FSD KenyaFinancial Sector DeepeningSupply chain finance support facilityProject briefing note
Unlocking working capital – Lessons learned aboutstimulating supply chain trade financeBox 1: Example of duration that sup...
When FSD’s Supply Chain Trade Finance Facility was started, the few banks inKenyathatofferedanyinvoicediscountingonlyhadsm...
Capturing repeat invoicesParticipantsintheSCTFFacilityexperiencedchallengesingettingclientstosubmitrepeat invoices. There ...
IDF demand-side issues – low awarenessamongst buyers and even suppliersSuppliers’weak demand due to lack of awarenessDeman...
legal form Advantages Disadvantagesgeneralcommercial bankoften good liquidity positionƒƒcorporate client base that could p...
Kenya’s SCTF Facility first concentrated on the micro-level of the enablingenvironment (i.e. the supply side of IDF). Howe...
ABOUT FSD KENYAEstablished in early 2005, FSD Kenya aims to support the development of inclusive financial markets in Keny...
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Supply Chain Finance Support Facility Project Briefing Note

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Purpose of this briefing note
Inclusive Growth is one of FSD Kenya’s four theme areas. The objective of the Inclusive Growth programme is to enhance financial inclusion of SMEs in Kenya.
One of its first projects was the Supply Chain Trade Finance (SCTF) Facility, which started in 2009 and will soon be merged into the new GrowthCap Programme.
This briefing note is based on experiences gained in the Supply Chain Trade Finance project. Its aim is to communicate how to successfully introduce Supply Chain Finance.

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Supply Chain Finance Support Facility Project Briefing Note

