Excerpt
Table of contents
List of figures
List of abbreviations
1 Introduction
2 Reasons for new company funding methods
2.1 Implications of the Basel accords
2.2 Importance of working capital managemen
3 Finetrading and factoring – methods of company funding
3.1 Finetrading
3.2 Factoring
3.3 Reverse factoring
4 Finetrading and factoring – pros, cons and consequences
4.1 Pros and cons of finetrading and factoring
4.2 Consequences for the working capital and the balance shee
5 Conclusion
Bibliography
Internet bibliography
List of figures
Figure 1: Cash conversion cycle
Figure 2: Exemplary procedure of finetrading
Figure 3: Market financing procedure of factoring
List of abbreviations
Abbildung in dieser Leseprobe nicht enthalten
1 Introduction
Ten years ago, from 2007 to 2011 the global financial and the euro crisis have caused a peak in bankruptcies of many companies and even states have experienced financial difficulties. Since 2011, the total number of companies’ bankruptcies declines. In 2016, there were 21,518 insolvencies of companies in Germany. In contrast to this, in 2010, at the peak of the crisis there were 32,687 insolvencies.1 Overall, most of the companies in Germany are small and medium-sized enterprises (SME). In 2014, they represented 99.3 percent of all companies in Germany.2
A proper working capital management is essential for all companies. Especially, SME are otherwise threatened to lack of liquidity or risk to become insolvent.3
Company funding has experienced profound changes lately. Basel I-III have extensively changed the regulatory circumstances for banks and their granting of credits. Banks have to comply with changed regulatory capital and liquidity requirements as well as with new debt caps. This has a strong influence on company funding. Therefore, the rating of a firm and the risk of an investment will increase the price of the company funding.4 The changed importance of working capital management and the new regulatory requirements have altered companies’ financing possibilities and partners. Moreover, the financial crisis has revealed their dependency on certain bankrollers.5
Thus, other methods of financing suchlike factoring, finetrading, leasing and crowdfunding increased their importance. This paper examines finetrading and factoring with regard to their differences, advantages, disadvantages and the methods’ influence on the balance sheet.
First, a brief introduction of the Basel requirements is outlined. Second, finetrading, factoring and reverse factoring are defined and distinguished. Third, the advantages and disadvantages are explained. Finally, the influences on the balance sheet of the involved parties and on working capital are investigated.
2 Reasons for new company funding methods
There are two main drivers for a change and uprising of novel company funding methods. On the one hand, the numerous financial crises have established a new scope of requirements for banks represented in the Basel I, II and III regulations. On the other hand, working capital management and its optimisation have tremendously gained importance.6 Thus, company financing is top-ranking but the traditional bankroller, the house bank, is no longer the sole partner for companies.
2.1 Implications of the Basel accords
In 1974, the Basel Committee on Banking Supervision was founded. It suggests requirements for the financial sector to unify supervisory rules. The suggestions have no legal force and represent a global, voluntary framework. Nevertheless, G20 and additional states transpose them into law.7
In general, the Basel accords are created to establish capital requirements for banks. Banks are granting credits but have to obtain their solvency. In short, the Basel accords require banks to have a certain equity ratio to minimise the risk of bankruptcy.
In 1988, the First Basel Accord was introduced. This guideline weights on- and off-balance sheet items to estimate their risk level, which is faced by the minimum capital level. It requires an eight percent equity ratio as a minimum capital level.8
In 2004, Basel II and in 2010 Basel III were introduced. Basel II is based on a framework of three pillars: minimum capital requirements, supervisory review and the market discipline. Essentially, the importance of the risk involved when granting credits was heavily emphasised. Basel III extends the three pillars of Basel II and demands banks to have a 4.5 percent stake of core capital to improve liquidity in need.9
Basel I-III requirements have changed the banking sector, but there are significant changes for SME financing possibilities, too. A company’s rating is the most important factor, when a bank decides to grant a credit. There are several qualitative, quantitative and branch specific key indicators, which influence the rating and therefore the credit’s terms.10 The cost of capital is highly dependent on the risk a company’s rating represents for the bank. Indicators suchlike, equity ratio, cash flow, revenue and forecast influence the lending. Moreover, this increases the price for bank loans, due to rating costs or a poor rating as well as it requires SME to have a high degree of transparency towards the bank.11 This and the dependency on the bankroller have changed the importance of company funding for SME.12
2.2 Importance of working capital management
The past financial crises were especially rough for SME, because they often suffered and relied on a single provider of debt capital. Therefore, upcoming investments and projects were delayed. Thus, most of the SME identified company funding and working capital management as strategic factors, which need attention on their own.13,14
Current assets and liabilities represent the working capital of a company. The difference between current assets and current liabilities is defined as net working capital. Current assets are e.g. cash, marketable securities, accounts receivables and inventory. Current liabilities are e.g. short-term loans, accounts payable or accrued income taxes.15
Procurement, commodities management and sales are influencing the working capital, depending on the business’ type and its current situation.16
The two main influencers of net working capital are accounts receivable and accounts payable. Accounts receivable are customers’ unpaid bills, which have not been paid for right away. Companies often grant a trade or consumer credit for their customers (either business or individual customers), which is free of charge or has cash discount for prompt payment. Accounts payable are outstanding payments to other companies for received goods or services.17
The main task of working capital management is to ensure liquidity. Therefore, the right amount of cash and cash equivalents must be available to be able to pay the accounts payable. Simultaneously, the conversion of accounts receivable into cash has to be taken into account to plan the company funding.18
Figure 1: Cash conversion cycle19
Abbildung in dieser Leseprobe nicht enthalten
Figure 1 shows the cash conversion cycle, which is split in four different periods. First, a company purchases raw materials, which are not paid instantly. The raw materials are manufactured into products. Therefore, the accounts payable period starts at the same time as the inventory period. As soon as the finished products are sold the inventory period ends and the accounts receivable period starts. In the meantime, the payment for the raw materials is made. The cash conversion cycle starts from this point on and ends, when the customers pay for their received products.20 To bypass the period between paying for the raw materials and receiving cash from the customer needs a planned company funding to ensure liquidity. Finetrading and factoring are methods to shorten the cash conversion cycle.
