is that
it might not be able to repay it. And if it
can’t, the larger implications are that something is failing in its business.
What type of insurance is included for the
shipped product?
When you’re financing a whole series of
transactions from start to finish, collateral
protection against loss is important, so
cargo insurance is a key. Credit or
accounts-receivable insurance can be purchased by the company taking out the loan.
For the bank, an insurance product is available that provides it with risk-of-loss insurance.
Are commercial banks the only institutions
where a company can apply for trade cycle
financing?
To my knowledge, the players are mostly
commercial banks and commercial finance
entities or intermediaries.
If this concept piques your interest, talk
to your relationship manager and/or trade
finance specialist at your bank.
GLENN COLVILLE is senior vice president and group manager,
Western Market, International Trade Finance for Comerica Bank.
Reach him at [email protected] or (925) 941-1931.
