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@example.com or (925) 941-1931.