TRADE AND RECEIVABLES

FINANCEA PRACTICAL GUIDE TO RISK

EVALUATION AND STRUCTURING

STEPHEN A. JONES

Trade and Receivables Finance

Stephen A. Jones

Trade and Receivables Finance

A Practical Guide to Risk Evaluation and Structuring

ISBN 978-3-319-95734-0 ISBN 978-3-319-95735-7 (eBook)https://doi.org/10.1007/978-3-319-95735-7

Library of Congress Control Number: 2018953562

© The Editor(s) (if applicable) and The Author(s) 2018This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed.The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use.The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Cover credit: © Geo Images / Alamy Stock Vector Cover design by Oscar Spigolon

This Palgrave Macmillan imprint is published by the registered company Springer Nature Switzerland AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

Stephen A. JonesAXS Trade Finance Ltd.Solihull, West Midlands, UK

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About This Book

Trade and Receivables Finance provides hands-on practical guidance on how to evaluate trade-related propositions, mitigate risk, and structure finance.

Whilst books have been written on trade finance, none in my opinion deal adequately with the evaluation of risk, the structuring of trade products and financing facilities, and the integration of a receivables finance solution as the source of facility repayment.

Why the Book Has Been Written

During my 43 years in trade finance, I would have welcomed a ‘go-to’ manual which provided an easy reference for the appraisal and formulation of trade and receivables finance propositions.

When a trade-related proposition is properly evaluated so that the transac-tional risks are fully understood and mitigated to an acceptable level, and the source of repayment is identifiable and considered reliable, a well-structured trade and receivables finance facility reduces the risk of default when com-pared to conventional lending products.

When the transactional source of repayment is of better credit quality than the client themselves and the credit support or financing is provided on a fully or partially structured basis, trade and receivables finance can generate addi-tional credit appetite and thus enable the financier to lend more in a controlled manner. It is not limited to the credit status, debt capacity, and available secu-rity of the client but leveraged by the status of whom they are selling to.

Preface

vi Preface

Trade and Receivables Finance will provide the reader with the tools for gathering information, evaluating risk, advising on the use of trade products, and how to optimally structure the financing of the purchase, warehousing, and sale of goods on a controlled basis.

Whilst the opportunities for the financier arising from global trade are vast, a limiting factor for many is that knowledge is concentrated into a relatively small number of seasoned practitioners. The significant potential for trade- based revenue generation is not fully realised due to the relatively low levels of knowledge and understanding by a bank’s front-line personnel and credit risk managers.

The increasing trend for integrating the trade and invoice finance client- facing specialists gives rise to the need for a deeper mutual understanding and improved competency around the identification and structuring of trade and receivables financing solutions.

Who the Book Is For

This book is written as a reference manual for risk managers and financiers to aid their understanding of international trade, risk assessment, and formula-tion of funding solutions. The information and guidance will provide practi-cal help to relationship managers, trade sales and advisory specialists, middle office and operations personnel, invoice financiers, credit departments, alternative market providers, export development agencies, credit insurers, and lawyers.

Trade and Receivables Finance aims to become the definitive and constant companion for anyone involved in the provision of credit support and lend-ing to companies who trade internationally.

This book will also be of value to those who import or export and have responsibility for the financial or commercial areas of trade such as finance, credit risk management, sales, and purchasing. The business reader will ben-efit from an improved understanding of the key aspects of commercial and financial risk, methods of risk mitigation, the types of trade-related finance, and thus be better equipped to negotiate commercial trade terms and to seek the best form of financial support. These aspects are often critically important to enable a company to offer competitive trade terms to their customers and to fund the gap between making payment for goods, or incurring the costs of manufacture, and the eventual receipt of sales proceeds.

vii Preface

How the Book Is Organised

The content of this book is structured to take the reader on a journey from the commercial aspects of international trade to credit assessment and transac-tional risk analysis, the use operation and structuring of trade and receivable products, the formulation of financing solutions aligned to the client’s trade cycle, and the key aspects of formulating a compelling credit application.

Given the increasing practice of banks to bring the trade and invoice finance teams together under a common divisional reporting structure, and the importance to trade financiers of having an identifiable and reliable source of transactional repayment, this book delivers analysis and detailed advice on both trade and receivables finance to provide a complete trade-related risk evaluation and financing guide.

