Financing imports - a case study - with tips on what a bank will focus on when considering facilities to support an importing business

 

Coastal Fabrics Limited was established in 1980 as a manufacturer of soft furnishings and has grown steadily over the years, and is now a significant designer and wholesaler of curtains, blinds, pillows and linen goods. The vast majority of the textiles are imported as finished goods from a spread of suppliers in six different territories with a variance of payment methods and terms. Buyers are predominantly UK based but Coastal are seeking to grow their modest export sales.

Having been customers of their current bank since the company was established, Coastal are seeking to put their banking out to tender, to ensure that they receive the most appropriate facilities and service to help grow the business in line with the company's strategic plans. 

A bank will need to understand a great many areas relating to this business before  a relationship director can begin to assemble a report which the bank's credit function will consider, before any decisions can be made. These areas would include detailed financial analysis with scrutiny of audited accounts, current and forecasted sales, profitability etc. However this article is purely focusing on the importing (and exporting activities) of the business. Most banks will require a trade and working capital specialist to prepare a separate report/recommendation which will be considered along with the relationship director's main report.

In our case study using Coastal Fabrics Limited, the main areas of focus for the trade and working capital director will be;

Description of the business

Coastal Fabrics Limited will need to provide a comprehensive history of the business, with current ownership and management structure and future strategy. Essentially the potential banker must feel that they have an understanding of the business, but the majority of this detail will be covered in the bank relationship director's main report.

Trade Cycle/s

 A Trade Cycle is the graphic cornerstone/building block in terms of the  bank's understanding of the customer's international business and working capital requirements. Every bank which provides facilities to a customer to help support its importing and exporting activities will need to understand the customer's trade cycle or in most cases, trade cycles. A cycle will generally start when a customer places an order with a supplier, in Coastal's case, an overseas supplier. This can be deemed Day 1 on the trade cycle, and then the average period for manufacturer to date of shipment of the goods must be established. The method of transport of the goods will help determine how long the transit time will take, and commonly Coastal imports from China, so an average transit time of 30 days is often quoted. Once the goods have been cleared from UK customs and then transported to Coastal's warehouse in Hertfordshire, the average stocking period must be calculated taking the cycle up to the average point of sale for the goods. Traditionally once the goods have been sold and an invoice has been raised, the final section of the trade cycle will be the credit period offered to Coastal's debtors which will need to cover their UK and export sales. It is  necessary to establish when Coastal pay their overseas suppliers and by what method of payment, which will then allow the bank to work out the funding gap in the trade cycle.

Coastal Fabrics has around 30 suppliers in six different territories, so there will be a number of trade cycles required to allow the bank to determine the differing funding gaps which will relate to different territories, payment and credit terms. In order for the bank to make an approximation of the size of potential facilities, Coastal will need to provide forecasts for the approximate amounts of purchases, broken down to country level for the forthcoming year, and this will enable the bank to make a calculation of the required fully funded facility levels based on the funding gaps in the trade cycles.

Stock

A bank will need to know where Coastal holds its stock, and whether these premises are owned or rented and that sufficient insurance is in place to cover the goods during this period. In some circumstances the warehouses/premises will be inspected by bank officials to satisfy themselves that the stock which a customer claims to be holding, actually does exist and is being stored in an appropriate manner. Probably one of the most important facts for a bank to ascertain is whether the stock has been partly or wholly pre-sold. In Coastal Fabric's case around 60% of the stock is purchased against confirmed orders, and this will clearly add weight to a financing proposal. Coastal's linen goods are not perishable of course, which is another positive factor, as a financing proposition for example imported fresh flowers will obviously bring its own risks from a perishable perspective. Another consideration is whether the importing of the goods contravenes a bank's global sustainability policies relating to perhaps forestry or the chemicals industry. The bank will need to determine whether there are any extended retention of title issues relating to the stock, but this is not a problem with Coastal Fabrics as there are no such issues.

Suppliers, payment methods & terms.

Coastal Fabrics will need to explain how many suppliers they have, and where they are located. The 30 suppliers are as follows; China (15), Bangladesh (1), India (5), Pakistan (3), Turkey (5) and Italy (1).