3 Finetrading and factoring – methods of company funding
In 2013, an E&Y survey revealed a changing behaviour of companies choosing their financial partners and methods. The survey compares the results to a former. The most important company funding method is internal financing by cash flow or retained income. Bank loans lost in importance and alternative methods suchlike leasing, factoring, outside investors or mezzanine capital have massively increased their importance.21 Moreover, the study has shown an increase in companies using a differentiated mix of funding methods and companies. Those companies are growing faster than firms relying on traditional financing methods.22 Finetrading, factoring and reverse factoring are such alternative company funding methods and are examined in the next subchapters. All methods are alternatives to a traditional trade credit and accelerate the cash conversion cycle as well as they improve e.g. the cash flow.23
3.1 Finetrading
Finetrading is a method, which can be used to finance sales or purchases.24 It is a commercial transaction and can be defined as a drop-shipping transaction. The Banking Act does not affect Finetraders, therefore they are not supervised by the Federal Financial Supervisory Authority.25 The main goals are extending the date of payment, decreasing the capital lockup and receiving cash discounts for prompt payments. A trade intermediary (the finetrading association) offers a drop-shipping transaction, where the finetrader pre-finances the purchases of goods of a customer (customer of the drop-shipping). The finetrader grants an extended and flexible period of payment for which he demands a deferral and keeps the cash discount for prompt payment. Besides the deferral, an additional charge is payable, which depends on the frame agreement and the limit.26 Figure 2 depicts the relation between supplier, buyer and finetrader.
The customer/debtor and the finetrader arrange a frame agreement, which enables the debtor to pre-finance several purchases from different suppliers up to an agreed limit. The suppliers are not included within the frame agreement. A credit check of the debtor is performed, which includes commercial credit insurance. The maximum insurability is the maximum finetrading limit.27
Figure 2: Exemplary procedure of finetrading28
Abbildung in dieser Leseprobe nicht enthalten
After the frame agreement between finetrader and debtor is closed, the debtor negotiates the purchase of goods with the supplier. Subsequently, the debtor orders the goods at the finetrader. The finetrader contracts a purchase agreement with the supplier on basis of the previous negotiations between supplier and buyer and additionally with the debtor. The finetrader orders the delivery of goods and the supplier delivers them directly to the customer/debtor. Therefore, the finetrader is creditor towards the supplier and del credere agent towards the debtor. When the debtor has inspected and confirmed the goods, the finetrader pays the supplier’s invoice within the cashback period. As long as the debtor has not fully paid the goods and charges to the finetrader, the finetrader is the owner of the goods. According to the agreement between debtor and finetrader, the debtor has several months to pay for the goods flexibly.29 The procedure shown in figure 2 represents a merchandise financing. Other forms are market financing and warehouse financing. Market financing is identical to merchandise financing procedure, but the supplier uses finetrading to acquire new customers or markets. Warehouse financing needs an additional consignment stock, which has certain goods available for the buyer.
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1 Statistisches Bundesamt, “Insolvenzen,“ https://www.destatis.de/DE/ZahlenFakten/Indikatoren/LangeReihen/Insolvenzen/lrins01.html;jsessionid=94B634D2EF272178D6D8092018C2007B.cae2, accessed August 2017.
2 Statistisches Bundesamt, “Anteile kleiner und mittlerer Unternehmen an ausgewählten Merkmalen 2014,“ https://www.destatis.de/DE/ZahlenFakten/GesamtwirtschaftUmwelt/UnternehmenHandwerk/KleineMittlereUnternehmenMittelstand/Tabellen/Insgesamt.html, accessed August 2017.