The contents are divided into easily digestible sections with the aim of enabling the reader to use this book as a practical ‘go-to’ reference manual.

Notes and Disclaimer

This book does not provide legal advice; this must be sought by the financier when considered appropriate. Applicable law should be consulted to identify governing rights and liabilities.

The author accepts no responsibility or liability for the example wordings appearing in the figures contained within this book. The examples shown are purely for illustration purposes only and do not represent legally approved wordings. Legal advice should be taken on the interpretation and construc-tion of documentation, commercial agreements, credit facility documenta-tion, terms and conditions, and their incorporated wordings. Examples shown in this book are the subject of copyright and must not be copied or used.

The figures and example documentation contained within this book are simulated and the named parties and transactions appearing therein are entirely fictitious. The figures and examples do not purport to represent any actual party or transaction, and any similarity to the names of actual persons, entities, transactions or activities, past, present, or future, is purely coincidental.

The ‘financier checklists’ appearing in this book are indicative only and not intended to be either exhaustive or prescriptive. Financiers must adopt proce-dures in accordance with their own internal policies and external regulatory requirements.

viii Preface

This book covers the due diligence required for credit risk appraisal and not the compliance risks of money laundering or sanctions violation. Anti-money laundering, countering the financing of terrorism, and trade and financial sanctions violation prevention are vitally important to the trade and receiv-ables financier. Given their importance these are best covered in a dedicated form as a companion to this book.

Solihull, West Midlands, UK Stephen A. Jones

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This book is dedicated to my wife, Kath, and my children, Orla and Joseph, who have been supportive, patient, and understanding throughout this project.

My most sincere thanks to Michael Kenny, Gavin McLaren, Chris Jones, Martin Hodges, and Adrian Holmes for their valued review of chapters, feed-back, and input  and to Ian Fletcher and Graham Laurence for  helping to make this project happen.

Acknowledgements

xi

Applicable LawThis book is intended for global readership and cannot therefore be specific on the application or provisions of a country’s law and how this will impact the transaction, security, or financing.

Where it is recommended that the reader examines and considers the appli-cation, interpretation, and impact of governing law, this book will comment ‘subject to applicable law’. However, this should not be taken as an exhaustive indication. Because of the potentially significant impact that different laws can have as the goods, documentation, and money flow from one country to another, specialist legal advice should be taken.

ClientFor the purposes of consistency, the term ‘client’ is used to describe the party who requires trade and receivables credit support or financing.

Credit SupportThe party referred to as the ‘client’ may require a bank to issue an undertaking to pay in the form of a trade product such as a letter of credit, bank aval, standby credit, or bank guarantee. This is referred to as a ‘credit facility’ or ‘credit support’.

GoodsReference is made throughout this book to the sale and purchase of ‘goods’ for the sake of consistency and simplicity. The goods referred to may be in the form of raw materials, components, or finished goods, or the provision of services. Whilst many of the techniques provided within this manual can also

Terms and Definitions

xii Terms and Definitions

be applied to services, these are more vulnerable to dispute given their intan-gibility. Key aspects are clarity of the description of service required and docu-mented proof of delivery and acceptance of the services delivered.

ICC RulesReference is made within this book to the International Chamber of Commerce (ICC) rules relating to Incoterms® and the various trade products such as collections, letters of credit, standby credits, and demand guarantees. These rules relate to standardised and widely adopted ‘customs and practice’ but are not themselves enshrined in law. Whilst many banks around the world subscribe to the ICC rules when handling trade products, if the applicable law is contrary to the ICC rule, then the governing law will take priority and shall apply.

The ICC rules are the copyright of the ICC. The full text of the ICC rules referred to within this book are available via the ICC bookstore at http://store.iccwbo.org/.

International TradeFor the purposes of this book, the application of trade and receivables finance is referred to in the context of international trade. The trade products and financing solutions described can also be used or adapted for transactions which originate and are concluded in the same country, known as ‘domestic’ trade. Receivables finance in the form of invoice finance and factoring is com-monly applied to domestic trade, whilst trade finance is mostly used for cross- border transactions.

