Alternate Financing Solutions : Sharper liquidity for specific business needs

The CFO just got off the phone with his bank. He was unable to comprehend the reason why his company’s request for additional liquidity was being turned down by his house bank. They have been working with this bank for over 8 years and the company’s balance sheet continues to be healthy along with bottom-line accretive P&L.

“Our bank has rejected your application for additional funding proposal” said the bank official in a terse tone.

“The credit team has a certain threshold in place on your industry and they cannot accede to your request this time”, he added further.

This happens sometimes and the moot idea here would not be to criticise the opaqueness in the process or differing mindsets adopted by banks. The key idea to discuss here is on the remedial action - what should the company folks do in these situations. As a financier how can we really place ourselves into the shoes of the customer and not leave them out in the cold.

As a matter of fact, it does not need any further amplification that there is a huge widening gap between assessed working capital / funding needs of corporates and the actual liquidity provided to them. In most cases, the difference lies in the way the liquidity assessment is carried out, in-house / regulators view and overall trend in the market driven by macro forces.

Asian Development Bank

ccording to ADB (Asian Development Bank), that supports the regional development of 67 member countries needs, there is a global trade finance gap of $1.6 trillion to support buyers and sellers of goods (Link: https://www.adb.org/sites/default/files/publication/190631/trade-finance-gaps.pdf). Of this approx. $692 billion gap exists in Asia (including India and China). Astoundingly 56% of SME and 34% of Large Corporate's trade finance proposals face rejection and hence this places a liquidity embargo on them to grow — to add jobs, production capacities and expand their business volume.

Further as per the report, 37% of the firms don’t evaluate alternate financing solutions after their financing proposal is turned down. However, there is merit in checking out non-bank alternate financing solutions as they are extremely sharp and can meet specific liquidity needs of corporate's. While thinking of liquidity, we need to think of various underlying options that can generate liquidity and they are listed as under:

1. Receivables: Typically, a seller (SME, Mid-market and Large Corporate) has multiple options to secure early payment against the future confirmed receivable from their Buyer. Simple financing solutions involve Accounts Receivable Purchase (ARP) and Supply Chain Finance (SCF) aka reverse factoring. The eligible receivables can be from domestic or international buyers and can provide necessary upfront timely liquidity. The seller does not have to wait for the buyer to pay them till the due date. 

2. Inventory: The inventory in client’s warehouse or external warehouse can be financed at extremely competitive rates. During the peak period when the fund-based working capital draw-down peaks out, the specific inventory can be purchased by using alternate financing solutions. There are various procure-to-pay, cash-n-carry and inventory linked solutions that enable the corporate to secure inventory without straining its own balance-sheet. Unlike many other assets, inventory can strain the short-term liquidity and it can be unlocked by Alternate Financing solutions. Further, Collateral Management Agency (CMA) or popularly known as Warehouse Receipt Finance solutions where the trader, processor or corporate can place the goods in an external approved warehouse for seeking a certain % threshold finance against the value of goods.

3. Asset-Backed: Asset backed solutions dwell on the encumbrance of specific Asset, its value and liquidity valuation. These solutions can be part of the regular trade finance transaction or can be specific Asset backed financing. There are many interesting propositions available that also enable the end corporate user to buy Asset against a post-purchase charge creation. Also, when thinking of Assets don’t restrict to tangible assets but expand thinking horizon to Brand, Equity Shareholding, Intellectual property rights, Art (incl Sculptures, Private Jet, Cars Paintings) etc.

4. Supply Chain Finance (SCF): SCF is the talk of the town and there are many fintech / non-fintech players operating in this space. The basic idea being to on-board a strong buyer (e.g. IBM) and work with them to provide financing to their suppliers. Its an extremely competitive space and everyone wants to fund supplier of known large corporates. This leaves a good opportunity to provide SCF to establish mid-market players. Some SCF programs also entail providing Purchase Order finance but this may largely work on parameterized models and for established supply chains. Further the financing provided in these cases may not be adequate to meet the actual financing need of corporate's.

5. Invoice Discounting: Invoice discounting is quite basic. Party A sells to Party B. Party B accepts to pay the invoice on due date. If Party B is a strong counterparty, financier can leverage on Party B’s external rating / internally assessed limits and discount the invoice using Party B's credit limits. If Party A has some Invoice Discounting limits from any bank, the bank can discount the specific invoice using Party A credit limits. You got it right, it works either as Purchase Invoice Discounting and / or Sales Invoice Discounting.

6. Pre-shipment Finance: Let’s take a specific example of ‘agro commodities’ to make this trade leg crystal clear. In agro commodities space the buyer needs to pay cash upfront to the farmer / producer in most markets (viz Africa, Indonesia, India) to secure the post-harvest production. In this case, pre-shipment finance is the key need of any corporate operational in this space and such structures involve taking a higher amount of credit risk. Financing this leg of the trade where the money goes to a farmer / producer that is contingent upon externalities like good monsoon, adherence to crop protection measures and eventually on good ole ‘trust’ is not easy. Various alternate financier’s have developed solutions that can address these needs quite well using PO finance, Procurement Finance and Front-to-Back financing structures.

The intent is to keep is simple, relevant and workable to meet the end needs. 

This post first appeard on Linkedin (here) is my own and don’t necessarily represent my employers positions, strategies or opinions

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