Continuous Improvement -- Getting 'Payable Transactions' To Pay Off

Follow GAAP, work with suppliers.

Editor's Note: This is Part 2 of two parts. You can read the first installment here.

Setting up a trading financing program requires thoroughly working through several thorny accounting issues. In a speech given in December, 2004, Robert Comerford, professional accounting fellow from the Security and Exchange Commission's Office of the Chief Accountant expressed some concern about what he called "structured payable transactions."

Specifically, he indicated that if the date at which the financial firm is paid by the original buyer extends beyond the due date of the original transaction, or if the buyer pays the financial institution less than it would have paid the original vendor, the transaction should be classified as a short-term borrowing, rather than accounts payable. Few financial executives would want to do this, as it would increase the amount of short-term borrowing appearing on their company's balance sheet.

As a result, financial executives interested in trade financing programs will want to thoroughly understand the regulations. They'll also want to make sure that any programs they put in place adhere to the laws' letter and spirit.

Financial executives also will want to get their auditors involved from the start, says Pete Bonacci. He is a Louisville, Colorado-based area controller for global supply chain financial operations with StorageTek, a 2005 Best Plants winner that is now part of Sun Microsystems Inc., Santa Clara, Calif. [Editor's Note: This program was established and these interviews conducted before the Sun purchase was final this fall, so for the purposes of this article, the company will be called StorageTek.]

"You have to construct the deal appropriately to make sure you're following GAAP [generally accepted accounting procedures], and that you have business processes that work for your supply chain."

And, given the myriad regulatory, purchasing, logistics, operational and accounting issues inherent in trade financing, it's important to involve professionals from each of these areas when setting up a program, Bonacci says. If some transactions will cross borders, financial executives also will need to stay abreast of regulations in the other countries with which they do business.

When the programs are established and implemented correctly, all parties in the supply chain can benefit. "Suppliers get their cash flow, and I get manufacturing flexibility, plus hard savings that drop to the bottom line," Bonacci notes.

Some manufacturers need a financing firm that actually takes ownership of the goods. The trade financing program in place at StorageTek's Puerto Rico plant is one example. Many of the company's suppliers are smaller, and located in Asia, says Osvaldo Cruz, materials group manager in Puerto Rico.

These suppliers need to transfer ownership of their wares at their plants. If they retain ownership of the goods as they enter other countries, the suppliers would need to track tax reporting and payment requirements in those countries; most don't have the resources to do this.

On the other side of the table, StorageTek, like many buyers, wanted to keep its cash free until it actually needed the goods. That wouldn't occur until the products had made their way to the plant's supplier logistics center (SLC) in Puerto Rico and had been pulled for use. In total, the time between shipment and payment could span several months.

That made it difficult for some smaller suppliers to participate in the SLC, Bonacci says. "It just didn't make business sense for them."

Bonacci, working with Lightning Trade Group LLC, Livermore, Calif., structured what Ken Rosenberg, managing member of Lightning, calls "an inventory ownership program." Other parties in the program include several funding partners and a logistics firm.

Under this program, a funding partner takes ownership of the goods either at the supplier's dock, or once the goods arrive at the SLC. In doing so, they take on the risk of damage to the goods, as well the risk of any currency fluctuations. The funding partner then pays the supplier at terms the two parties negotiate. "They become like a distributor," Bonacci says.

Because the vendors are getting paid almost immediately, the plant often will ask them discount their prices to reflect the fact that their money does not need to be tied up for long periods of time.

The StorageTek plant pays the funding partner for the goods at the time it was originally scheduled to pay the vendor. It also pays a fee that covers the partner's cost of capital, administrative costs and need for a decent profit level.

A key component of the program is the partner's cost of capital. In order for the program to make sense, the trading partner's cost of capital needs to be lower than the buyer's. That way, they buyer can pay for the goods and cover the funding partner's charges, yet still come out ahead.

StorageTek's program launched in March 2005, after taking about a year to put in place. It didn't require many changes in business processes. Instead, the changes required were to ensure that the new program met all accounting and regulatory requirements.

The benefits already are becoming apparent. For example, since launching the program, the plant hasn't experienced any parts shortages. That's because many smaller suppliers located overseas now are able to have their goods stored at the SLC, rather than keeping them closer to home.

At first glance, today's trade payable financing programs sound similar to factoring, in which a firm sells its accounts receivable invoices at a discount. Some significant differences exist, however. First, factoring tends to be more expensive, as the factor takes on the tasks of obtaining payment from the buyer. In addition, in factoring transactions, the supplier typically receives only 70% to 80% of the invoice amounts when selling the invoices. It doesn't get the remainder, less the factor's fee, until the buyer makes its payment.

Karen M. Kroll is a writer specializing in financial issues.


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