3 Eckstein, A., Liebetrau, A., and A. Funk-Münchmeyer, Insurance & Innovation 2017 – Ideen und Erfolgskonzepte von Experten aus der Praxis (Karlsruhe: Verlag Versicherungswirtschaft GmbH, 2017), p. 91.
4 EY, “Wege zum Wachstum – Finanzierungsverhalten im deutschen Mittelstand,“ September 2013, http://www.ey.com/Publication/vwLUAssets/EY_Agenda_Mittelstand_-_Wege_zum_Wachstum_2013/%24FILE/EY-Studie-Wege-zum-Wachstum.pdf, accessed August 2017, pp. 9-11.
5 Krings, Thomas, “Die Bedeutung der Lieferantenfinanzierung in der Unternehmenskrise,“ in Refinanzieren statt Sanieren? – Unternehmen und Statten in der Krise, edited by Werner F. Ebke, Christopher Seagon, Michael Blatz (Baden-Baden: Nomos Verlagsgesellschaft, 2014), p. 81.
6 Krings, Thomas, “Die Bedeutung der Lieferantenfinanzierung in der Unternehmenskrise,“ p. 81.
7 EY, “Wege zum Wachstum – Finanzierungsverhalten im deutschen Mittelstand,“ p. 9.
8 Balthazar, Laurent, The Integration of State-of-the-Art Risk Modeling in Banking Regulation (New York: Palgrave Macmillan, 2006), pp. 16-17.
9 Zirkler, Bernd, Jonathan Hofmann, and Sandra Schmolz, Basel III in der Unternehmenspraxis (Wiesbaden: Springer Gabler, 2015), pp. 1-4.
10 Hofmann, Jonathan, and Sandra Schmolz, Controlling und Basel III in der Unternehmenspraxis: Strategien zur Bewältigung erhöhter Bonitätsanforderungen (Wiesbaden: Springer Gabler, 2014), pp. 52-56.
11 Fischl, Bernd, Alternative Unternehmensfinanzierung für den deutschen Mittelstand, 2nd ed. (Wiesbaden: Gabler Verlag, 2011), pp. 10-11.
12 EY, “Wege zum Wachstum – Finanzierungsverhalten im deutschen Mittelstand,“ p. 15.
13 Ibid.
14 Krings, Thomas, “Die Bedeutung der Lieferantenfinanzierung in der Unternehmenskrise,“ p. 81.
15 Brealey, Richard A., Myers, Stewart C., and Alan J. Marcus, Fundamentals of Corporate Finan ce, 3rd ed. (McGraw-Hill Higher Education, 2001), p. 167.
16 Eckstein, A., Liebetrau, A., and A. Funk-Münchmeyer, Insurance & Innovation 2017 – Ideen und Erfolgskonzepte von Experten aus der Praxis, p. 91.
17 Brealey, Richard A., Myers, Stewart C., and Alan J. Marcus, Fundamentals of Corporate Finan ce, pp.167-168.
18 Eckstein, A., Liebetrau, A., and A. Funk-Münchmeyer, Insurance & Innovation 2017 – Ideen und Erfolgskonzepte von Experten aus der Praxis, p. 91.
19 Brealey, Richard A., Myers, Stewart C., and Alan J. Marcus, Fundamentals of Corporate Finan ce, p.169.
20 Ibid., pp. 168-169.
21 EY, “Wege zum Wachstum – Finanzierungsverhalten im deutschen Mittelstand,“ p. 18.
22 Ibid., pp. 22-23.
23 Pike, Richard, and Bill Neale, Corporate Finance and Investment: Decisions & Strategies, 5th ed. (Harlow: Financial Times Prentice Hall, 2006), pp. 385-387.
24 Wöltje, Jörg, Investition und Finanzierung, 2nd ed. (Freiburg: Haufe Gruppe, 2017), p. 476.
25 Koch, Sven, and Tim Schade, “Mit Finetrading den Factoring-Umsatz steigern,” FLF – Finanzierung Leasing Factoring 3 (2015), p. 138.
26 Koch, Sven, “Finetrading versus Reverse Factoring: Fremdfinanzierungsinstrumente zur Working Capital-Optimierung,” Corporate Finance 11 (2014), pp. 461-462.
27 Koch, Sven, “Finetrading versus Reverse Factoring: Fremdfinanzierungsinstrumente zur Working Capital-Optimierung,” pp. 461-462.
28 According to: Koch, Sven, “Finetrading versus Reverse Factoring: Fremdfinanzierungsinstrumente zur Working Capital-Optimierung,” p. 462.
29 Koch, Sven, “Finetrading versus Reverse Factoring: Fremdfinanzierungsinstrumente zur Working Capital-Optimierung,” p. 462.