PartiesTo provide consistency throughout this book the parties are described as follows:

Financier: bank or provider of finance or credit facilitiesClient: the party to whom trade and receivables finance or credit facilities is

providedBorrower: the party to whom lending and/or credit facilities is providedSeller: the exporter or client who is selling the goodsEnd-buyer: the party who is buying the goods from the clientBuyer: the importer or client who is buying the goodsSupplier: the party who is providing the goods to the client

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1 Introduction 11.1 Trade Risk 11.2 Methods of Payment 31.3 Advance Payment 41.4 Letter of Credit 51.5 Documentary Collection 51.6 Bank Aval 51.7 Open Account 51.8 Commercial Terms 61.9 Working Capital 71.10 Funding Gap 71.11 Working Capital Cycle 81.12 Working Capital Management 81.13 Conventional Lending 81.14 Finance of International Trade 91.15 The Purpose of Trade and Receivables Finance 111.16 Trade Finance 111.17 Receivables Finance 121.18 Structured Finance 131.19 Banks and Alternative Market Financiers 14

Contents

xiv Contents

Part I Trade 17

2 Trade Credit 19 2.1 Key Requirements of a Seller 20 2.2 Trade Credit 20 2.3 Credit Risk Exposure 21 2.4 Liquidity Risk 21 2.5 Period of Trade Credit 21 2.6 Days Sales Outstanding (DSO) 22 2.7 Key Requirements of a Buyer 23 2.8 Days Payables Outstanding (DPO) 24 2.9 Early Settlement 25

3 The Trade Cycle 27 3.1 Order Lead Time 27 3.2 Goods in Transit 28 3.3 Manufacture 28 3.4 Warehousing 29 3.5 Delivery 29 3.6 Trade Receivable 30 3.7 Amount 30 3.8 Documentation 31 3.9 Risk Profile 31 3.10 Trigger Points 32 3.11 The Funding Gap 32 3.12 Calculating the Required Amount of Finance 33

4 Commercial Terms 37 4.1 Commercial Terms of Trade 38 4.2 Incoterms® Rules 38 4.3 Documented Agreement 39 4.4 Purchase Order 39 4.5 Agreement to Supply 40 4.6 Conditionality of Sale 41 4.7 Consignment Stock 42 4.8 Call-Off 43 4.9 Price 43 4.10 Trade Credit 44 4.11 Method of Payment 45 4.12 Place of Payment 45

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4.13 Contract and Financial Guarantees 46 4.14 Goods 46 4.15 Inspection 47 4.16 Mode of Transport 47 4.17 Delivery Date and Place 48 4.18 Documentation 48 4.19 Cargo Insurance 49 4.20 Acceptance of Goods 49 4.21 Entire and Divisible Contracts 50 4.22 Set-Off or Counterclaim 51 4.23 Taxes 52 4.24 Ban on Assignment 52 4.25 Transfer of Title 53 4.26 Damages 55 4.27 Force Majeure 56 4.28 Cancellation or Variation 56 4.29 Governing Law 58 4.30 Jurisdiction 58 4.31 Other Aspects of the Contract 59

5 Transport and Control 61 5.1 Goods Description 61 5.2 Issuer 62 5.3 Clean Transport Document 62 5.4 Freight 63 5.5 Containerisation 63 5.6 Bill of Lading 64 5.7 Consignee and Endorsement 66 5.8 Negotiable or Transferable? 67 5.9 Straight Bill of Lading 68 5.10 Constructive Possession 68 5.11 Master Bill of Lading 69 5.12 ‘House’ Bill of Lading 69 5.13 Full Container Load (FCL) 70 5.14 Less Than Container Load (LCL) 70 5.15 ‘Port to Port’ Bill of Lading 70 5.16 Multimodal or Combined Shipment Bill of Lading 70 5.17 Received for Shipment Bill of Lading 71 5.18 Sea Waybill 71 5.19 Express Bill of Lading 71

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5.20 Charter Party Bill of Lading 72 5.21 Key Aspects for the Financier 72 5.22 Fraud 77 5.23 Air Waybill 77 5.24 Truck Consignment Note 81 5.25 Rail Consignment Note 82 5.26 Forwarder’s Cargo Receipt (FCR) 82 5.27 Delivery Order 83

