Supply chain financing to sustain operations in food packaging
A small business began with the aim of packaging and exporting fruit and vegetables to international markets. It chose local fruit and vegetable producers as its primary suppliers and its key buyers became foreign companies and consumers.
After the first year, the business was struggling with liquidity. From the start, the business had approached the market aggressively and managed to secure a number of orders from large buyers.
It had to pay its suppliers for goods within 60 days – however, collecting payments from its international customers was taking on average 60-90 days. This created a gap between cash inflows and outflows and tied up working capital in the supply chain.
In order to continue to accept and fulfil orders, the business needed to improve its cash flow. An obvious option would have been to secure new financing through a bank loan. However, the business was in the early stages of development and only owned one vehicle. As it was leasing its other vehicles and renting its facilities, including its warehouse, it did not have any assets that it could use as collateral for a loan.
The business was short of capital and faced difficulty operating efficiently because it needed to wait for payment from customers before it could pay suppliers for new produce. It needed a way to improve its cash flow.
The business owners decided to go straight to the suppliers to negotiate extended payment terms.
The business asked its suppliers whether they would be able to extend their payment terms from 60 to 120 days. One of its larger suppliers agreed, but the smaller suppliers were conscious of their own cash flow positions and could not accept these terms, so the business offered the rest of its suppliers the option of supply chain financing.
Supply chain financing involves the business selling suppliers’ invoices to a financial institution who pays the suppliers promptly on behalf of the business but grants the business extended payment terms. The details and fees vary depending on the arrangement, but usually, suppliers have the option of either requesting payment immediately in exchange for a discount, or being paid under their original invoice terms. In both cases, a financial institution acts as an intermediary, taking on the small risk that the business will not pay the invoice. The result is an arrangement that can benefit the cash flows of both the business and its suppliers and increase stability in the supply chain.
The suppliers agreed because they wanted to get paid earlier and maximise their cash inflows. Even though the business was young, it had built close relationships with its local suppliers so negotiations proceeded smoothly.
To facilitate the supply chain financing, the business needed to find a financial institution to help with invoice payment. The business hired a bank, which then became a part of the supply chain. The invoice selling arrangement was successful for both the small business and its suppliers. It offset the negative impact of the longer payment terms the business was seeking from its suppliers, while still enabling the business to meet its cash flow optimisation objectives.
This slowdown of cash outflow also gave the business access to more working capital to use for investment, innovation and business growth. By employing these measures and without having to provide any collateral, the business had gained immediate access to 80% of receivables that were not yet due from its buyers after showing confirmed invoices. This enabled the business to expand five times more quickly, allowing it to settle obligations towards employees and suppliers, and to invest in its own distribution channels.