By Justin Milo, Head of Trade & Working Capital for South Africa at Standard Bank CIB
In the context of challenging macroeconomic conditions and a competitive business environment, companies increasingly rely on their finance and treasury functions to support business growth, manage risk and reduce costs. As a result, the modern treasurer plays a vital and dynamic role in supporting these business requirements.
At its core, the treasury function is typically responsible for managing the day-to-day liquidity requirements of a company.
This practically involves the management of cash flows in and out of the company, understanding the company’s consolidated cash position, forecasting future cash flows, as well as the implementation of programs that make the best use of surplus cash for investment and sourcing short-term working capital funding for anticipated cash flow gaps.
With increased complexity and changes in corporate practice, treasurer responsibilities have stretched to include risk management (especially exchange rate risk), capital structure optimisation, long term financing and capital raising. They also encompass treasury operations management, the implementation of treasury policies and the rollout of treasury management systems to enhance the accuracy and efficiency of the treasury function.
While cash flow forecasting, payments and collections, exchange rate risk management and yield enhancement are “bread and butter” considerations in relation to treasury management, the expectation of modern treasurers extends to other considerations. These include the mitigation of payment risk, the optimisation of working capital and the creation of efficiencies through the automation and digitisation of treasury tools. This means that there is increasing relevance of trade finance in the Treasurer’s Toolkit to meet the new expanded objectives of modern treasuries.
Mitigating payment risk and performance risk
Payment and collections methods are typically dominated by domestic payments to suppliers and collections from customers through electronic funds transfers, debit orders, card acquiring and physical cash settlements. The use of these payment methods will vary based on business models – for example, a retailer may collect from customers via card or cash, while an insurer or mobile network operator may collect from debtors through debit orders.
But what about industrial companies, mines and companies in other sectors which operate on a cross-border basis? These companies have the option of cross-border payments for open account or cash-in-advance arrangements, but this doesn’t address the inherent risks faced by these companies when engaging in cross-border trade. This creates a need for financial instruments such as letters of credit which enable exporters to derisk the collection of their export proceeds and equally allow importers to structure a letter of credit to assist in mitigating performance risk.
A letter of credit (LC) is an irrevocable undertaking, issued by a bank, at the request of the applicant (importer/buyer), in favour of a beneficiary (exporter/supplier), whereby the bank agrees to make payment against bills of exchange, transportation and/or commercial documents that comply with the terms and conditions of the letter of credit. If the terms and conditions of the LC have been met, but the importer is unable to make payment, the issuing bank of the LC must honour the payment – providing payment risk mitigation to the exporter. Importers can leverage off the LC mechanism by carefully structuring the LC terms to ensure that payment is only triggered upon presentation of documents which provide evidence of performance by the exporter – providing performance risk mitigation for importers.
In cases where exporters are also concerned with country risk and/or the financial position of the issuing bank of the LC, they may opt to add confirmation to the LC. A LC confirmation is an additional undertaking by the confirming bank to make payment to the beneficiary, provided that the terms and conditions of the LC have been met – providing mitigation against bank and country risk.
Working capital optimisation
Even in cases where risk mitigation is not the main consideration, open account arrangements (domestic & cross-border) may be complemented by mechanisms such as supply chain finance and working capital solutions to provide support to assist buyers and suppliers with cash flow enhancement, working capital optimisation and supply chain continuity.
A company’s working capital should be adequate to keep the business running efficiently, while continuing to serve its customers and maintaining strong relationships with suppliers. To manage and assess the appropriate level and efficiency of working capital, the treasurer needs to understand the drivers of working capital – accounts receivable, inventories, accounts payable and cash, and how working capital is measured.
Measures such as the Cash Conversion Cycle, Net Working Capital, net working capital intensity (NWC as % of sales) and Liquidity Ratios are all examples of measures which may be used to benchmark working capital performance against past performance, peers and competitors.
Treasurers will look to optimise the three key levers of working capital – for example, by speeding up the collection of accounts receivable, reducing the amount of working capital tied up in inventories and stretching out supplier repayment terms.
There are working capital and supply chain finance solutions to assist treasurers in these endeavours. For example:
- A seller of goods on credit terms may wish to discount their receivables to optimise their cash position and improve their debtor collection period.
- A buyer of goods may wish to fund their procurement and boost their cash flows through an invoice financing facility or alternatively, extend creditor payment terms through a supplier financing structure.
- A customer in need of funding for procurement or operational expenditure while awaiting debtor proceeds may draw down on an overdraft or short-term loan to fund this working capital gap.
- A customer with eligible receivables and inventories may opt to provide the bank with security over these current assets to support working capital drawdowns linked to the natural cycle of these current assets – this is routinely executed through borrowing base facilities.
- Letters of credit may also be a source of liquidity and working capital in cases where the exporter opts to discount the drawings under a confirmed letter of credit to accelerate the proceeds due under the LC, provided that the terms and conditions of the LC have been met.
Trade finance digitisation
Trade finance solutions also align with the automation and digitisation goals of treasuries through the implementation of trade finance customer platforms, alongside conventional treasury system implementations such as host to host solutions, payment platforms and treasury management systems, such as Standard Bank’s Treasury Online platform.
Working capital solutions such as overdrafts are conventionally available via electronic payment platforms, while supply chain finance solutions are typically availed to customers through Fintech platforms or bank proprietary platforms. Documentary trade solutions such as letters of credit, guarantees and documentary collections are often executed via Trade channels. Trade Online conveniently enables customers to digitally request for the issuance of an instrument, self-generate draft instruments, review credit line availability, facilitate payments and keep an eye on the transaction status throughout the transaction lifecycle.
These digital solutions aim to boost customer experience through improved turnaround times, enhanced visibility of transactional data, reduction of risk by removing manual processes and an intuitive user interface which simplifies the transaction process.
Payments and collections, cash flow forecasting, yield enhancement and exchange rate risk management are often regarded as the backbone of corporate treasury management.
However, trade finance solutions provide treasurers with an opportunity to enhance treasury performance through financial instruments to mitigate payment and performance risk, financing solutions to assist with working capital optimisation and a host of digital trade solutions to drive the efficiency of the treasury alongside other treasury tools.