Part II Credit Risk 85

6 Credit Risk 87 6.1 Default Risk 87 6.2 Reasons for Default 88 6.3 Early Warning Signs 88 6.4 Risk Philosophy 89 6.5 Risk and Reward 90 6.6 Trade and Receivables Finance Credit Assessment 91 6.7 Risk Identification 92 6.8 Identifiable Means of Repayment 92 6.9 Comparison with ‘Balance Sheet’ Lending 93 6.10 Use of Funds 93 6.11 Sales Forecast 94 6.12 Cash Flow Projections 94 6.13 Identification of Transactional Issues 95 6.14 Reduced Risk of Default 95 6.15 Reduced Loss Given Default 96 6.16 General Trade Product Facilities 96 6.17 Recording the Liability 97 6.18 Contingent Liability 97 6.19 Actual ‘Hard’ Liability 98

7 Evaluating the Client 99 7.1 Character 99 7.2 ‘Going Concern’ 100 7.3 Shareholder Support 100 7.4 Relevance of the Client’s Financial Statements 102

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7.5 Balance Sheet 103 7.6 Tangible Net Worth 105 7.7 Indicator of Future Performance 109 7.8 Liquidity 111 7.9 Debtor Listing 112 7.10 Creditor Listing 114 7.11 Stock 116 7.12 Profit and Loss Account 118 7.13 Other Lending Facilities 120 7.14 Debt Capacity 122

8 Trade Loans 125 8.1 Loan Period 126 8.2 Documentary Trade Loan 127 8.3 Clean Trade Loan 128 8.4 Structuring Trade Loans 129 8.5 Managing the Type of Risk Exposure 129 8.6 Repayment 131 8.7 Multiple Sales 131 8.8 Stock Call-Off 133 8.9 ‘Mind the Gap’: Determining the Trade Loan Structure 134 8.10 Partially Structured Lending 135

9 Security 137 9.1 Purpose of Security 137 9.2 Ownership 138 9.3 Possession 139 9.4 Ownership or Possession? 139 9.5 General Security 140 9.6 Security over the Goods 143 9.7 Personal Guarantees 145 9.8 Applicable Law 146 9.9 Security Held by Another Financier 150 9.10 Bank Guarantee Held by the Borrower 150 9.11 Pledge 151 9.12 Trust Receipt 153 9.13 Hypothecation 154 9.14 Lien 155 9.15 ECA Guarantee 155

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Part III Trade Products 157

10 Collections 15910.1 Liability for Payment 15910.2 When Used 16010.3 Process 16010.4 Documents Against Payment (DP) 16210.5 Documents Against Acceptance (DA) 16510.6 Dishonour 16710.7 Protest 16710.8 Documents in Trust Facility 16710.9 Advance Against Collections 16810.10 Outward Bill Discounting 17210.11 Refinancing Inward or Import Collections 17310.12 Inward Bill Discounting 17410.13 Retirement of the Bill 175

11 Bank Aval 17711.1 Liability for Payment 17811.2 Process 17811.3 Maturity 18011.4 Risk and Control 18011.5 Finance 18111.6 Debt Purchase 18111.7 Recourse 18111.8 Credit Facility 18211.9 Performance 18211.10 Warranties, Representations and Undertakings 18311.11 Discount Purchase 18311.12 Financing by the Remitting Bank 18511.13 Financing by the Avalising Bank 18511.14 Forfaiting 18511.15 Commitment to Purchase 18711.16 Due Diligence 18711.17 The Secondary Market 189

12 Letters of Credit 19112.1 Rules 19112.2 Bank Liability 19212.3 When Used 195

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12.4 Issuing the Letter of Credit 19712.5 Advising Bank 19712.6 Expiry Date 19912.7 Place of Expiry 19912.8 Availability 20012.9 Confirmation 20712.10 Silent Confirmation 21012.11 Document Presentation Period 21312.12 Calculating the Credit Facility Limit 21412.13 Issuing Bank: Risk Mitigation 21612.14 Transmission of the Letter of Credit 21812.15 Structuring Import Letters of Credit 21812.16 Structuring Export Letters of Credit 22212.17 Amendments 22412.18 Documentary Presentation 22512.19 Discrepant Presentation 22612.20 Bank-to-Bank Reimbursement 22712.21 Financing Export Letters of Credit 23012.22 Financing Import Letters of Credit 23612.23 Fraud 238

