The Working Capital Cycle in International Trade September Copyright The Institute of Export and International Trade 2013

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1 The Working Capital Cycle in International Trade September 2013 Copyright The Institute of Export and International Trade

2 Contents Finance During the Business Lifecycle The Working Capital Cycle in International Trade Impacts on Working Capital Working Capital Example Working Capital and Business Decisions Good Practice in Working Capital How Banking and Trade Instruments Improve Working Capital Key Working Capital Ratios 2

3 Finance During The Business Lifecycle Start-Up Growth Maturity Decline Start-up costs -infrastructure -Assets -Working capital -Marketing Investment in working capital, improved infrastructure and increased marketing. Expansion through acquisition, new business premises Continued investment in staff, assets & technology New sales outlets Changing business circumstances e.g. Director sells shares Recessionary environment, pressure on margins Costs of replacing ageing assets, outdated stock Business equips itself for a quick recovery Finance Pressure Points Large new sales orders When selling overseas Higher commodity prices e.g. Fuel Supplier closes down at short notice Finance Pressure Points Production difficulties Shareholder wants to sell Replacing ageing stock Economic downturn Importers and Exporters generally face greater pressure on working capital 3

4 The Working Capital Cycle in International Trade For importers and exporters working capital will come under grater strain, due to; Longer time involved in receiving and shipping goods Chasing slow payers is harder; different law and legal system Settlement through the international banking system can take longer Goods can be held up at Customs Stages of the Working Capital Cycle Supply Side Contract to Purchase of Stock/Raw Materials -on immediate payment or credit terms -lead time may be necessary to produce and ship goods Stock (Work In Progress) Receive imported goods -refine/manufacture -ready as a finished product Sales Side (Trade Creditors) contract to sell ship goods to customer on credit terms? PLUS ONGOING COSTS THAT THE BUSINESS MUST PAY e.g. Employment Costs Ongoing overheads and fixed assets Legal and Administration incl. Protection of Intellectual Property 4

5 An Example of the Extended Working Capital Cycle IN THIS CASE WITH NO STOCK MODIFICATION Production of goods COB Vessel & Supplier Invoiced raised 21 Days Sailing Time Received in warehou se & loaded on a container Customer invoice raised 10 days transit time Receipte d into overseas franchise e warehou se Transport ed to stores Goods sold to end user CASH UP FRONT OR CREDIT TERMS? PLUS CREDIT TERMS? PLUS ONGOING COSTS THAT THE BUSINESS MUST PAY e.g. Employment Costs Ongoing Overheads and Fixed Assets Legal and Administration incl. Protection of Intellectual Property 5

6 Impacts on Working Capital Supply Side Open Account (buyer receives goods before paying) Letter of Credit payable at Term (buyer receives a period of credit before paying) Documentary Collection payable at term (buyer receives a period of credit before paying) Stock Side Readily, saleable good quality stock Sales Side Cash Up-Front (exporter receives cash before they ship the goods) better still if cash is received before the goods are produced!) Supply Side Cash Up-Front (buyer parts with the cash before they receive the goods) Stock Side Stock requiring customisation Slow moving stock Sales Side Open Account (exporter receives cash after they have incurred costs of production worse still for open account with credit terms More Neutral Staged (part payment) Sight Letter of Credit Documentary Collection at Sight 6

7 Payment Methods The Risk Ladder Seller (Exporter) Method of Payment Buyer (Importer) Least Secure Most Secure With Credit Insurance or Invoice Finance Open Account With Standby Letter of Credit Documentary Collection Letters of Credit Confirmed / Unconfirmed With Advanced Payment Guarantee Advanced Payment (Cash Up Front) Most Secure Least Secure Alternative middle ground Part Payment or Escrow Accounts 7

8 Open Account (Least Secure for an Exporter, Most Secure for an Importer) Production prior to payment Shipment prior to payment Open account is frequently used for exports to European Union countries; where cover through the likes of credit insurance and invoice finance may be possible Open account has minimal security to the seller, with maximum advantage to the buyer. The seller hands over control of the goods before payment is received Strong credit control is required always know your buyer and the credit status The shipper can stop the goods being sold in transit, by issuing Consigned Bills of Lading although be clear when this should and should not be used Open account can help the exporter win the contract by competing on credit terms; although this should only be applied when the risk of non-payment can be controlled The buyer may try to play off the exporter by claiming competitors are selling on open account terms 8

