Charles Darwin championed “survival of the fittest,” but for small and medium companies in today’s global financial environment, being among the “fittest” goes beyond simply having better products, services, and prices. Today, companies also need innovative solutions for overcoming the supply chain and financial hurdles that challenge companies engaged in global trade.

In an effort to continue to compete and grow their top lines, small and medium companies are increasingly entering new markets and new relationships with suppliers and buyers in other countries. While seeking these new global business opportunities is smart, it also poses risks and challenges. For instance, a business selling to a buyer internationally likely needs to offer and sustain longer payment terms, allowing customers to pay in 60 or 90 days instead of 10, 20, or 30. For many small and medium enterprises, this severely impairs cash flow and requires some type of financing, which can be difficult to obtain in this economic environment. Further, traditional methods of financing, such as using receivables as collateral, are counterproductive to implementing better terms of sale.

One innovative approach to overcome these challenges is to obtain financing that lends against the value of a company’s in-transit inventory. This type of financing, known as cargo financing, is designed to provide working capital earlier and more often in the supply chain. 

Unfortunately, not all cargo financing options are equal. Some lenders claim to finance in-transit inventory while it’s being shipped from its point of origin, but then require sufficient collateral domiciled in the United States to cover the value of the in-transit goods. And even when the landed inventory is in the United States, it is often considered speculative unless the financing is tied to receivables. Therefore, without the availability of adequate inventory financing to support inventory purchases, companies are left to use accounts receivable financing or very expensive and hard-to-get equity. Exhausting precious working capital in this manner shortens the terms they can offer in support of their customers’ purchases. 

The key to a true cargo finance solution is the ability of the lender to have a clear window into the location and status of the in-transit goods at all times, which significantly reduces the risk of lending against those goods. Many banks, unfortunately, lack this visibility, which leads them to either not offer cargo financing or to require U.S.-domiciled collateral. But by partnering with supply chain service providers, lenders can obtain the in-transit goods visibility necessary to provide true cargo financing. This can be a critical life raft that shores up a company’s international trade and sales and strengthens its balance sheet. By using in-transit inventories to allow for additional cash flow, cargo financing essentially provides the float while the goods are on the boat.

Depending upon the means of transportation-slow boat or fast plane-and the “from and to” destinations, cargo financing that uses in-transit inventory as collateral allows businesses to offer better terms of sale to grow revenue and remain competitive. 

This is best illustrated by using examples of a simple “Income Statement and Balance Sheet” for a hypothetical company. We’ll call it Our Company.

 

INCOME STATEMENT FOR OUR COMPANY



 

  Sales   $12,000,000  

  Cost of Goods Sold   $6,000,000  

  Gross Profit   $6,000,000  

  SG&A   $5,400,000  

  Net Income   $600,000 

 

BALANCE SHEET FOR OUR COMPANY

 

 

  Assets  

  Accounts Receivable   $2,000,000  

  Inventory   $1,000,000 ($500,000 in warehouse; $500,000 in transit)  

  Liabilities  

  Accounts Payable   $0  

  Debt   $1,600,000  

  Equity   $1,400,000  

  Return on Equity   43%  (Net Income/Equity = $600,000/$1,400,000) 

 

 

Our Company currently gives customers 60 days to pay invoices. This payment policy puts stress on Our Company’s cash flow, but its competitors are also offering 60-day terms, so Our Company has little choice but to follow suit. Further complicating the situation is that Our Company’s suppliers do not give terms and its lender will not lend on inventory (domestic or in-transit). 

Now, suppose Our Company could offer its buyers 90-day terms. Wouldn’t that be attractive to its competitors’ customers? But, how could Our Company do this with its current financial situation? And, wouldn’t it hinder Our Company’s ability to purchase inventory?  

Additional purchasing power hinges on raising liquidity through debt or equity, and most companies prefer debt, which is typically restricted by collateral available for financing. Previously, Our Company’s only access to debt financing was accounts receivable financing. With current accounts receivable of $2 million, the most a bank would lend Our Company is 80 percent, or $1.6 million. 

With a cargo finance solution that uses in-transit inventory as collateral, or acquiring a float for what’s on the boat, Our Company can offer better terms than its competitors. Consider that Our Company gains an additional $250,000 in liquidity, or a 50 percent advance on in-transit inventory. With additional cash flow, Our Company can begin to offer better terms, which makes Our Company more attractive to its competitors’ customers. With more customers, sales will increase, which translates into more profit. 

If Our Company uses the $250,000 in additional cash flow to extend terms to 90 days for new customers, then it is possible to increase sales by $1 million.  

Now, let’s consider the effect of this increased liquidity on Our Company’s “Income Statement and Balance Sheet.”

 

INCOME STATEMENT FOR OUR COMPANY



 

  Sales   $13,000,000  

  Cost of Goods Sold   $6,500,000  

  Gross Profit   $6,500,000  

  SG&A   $5,425,000

 (Cost of funds depends on financial condition.)  

  Net Income   $1,075,000 

 

BALANCE SHEET FOR OUR COMPANY

 

 

  Assets  

  Accounts Receivable   $2,250,000

 (Only new accounts receive 90 days, so $1 million in new sales for 90 days is $250,000.)  

  Inventory   $1,000,000 ($500,000 in warehouse; $500,000 in transit)  

  Liabilities  

  Accounts Payable   $0  

  Debt   $1,850,000  

  Equity   $1,400,000  

  Return on Equity   77%  (Net Income/Equity = $1,075,000/$1,400,000) 

 

For a company importing finished goods into the United States, this cargo finance solution can be an advantage that differentiates it from competitors, while working especially well for small and medium companies that want to grow sales. Few companies start out with a level playing field against competitors, and no one wants to compete on price alone. Having an innovative financial strategy can help increase return on equity no matter how rough the seas or how tough the competition. 

Gary Carleton is Managing Director of Global Supply Chain Finance for UPS Capital, the financial services arm of UPS. For more information about UPS Capital, please visit capital.ups.com or call 1-877-263-8772.