13 Special Types of Letters of Credit 24113.1 Oil Credits 24113.2 Transferable Credits 24513.3 Back-to-Back Letters of Credit 24913.4 Revolving Credits 26113.5 Reinstateable Credits 26313.6 Red Clause Credits 26413.7 Green Clause Credits 26613.8 Non-bank Issuer Credits 26713.9 Synthetic or Structured Letters of Credit 268

14 Standby Letters of Credit 27114.1 ICC Rules 27214.2 Types 27214.3 Commercial Standby Credit 27414.4 Claim Demand 27614.5 Amount 27614.6 Process 27714.7 Issuer’s Perspective: Risk Appreciation 279

xx Contents

14.8 Applicant’s Perspective: Risk Appreciation 28114.9 Beneficiary’s Perspective: Risk Appreciation 28214.10 Transferable Standby Credits 28314.11 Assignment 28314.12 Structuring Standby Credits: Protecting the Applicant

and Issuer 28414.13 Documentary Safeguards 28414.14 Structuring Standby Credits: Protecting the Beneficiary 28714.15 Comparison with Standard Letters of Credit 28814.16 Comparison with Demand Guarantees 28914.17 Financing Against Standby Credits 290

15 Demand Bank Guarantees 29515.1 Unconditional Guarantees 29515.2 Conditional Guarantees 29615.3 When Used 29615.4 URDG 29715.5 Independence 29715.6 Liability for Payment 29715.7 Credit Facility 29815.8 Issuing the Guarantee 29815.9 Counter Indemnity 29915.10 Guarantee Amount 29915.11 Direct Guarantees 29915.12 Types of Trade-Related Guarantees 30015.13 Guarantee Text 30515.14 Clause Structure 30515.15 Indirect Guarantees 31715.16 Counter Guarantee 31815.17 Notification of a Claim Demand 32315.18 Period for Examination 32415.19 Procedure for Rejection of a Claim 32415.20 Fraud: Exception to the Rule of Payment 32415.21 Foreign Law and Usage 32515.22 Extend or Pay 32515.23 Transferable Guarantees 32615.24 Assignment 32715.25 Cancellation 327

xxi Contents

Part IV The Goods 331

16 Nature of Goods 33316.1 Performance of the Goods 33316.2 Reputational Risk 33416.3 Fragility or Perishability of Goods 33416.4 Branded Goods 33516.5 Promotional Goods 33616.6 Licensed Goods 33616.7 Marketability of the Goods 33716.8 Price Volatility 33816.9 Certification, Licence, and Approvals 33916.10 Cargo Insurance 339

17 Payables Finance 34517.1 When Used 34517.2 Pre-shipment Phase 34617.3 Advance or Deposit Payment 34617.4 Goods in Transit 34717.5 Manufacture and Warehousing 34717.6 Source of Repayment 34817.7 Letters of Credit 34817.8 Status of the Supplier 34917.9 New Suppliers 35017.10 Supply Chain Sensitivity 35117.11 Encumbrance 35117.12 Performance Risk 35217.13 Lead Time of Supply 35317.14 Cargo Insurance 35317.15 Funding Structure 35317.16 Amount of Financing 35417.17 Payment to the Supplier 35517.18 Finance Drawdown 35517.19 Payment Against Copy Bill of Lading 35617.20 Use of Documentary Collections 35717.21 Use of Letters of Credit 35717.22 Delivery Date 35817.23 Trade Loan 358

xxii Contents

17.24 Funding Deposit Payments 35917.25 Funding the Manufacturer 36117.26 Approved Trade Payables Finance 363

18 Warehouse Finance 37118.1 Warehouse Receipts 37118.2 Holding Certificate 37418.3 Warehouse Warrant 37418.4 Security and Control 37518.5 Risk Assessment 37818.6 Collateral Manager 38218.7 Indemnification 38318.8 Insurance 38418.9 Financing Structure 38518.10 Fraud 38818.11 Borrowing Base 389

Part V The Receivable 393

19 Sales Invoice and Debt Instruments 39519.1 Sales Invoice 39519.2 Commercial Invoice 39619.3 Proforma Invoice 39619.4 Debt Assignment 39719.5 Invoice Debt Assignment Clause 39819.6 Bill of Exchange (Draft) 39919.7 Acceptance 40119.8 Negotiable Instrument 40219.9 Holder in Due Course 40219.10 Non-payment 40219.11 Protest 40319.12 Promissory Note 40419.13 Key Differences to a Bill of Exchange 406