9 Working Capital Example Production Cycle* Goods Production (supply side, stock side) Financial Cycle Payment to Suppliers Cost of Stock Production Costs +Early Payment Received from Customer Goods ready for dispatch - Later Payment Received from Customer Goods dispatched In a lot of businesses cash outflows are more likely to arise before cash is received in Later payment may result in a need to access bank finance *Production times will vary depending on the nature of goods and services *Goods and services may require intellectual property protection PLUS ONGOING COSTS THAT THE BUSINESS MUST PAY 9

10 The Impact of Late Payment on the Working Capital Cycle Percentage of Respondents noting difficulties (in a time of recession) -selected countries only (Europa eu.) Greece 96% Portugal 81% Spain 80% Italy 70% Germany 43% Switzerland 38% Finland 37% The due date for payment is not always the date of receipt of payment, late payment can arise. In Europe during 2012 consumers took 38 days on average to pay, businesses 52 days average and Public Sector 62 days. EXTRACT FROM EXPERIAN: During 2012, UK firms paid their overdue invoices on average days after agreed terms Micro businesses with 1-5 employees paid on average days late in 2012, whilst large firms with over 100 employees paid on average days late. 10

11 Stock Side Sales Side Working Capital and What A Business Must Consider Identifying suitable suppliers Agree -contract terms -terms of trade Supply SideImporter -shipping terms -quality control process Is this a regular or one-off supplier Currency of payment? Banking instrument? VAT /Accounting Subject to Free Trade Agreement Stock Stock levels to be considered Storage facilities Distribution arrangements to be considered 'Just In Time' stock What's in and out of 'fashion'? Origin / Commodity Code Exporter Identifying suitable customers 'Make the sale' Agree -contract terms -terms of trade -shipping terms -quality control Will this provide repeat orders Currency of payment? Banking instruments? VAT/Accounting PLUS ONGOING BUSINESS DECISIONS RELATIVE TO; Employment Costs Ongoing Overheads and Fixed Assets Legal and Administration incl. Protection of Intellectual Property 11

12 Good Practice in Working Capital Sales Promptly collect monies due from debtors Strong credit control policy (know your customer) Cleared laid out invoice with full bank details Avoid comprising quality Stock Manage stock levels relative to sales Apply tight stock controls Order what is necessary (don t over order) To consider Whether to purchase outright or lease/rent assets such as ; Buildings Cars Machinery Computers Supply Negotiate improved credit terms with supplier (shop around; use tendering for large supplies) Purchase office essentials from national suppliers, if discounts available Business Management Everyone in the company is involved in managing working capital Manage bank account closely (online banking) Use budgeting and cash flow forecasting Use ratio analysis to identify and manage, both what is working and what is not working (e.g. debtor days, creditor days, product profitability, stock t/o) 12

13 How Banking and Trade Instruments Can Improve Working Capital Advanced Payment Guarantees Standby Letters of Credit Letters of Credit for Importers and Exporters UK Exporter receives payment or part payment EARLIER in the cycle UK Importer does not have to pay for the goods until LATER in the cycle UK importer can make payment LATER in the cycle UK exporter can receive payment EARLIER Term Bills of Exchange Transferable Letters of Credit Online Trade Solutions Credit Card Acquiring SEPA Direct Debit UK importer can gain a period of credit. Payment made LATER in the cycle UK exporter receives payment EARLIER in the cycle For the UK importer /exporter responsibility for paying the supplier is TRANSFERRED to the buyer EARLIER settlement of trade transactions. ICC Bank Payment Obligations UK Exporter offering payment option resulting in EARLIER settlement UK Exporter to Europe can increase certainty and timing of payment by direct debit Refer to syllabus for more detail on these items 13

14 Key Working Capital Ratios Debtor Days (Receivables Ratio) Formula: Debtors Turnover 365 =...days Meaning: The business can take on average... days to collect monies due. Compare this with the official credit policy of the business Creditor Days (Payables Ratio) Formula: Creditors Purchases 365 =... days Meaning: On average your business pays suppliers every... days. How does this compare with the credit periods being negotiated -if it is longer are supplier relationships and the company's credit rating being damaged by late payment? Stock Turnover Formula: Cost of goods sold Stock 365 =... days Meaning: On average the business turns over the value of its stock every... days. Compare this with what you would expect from the industry sector - is there a cost to the business of carrying extra stock 14

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