In order to have mapped out the previously mentioned trade cycles, Coastal Fabrics would have needed to explain the various payment methods and terms with the different suppliers. In China, Coastal generally need their bank to issue Letters of Credit in favour of their suppliers payable at 90 days after the Bill of Lading date. In India and Pakistan, Coastal enjoys open account terms, with payment being effect 60 days after the shipment date. It is likely that some averages will have to be taken into account to provide a rounded picture, rather than mapping out dozens of different trade cycles.

Coastal Fabric have very stringent quality checks in place with all their suppliers to ensure that the goods met exacting specifications. If the quality does start to falter, local agents are employed to quickly select alternative suppliers, ensuring that the overall supply chain is not adversely affected.

A funding bank will want to arrange its own due checks on an importer's overseas suppliers, to satisfy itself that they do exist and they appear to manufacture the type of goods which the importer is sourcing. These checks may not be exhaustive, but they are part of the bank's due diligence procedures. 

A bank will seek to understand under which Incoterms ® rule, Coastal has agreed with their suppliers. This will help a financier understand where the supplier has legally delivered the goods, and therefore where Coastal Fabric's responsibilities commence should the goods be damaged or lost.                          

Buyers

Coastal Fabrics will be required to provide details of their key buyers, who are a mix of wholesale distributors and large retailers such as Next, House of Fraser, John Lewis, Selfridges and Matalan. A financier will be keen to understand if there are any concentration issues with any buyer perhaps accounting for more than 20% of sales. The wider bank report will include research about the sector, seeking specialist advice about market conditions and industry traits. As with suppliers, the bank will want to understand when the proceeds of the sales are received on average, and they will scrutinise bad debts and aged debtor listings. Coastal Fabrics has a credit insurance policy which provides some comfort should a debtor become insolvent or fail to pay, provided that there is no dispute regarding the quality of the goods. A credit insurance policy will be seen as a positive sign by all banks, and in some cases the customer may assign the policy over to the bank to help support specific facilities. 90% of the sales are to UK buyers with the remaining 10% sold to buyers in Ireland and the USA  

Operational Risks and Mitigants

An assessment of the political and economic risks associated with trading in the territories is an important consideration for a financier to consider. In Coastal Fabric's case, the manufacturing entities in China have seen their European markets significantly shrink within the past few years as the downturn continues. Floods in Pakistan and Bangladesh have threatened the cotton crop, which has affected the availability of finished goods and the price demanded in the market.

Coastal Fabrics pay their Chinese suppliers in US Dollars and their European suppliers in Euros and the majority of their buyers pay in Sterling. A bank will want to understand what measures Coastal Fabrics will take to avoid adverse foreign exchange rate movements, and in most cases the bank will want to involve one of their treasury specialists. Coastal use a mix of forward contracts and vanilla currency options, and they use a number of different FX providers to keep all of them on their toes.                                

Summary

One of the most important considerations for a bank when they are deliberating about a lending proposition for an importer is that they really understand the business. The trade cycle/s form a key part of this as the bank will be able to, in effect "follow the cash" from order to receipt of proceeds from sales. Tangible evidence of the import transaction in the form of shipping documents can also add weight to the case, especially if the bank handles the documents if settlement is made by a Documentary Collection or a Letter of Credit. If loans are structured during the entire process, the bank will know when the cash should be available to repay the loans having mapped out the trade cycle. If the customer has difficulties in repaying the loans then the bank has an early indicator that there may be some issues within the business. In the Coastal Fabrics example they were able to find a new banking partner who was able to work with them to identify the funding solutions which  really suited their business. These included a mix of Import Letter of Credit facilities which are retired by Import Loans, and also an invoice financing facility. A series of facilities has been structured to provide Coastal with a fully financed cycle should they require this, and the new banking partner has worked closely with them from an operational and administrative level to ensure that the staff at Coastal who need to liaise with the bank's trade processing function are fully trained and familiar with any new procedures.

 

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Written on 27th June 2013 by Richard Casburn Associate at MJ Hayward & Associates- www.mjhayward.co.uk

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