20 Evaluating the End-Buyer 40720.1 End-Buyer Risk 40720.2 Risk Assessment 40820.3 Payment History 408

xxiii Contents

20.4 Credit Insurance 40920.5 Financial Statement Assessment 40920.6 Credit Reference Agencies 40920.7 Other Sources of Information 41020.8 Trade Credit Terms 41120.9 Importance of the End-Buyer’s Bank 41120.10 Bank or Institutional Risk 41320.11 Transfer Risk 41320.12 Political Risk 41420.13 Collectability of Debt 415

21 Credit Insurance 41721.1 Types of Policy 41721.2 Nature of the Debtor 41821.3 The Importance of the Proposal Form 41821.4 Insurance Policy 41921.5 Commercial Risk 41921.6 Political Risk 42021.7 Pre-delivery Risk 42121.8 Exclusions 42221.9 Retention of Title 42221.10 Declaration of Material Information 42321.11 Period of the Policy 42321.12 Insured Percentage 42421.13 Minimum Retention 42521.14 Excess 42521.15 Aggregate First Loss 42521.16 Insured Debtor Limit 42621.17 Payment Method 42721.18 Maximum Terms of Payment 42721.19 Maximum Extension Period 42721.20 Countries Covered 42821.21 Third-Country Risk 42821.22 Discretionary Limit 42821.23 Maximum Liability 42921.24 Claim Demand 43021.25 Calculation of Loss 43021.26 Subrogation 43121.27 Financier’s Perspective 43121.28 Using the Client’s Insurance Policy 431

xxiv Contents

21.29 Status of the Insurer 43221.30 Previous Claims History 43221.31 Premium Payment 43221.32 Joint Insured 43321.33 Loss Payee 43321.34 The Financier’s Own Policy 434

22 Performance Risk 43722.1 The Need to Perform 43722.2 Performance Risk Assessment 43822.3 Place or Point of Delivery 43822.4 Entirety of Contract 43922.5 Experience of the Client 43922.6 Preparation of Goods for Sale 44022.7 Track Record 44022.8 Commercial Leverage 44122.9 Frustration 44222.10 Documentary Performance Risk 44222.11 Goods Inspection 443

23 Receivables Finance 44723.1 When Used 44823.2 Debt Advance 44923.3 Debt Purchase 45023.4 Risk Assessment 45123.5 Fraud 45223.6 Dispute 45323.7 Dilution Risk 45523.8 Concentration 45623.9 Contra Trade 45723.10 Retention Reserve 45723.11 Prepayment 45823.12 Undisclosed Facilities 45923.13 Disclosed Facilities 46023.14 Credit Insurance 46023.15 Capture of the Trade Receivable Proceeds 46123.16 Rights of Recourse 46223.17 Receivable Value 464

xxv Contents

23.18 Debt Reserve Account 46523.19 Specific Debt Purchase 46523.20 De-recognition 46723.21 Structuring Receivables Finance 46823.22 Financier’s Perspective 470

24 Invoice Finance 47324.1 Factoring 47424.2 Confidential Invoice Finance 47624.3 Audit 47724.4 Security over the Book Debts 47824.5 Tripartite Agreement 47924.6 Trade Financier: Invoice Finance Repayment Risk 47924.7 Invoice Finance Repayment Solutions 48124.8 Ongoing Communication 485

Part VI The Proposition 487

25 The Credit Facility Application 48925.1 Key Principles 48925.2 The Credit Application 49025.3 Annual Review and Audit 49825.4 Transactional Control Matrix 49825.5 The Financing Agreement 50025.6 Trade Facility 50125.7 Receivables Facility 501

