In any business opportunity, it’s always important to weigh up the cost versus the reward and make sure that the balance is in your favour. This equation certainly extends to commercial finance.
If you require commercial finance in order to take advantage of a new opportunity, it’s definitely worth doing the maths to make sure the deal works for you. For example, the cost of finance might appear high in isolation, but if you can use those funds to generate a reward that’s even higher, then it’s probably worth doing the deal.
On the other hand, you might have access to cheap funds, but if you aren’t going to put them to work and generate a return on your investment, is there any point?
Deal or No Deal
Recently, I was discussing trade finance with a client. They needed it badly – their business was growing rapidly, a huge purchase order had come in from a key customer and they needed trade finance to pay their supplier for the goods as they didn’t have the necessary cash flow to make the payment without it.
The supplier, who was based in China, required payment in full before they would release the goods and allow the freight forwarder to load them onto the ship to be delivered to a port in the UK. This is quite a common scenario and one we get involved in regularly at Ping Finance.
There was a longstanding relationship between the supplier and the client, so the supplier was happy to manufacture the goods after a small deposit had been paid. Now the goods were finished and ready for shipping, the manufacturer understandably wanted the balance to be paid before he would wave goodbye to them.
A Game-changing Deal
The order was going to be a game changer for our client. It was 3 times bigger than the usual order that they were used to and not only would it be extremely profitable for them, it would demonstrate to their biggest customer – a blue chip supermarket – that they could handle their business. If they could deliver on this order and prove themselves, multiple orders of this nature would undoubtedly follow and their business would go from strength to strength.
Despite all of this, when we discussed the trade finance fees, they baulked. It’s completely understandable. On the face of it, it isn’t the cheapest form of finance. Trade finance or purchase order finance as it’s sometimes known is often shown as a fee per 30 days e.g. 2% of the total payment value per 30 days.
Understandably, when I said 2% per month, the cogs started turning in our client’s head and they worked out that the facility would cost them 24% per annum which is expensive money in anyone’s book. But trade finance is transactional and typically, it wouldn’t take 12 months to convert the purchase order into a sale. If that was the case at the outset, the trade finance provider probably wouldn’t have lent the money in the first place.
So to break it down, on a purchase order for £100,000 which takes 60 days to convert into a sale, the fee would be £4,000 (60 days = 4% x £100,000).
Therefore, the real cost of the finance was 4% of the gross profit margin in the transaction. Usually, the business achieved a 20% gross profit margin in their deals with this customer but on much smaller orders. If they sacrificed 4% of this margin it would allow them to take on a purchase order 3 times bigger and earn 3 times more profit.
Would you rather have 16% of £300,000 or 20% of £100,000? Surely, that’s a no-brainer.
Ping Finance specialises in trade and stock finance for importers and exporters. Get in touch today to see if we can help you grow your business.