In the following articles we will embark on some financial news of a different kind that owners of startups and SMME's might consider and which may be beneficial for them. Let's dive in!!!
Suppliers: ‘Best Practice’ Working Capital Techniques
What we are looking at above are the two major types of Supplier today:
The man who produces crops off his farm or plot for a local BIG Buyer.
The modern supplier of goods who will be using ships, trains, trucks and ‘planes to deliver his goods to creditworthy buyers, because ultimately his desire is to be paid for his production.
Therefore the supplier will seek out creditworthy buyers to sell his produce or goods to hoping that he will be paid according to the arrangements he concludes with the buyer, and not be disappointed in any way whatsoever – even although this can sometimes be a pipe dream!
The accounting forms that will cover the delivery of produce or goods are all the same:
- The Invoice
- The Proof of Delivery
In decades gone by delivery of goods also included a Bill of Exchange – A ‘Promise To Pay’ to pay for the goods at some future date.
Computerization and digital payment methods have seen Bills of Exchange, cheques (checks) and the like fall into disuse. This fact benefited Financiers and Buyers, but worked to the disadvantage of the Supplier because getting credit from a Buyer became problematical.
Why?
Because the Buyer while still perhaps helping the unsophisticated Supplier to some extent, many a time reneges on the tenets, the payment terms that he undertook to pay the Supplier on, say 30 days.
These delaying tactics are a disaster for both the unsophisticated Seller and the more sophisticated one. These Sellers, after all, have a responsibility to their employees who rely on salaries and wages to keep rent paid, food on the table, clothes for the family and to pay for their children’s education. Late payment of amounts due scupper these national and social well being objectives.
How Suppliers have traditionally raised Working Capital
Supplier Credit
This is the best kind of credit Suppliers can get.
However, it is not always easy to get and sometimes a supplier will withdraw giving credit for a number of reasons.
Bank Credit
This credit is applied for through banks who grant Long and Short Term Loans repayable at fixed monthly intervals.
Or they may provide a Supplier and overdraft. Rarely do unsecured overdrafts get provided today. The banker will always look for security in the form of a creditworthy guarantor, a Bond over Fixed Property or a Notarial General Bond over the business’ moveable assets.
As a matter of course bankers would take Cessions of Outstanding Amounts (Debtors) to cover any liability that may occur in their books. Belt and braces is usually what they require.
If the banker is going to rely on a Cession of Debtors to grant an overdraft, he will invariably be very conservative and grant up to say 20% of an outstanding Debtors Ledger.
Most times this kind of Working Capital credit is simply not enough for a fast growing supplier and his search has to become more imaginative so he seeks out a Finance House who effectively will buy out the Supplier’s outstanding invoices and finance future invoices to creditworthy buyers.
This is a very good way to raise Working Capital. A lot depends on the Finance House that gets chosen for this purposes. Some are better than others. The trick is look for the Finance House who will act as though it is a partner in your business. Few really do this and one has to be careful in their relationship with such a House.
Today, stirring in the Commercial World, is a new option developing that will soon become ‘best business practice’ not only in South Africa but further afield as well.
This system works for the benefit of Suppliers in two ways:
Firstly, it helps suppliers raise money on their production, in the form of financing invoices issued to creditworthy buyers in respect of goods sold and delivered, due for payment on a future date.
The easy way to understand this system is to examine the graphic below realizing that what is happening here is that an ordinary invoice is being validated or confirmed for payment on a future date.
This means that:
- The Buyer is indicating to a Seller and a Financier exactly on which day he is going to pay the invoice, AND what account is going to be credited.
- I also means that to some extent the Promise To Pay an amount due on a specific future date that existed in the old Bill of Exchange is restored somewhat! – This gives great confidence to Supplier and a potential Financier!
The graphic below helps us understand the procedure a little better – The original invoices still covers the goods delivered from Supplier to Buyer – In the graphic we trace a copy invoice that eventually will raise the Working Capital the Supplier needs:
Easy to follow! – Once the validated invoice pops up on the Financier’s computer screen he makes the decision whether he will finance or not! – In need the trade can be insured!
The Financier then credits the Supplier’s bank account with the Working Capital sought and waits for the Buyer to settle the amount outstanding, on due date, thus closing the open item in the Financier’s books.
Secondly, the Financier can help a Supplier in a slightly different way.
This is very helpful to Supplier who is unsophisticated and needs to be paid more promptly for his produce, e.g. sorghum being sold to a brewer (the Buyer).
Buyers like to keep sources of supply regular and paid early. (Sometimes his inward Cash Flow precludes him from doing this).
So today what can happen is this:
The Buyer selects those Suppliers that he wants to pay early.
The Buyer then can pay the Supplier early in cash.
The cash payments are tallied up and once a week or once a month the Buyer presents a Payment Request (invoice if you like) on the Financier. The Financier then waits for the number of days to pass and then passes a debit to the buyer and crediting the open item in his books to close the transaction.
Graphically this procedure looks like this:
Summing up
What we have been looking at here is ‘best practice’ in Modern Working Capital Management Techniques as it affects a Supplier of produce or goods.
The Hundred Dollar Question is, “Who provides this kind of Financial Service today?”
The way to find out the answer to this question is by contacting us on +27 83 417 0319 or Email nevillesol@icloud.com
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