Appendix A: Trade Proposition Evaluation Checklist 507

Appendix B: Financial Ratio Analysis 517

Index 523

xxvii

Fig. 1.1 Payment risk ladder 4Fig. 3.1 The trade cycle timeline 28Fig. 3.2 The funding gap 33Fig. 5.1 Container ‘BIC’ code 63Fig. 5.2 Bill of lading 65Fig. 5.3 Bill of lading control of goods: financier’s checklist 76Fig. 5.4 Air waybill 78Fig. 5.5 Air waybill control of goods: financier’s checklist 80Fig. 7.1 The balance sheet 104Fig. 7.2 Positive tangible net worth 106Fig. 7.3 Negative net worth 108Fig. 7.4 Days sales outstanding ratio 113Fig. 7.5 Days payables outstanding ratio 115Fig. 7.6 Days inventory outstanding ratio 117Fig. 7.7 The profit and loss account 119Fig. 8.1 Trade cycle timeline 126Fig. 8.2 Repayment of trade loans from multiple sales 132Fig. 8.3 Trade loans: stock call-off 133Fig. 9.1 Trust receipt extract example 154Fig. 10.1 Collection schedule of instructions 161Fig. 10.2 Documents against payment process 163Fig. 10.3 Documents against acceptance process 165Fig. 10.4 Advance against collections: financier’s checklist 172Fig. 11.1 Avalised bill of exchange 178Fig. 11.2 Aval process 179Fig. 11.3 Rights of recourse: financier’s checklist 182Fig. 11.4 Bill discount: warranties, representations, and undertakings 183Fig. 11.5 Discount calculations 184

List of Figures

xxviii List of Figures

Fig. 11.6 Primary forfait 186Fig. 11.7 Forfaiting agreement: summary of terms 188Fig. 12.1 Letter of credit process 193Fig. 12.2 Letter of credit application form 198Fig. 12.3 Commitment to negotiate: terms and conditions summary 212Fig. 12.4 Document presentation timeline 214Fig. 12.5 LC facility limit calculation 216Fig. 12.6 Letter of credit example 219Fig. 12.7 Document examination: summary 226Fig. 12.8 Discount calculation 232Fig. 12.9 Letter of allocation 234Fig. 13.1 Letter of indemnity (LOI) example 243Fig. 13.2 Shipping guarantee example 244Fig. 13.3 Transferable letter of credit process 247Fig. 13.4 Transfer changes 248Fig. 13.5 Back-to-back letters of credit process 251Fig. 13.6 Master credit structure: financier’s checklist 259Fig. 13.7 Counter credit structure: financier’s checklist 260Fig. 13.8 Counter credit: process for discrepant presentation 261Fig. 13.9 Synthetic letter of credit example process 269Fig. 14.1 Standby credit example 275Fig. 14.2 Commercial standby credit process 278Fig. 14.3 Claim demand statement example 286Fig. 14.4 Standby credit support: financier’s checklist 292Fig. 15.1 Direct guarantee process 300Fig. 15.2 Advance payment guarantee example 302Fig. 15.3 Indirect guarantee process 318Fig. 15.4 Primary guarantee: information required checklist 319Fig. 15.5 Assessment; guarantee cancellation 329Fig. 17.1 Trade cycle timeline pre and post-shipment phase 346Fig. 17.2 Letter of credit pre-shipment finance: financier’s checklist 349Fig. 17.3 Goods in transit: financier’s checklist 359Fig. 17.4 Funding the manufacturer: financier’s checklist 363Fig. 17.5 Approved trade payables process 365Fig. 18.1 Warehouse receipt 373Fig. 18.2 Warehouse trade cycle 385Fig. 18.3 Warehouse financing: goods purchase 387Fig. 18.4 Warehouse financing: trade receivable 389Fig. 18.5 Warehouse financing: financier’s checklist 390Fig. 18.6 Borrowing base illustration 391Fig. 19.1 Commercial invoice 396Fig. 19.2 Accepted draft (trade acceptance) 401Fig. 19.3 Bill of exchange ‘draft’: financier’s checklist 405

xxix List of Figures

Fig. 19.4 Promissory note 405Fig. 21.1 Insurance schedule 419Fig. 21.2 Loss payee acknowledgement example 433Fig. 21.3 Credit insurance: financier’s checklist 435Fig. 23.1 Specific debt purchase (insured) process 466Fig. 23.2 Receivables finance ‘with recourse’ financier’s checklist 469Fig. 24.1 Factoring process 475Fig. 24.2 Prepayment calculation examples 482Fig. 24.3 Client instruction to invoice financier: payment to trade financier 483Fig. 25.1 Transactional control matrix (TCM) 499Fig. 25.2 Pre-commencement conditions: financier’s checklist 500Fig. 25.3 Post-commencement conditions: financier’s checklist 501Fig. 25.4 Trade finance facility extract 502Fig. 25.5 Invoice finance facility extract 503Fig. 25.6 Warranties: receivables finance 504Fig. 25.7 Undertakings: receivables finance 505

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Table B.1 Gross profit margin 518Table B.2 Net profit margin 518Table B.3 Debtor collection 518Table B.4 Creditor payment 519Table B.5 Current ratio 519Table B.6 Quick ratio 520Table B.7 Stock 520Table B.8 Debt/equity ratio 520Table B.9 Operating profit margin 521Table B.10 Overhead cost ratio 521Table B.11 Interest cover ratio 521Table B.12 EBITDA (earnings before interest, tax, depreciation, and

amortisation) leverage ratio 522Table B.13 Debt service coverage 522Table B.14 Sales breakeven 522

List of Tables

1© The Author(s) 2018S. A. Jones, Trade and Receivables Finance, https://doi.org/10.1007/978-3-319-95735-7_1

1Introduction

International trade has been a driver of growth and economic prosperity since the very beginning of commercial activity. Trade is defined as the sale of goods or services by a seller to a buyer in exchange for money, or other commercial consideration.

Cross-border trade can involve a wider and higher level of risk for the seller, buyer, and financier and increased financing requirements compared with domestic trade. It benefits however from potentially greater returns, diversifi-cation of business, and the opportunity to grow sales and revenue beyond the home market.

A key aspect of trade is the conflicting needs of the seller and the buyer. Each is concerned with different risks and payment requirements. The seller wishes to get paid straightaway, whilst the buyer wants to pay as late as possible.

It is these conflicting demands which give rise to the need for trade and receivables finance. Trade products issued or handled by banks referred to in Sect. 1.2 are used to mitigate risk for the seller and buyer. Trade and receiv-ables financing products and solutions are used to fund the gap between set-tlement of goods purchased and receipt of the related sales proceeds.

1.1 Trade Risk

A company that is considering the sale of goods to an overseas end-buyer, or a buyer wishing to purchase goods from an overseas supplier, is faced with the difficult task of assessing the risks of the international transaction.

2

The seller is concerned that they may not be paid for goods supplied, be paid late, or their sales invoice may not be settled in full. The buyer is exposed to the risk that they may not receive the goods at all, or receive them too late, or the specification, quantity, and quality of the goods received do not con-form to their purchase order. Without the benefit of an established trading track record, the seller is exposed to the risk of non-payment, and the buyer to the risk of not receiving the required goods.

It can be difficult to obtain information on an end-buyer or supplier which is based overseas. In the absence of a trading track record, or local knowledge, reliance is placed on publicly available financial statements, a report from a credit reference agency, press articles, and any internet-based information or market feedback.

Accounting standards, regulations, and market practice vary in overseas markets. This can render the type of financial information that is publicly available either virtually non-existent, unreliable, opaque, or significantly out of date. The local requirement for independent audit of statutory financial statements can also vary.

Financial information on the end-buyer may therefore be of a nature that cannot be relied upon to predict their ability to settle an invoice on the future due date for payment. Even when the credit risk assessment of the end-buyer is deemed acceptable, their country may have insufficient foreign exchange reserves in which to transfer the currency value of the invoice, even though the end-buyer has paid in local currency.

The government of the overseas end-buyer, or countries through which the goods will travel, or money may pass could introduce measures which prevent the importation of goods or the transfer of funds in settlement of the transaction.

Historic financial information and limited market feedback are unlikely to provide substantive independent validation of a supplier’s ability to perform and deliver goods of the required nature and quality on a timely basis.

A seller or buyer is therefore faced with a decision to make against an incomplete information base upon which to adequately evaluate risk.

This also exposes the trade or receivables financier who relies primarily on the receipt of sale proceeds from the transaction financed for their repayment. Any risk which impacts upon or impairs the successful conclusion of the financed trade transaction can result in non-payment, or a reduced settlement amount, thus placing in jeopardy the financier’s source of repayment.

The risk profile will vary from transaction to transaction. Factors that impact on the level of trade risk are the credit status of the end-buyer, the

S. A. Jones