  1. 1. FSD KenyaFinancial Sector DeepeningSupply chain finance support facilityProject briefing note
  2. 2. Unlocking working capital – Lessons learned aboutstimulating supply chain trade financeBox 1: Example of duration that supplier working capital is locked inIn this case, to supply 100 boxes of wine, thesupplier must pre-finance 50% of its costs for30 days, estimated at 35% of total sale value1.During that period, this working capital is lockedin and cannot be used for anything else. Whenthe wine is delivered, the supplier must paythe remaining 50% for the wine (i.e., financeanother 35% of sales value on the wine costs) aswell as an estimated 50% of its own personnel,administration and transport costs, representingabout 5% of sale value). The hotel only pays itsinvoice after 60 days.This process locks in 75% ofthe sale value for 60 days. For the supplier, this istheequivalentofatotalof 92%2 ofthesalevaluelocked in for two months.Importer places order with producerNeed to pay 50% in advanceProducer sends the order via sea freight.Producer pays for shipping upfront.Producer pays for harbour-delivery, duty etcImporter delivers the order.Supplier pays other 50% up frontSupplier delivers the order.Pays local transport up frontReceives invoice w/60-day termSupplier places order with ImporterNeed to pay 50% in advanceBuyer orders 100 boxesof wine from supplier3: day 24: day 4 5: day 30 6: day 302: day 1 17: day 90 Buyer pays invoice to supplierProducer in Chile Importer - Kenya based Supplier - Kenya based Buyer - Large hotelLarge hotel orders 100 boxes of wine1 Assuming the supplier spends 70% of the total sale costs to purchase the wine.2 35% is locked in for 30 days, which is equivalent to 17.5% locked in for 60 days.3 http://en.wikipedia.org/wiki/Invoice_discounting (October 14th, 2012)Purpose of this briefing noteInclusive Growth is one of FSD Kenya’s four theme areas. The objective of theInclusive Growth programme is to enhance financial inclusion of SMEs in Kenya.One of its first projects was the Supply ChainTrade Finance (SCTF) Facility, whichstarted in 2009 and will soon be merged into the new GrowthCap Programme.ThisbriefingnoteisbasedonexperiencesgainedintheSupplyChainTradeFinanceproject. Its aim is to communicate how to successfully introduce Supply ChainFinance.Access to working capital through invoicediscounting“Insufficient working capital”is the number one complaint of Kenyan SMEs, andis particularly common among traders and suppliers. While their typically largecorporate clients expect 60-day payment terms, these small companies cannotsecurepaymenttermsfortheirinputs,suchasgoodsorlabour,andlacktheassetsto access collateral-based credit. Their inputs may require immediate paymentor even pre-payment. In practice, the working capital of traders and suppliers is“locked in”for much of the time.Mostofsuppliers’workingcapitalislyingidleindeliveriespendingpayment.Theyare only left with the certified invoices....These invoices are exactly where the opportunity lies: as they are for goodsdeliveredtoandcertifiedbylargecorporatebuyers,theirpaymentisguaranteedbyentities(thecorporatebuyers)morecreditworthythanthesupplier.Theseinvoicescan serve as collateral for credit. This type of credit is called‘invoice discountingfinance’(IDF).“Invoice discounting allows a business to draw money againstits sales invoices before the customer has actually paid. To dothis, the business borrows a percentage of the value of its salesledger from a finance company, effectively using the unpaidsalesinvoicesascollateralfortheborrowing.”31 • SUPPLY CHAIN FINANCE SUPPORT FACILITY: PROJECT BRIEFING NOTE
  3. 3. When FSD’s Supply Chain Trade Finance Facility was started, the few banks inKenyathatofferedanyinvoicediscountingonlyhadsmallIDFoperations.However,several banks showed interest in starting invoice discounting finance and this iswhat the SCTFF focused on.How invoice discounting finance worksThe invoice discounting finance process is summarized in the following diagram: the supplier applies for the credit, but the risk depends on the buyer.ƒƒThese differences imply that successful IDF requires:ƒƒ very fast turnaround to the client, and quick decisions for each invoiceƒƒ capture of the‘repeat’invoices issued to the same buyer over timeƒƒ riskassessmentandduediligenceperformedontheclient’sbusinesspartnerƒƒ(the buyer), and not on the bank’s client (the supplier).Fast turnaroundThe lesson in Kenya so far is that banks require a turnaround in thinking anddoing in order to become successful in IDF. Crucial to this is fast decision-makingprocesses. Rather than each invoice going through the full risk-assessment andapproval process which takes at best several days, banks need to approve‘lines’,rathersimilartooverdraftfacilities.Forexample,eachsupplier-buyercombinationcould be assessed for a maximum IDF line lasting six months. Once created,supplierscouldusesuchlinestosubmitinvoicesfordiscountinguptotheapprovedmaximum. These invoices could be approved directly by the responsible IDF in amatter of hours without being approved by the risk-management section.The line’s validity could be extended through a shortened approval process thatconsiders its past performance.Bank (or supplier) requests buyer1. cooperationBuyer agrees to cooperate and pay into2. supplier’s account at bankBank assesses and approves buyer3. Supplier delivers goods4. Buyer signs receipt of goods note5. (recognising invoice)Supplier submits signed invoice for IDF6. at bankBank approves individual IDF7. Bank pays supplier 70% of invoice value8. Buyer pays into supplier’s bank account9. Bank transfers advance + fee + interest10. from supplier’s account to own accountProcess finished11. Invoice discounting finance is substantially different from othercredit productsAfter FSD Kenya’s three years’experience, it is clear that invoice discounting is verydifferentfromthecreditproductswithwhichbanksarefamiliar,requiringadistinctapproach and different skills. In invoice discounting: credit cycles are short, about 60 days longƒƒ amounts per invoice can be small, but there are often numerous ‘repeat’ƒƒinvoices12731068549SUPPLIERSUPPLY CHAIN FINANCE SUPPORT FACILITY: PROJECT BRIEFING NOTE • 2A typical grocery shelf in a supermarket.“Insufficient working capital”is the number one complaint of Kenyan SMEs, and is particularly common among traders andsuppliers.Wakulima SACCO’s Banking hall. Several banks showed interest in startinginvoice discounting finance and this is what the SCTFF focused on.
  4. 4. Capturing repeat invoicesParticipantsintheSCTFFacilityexperiencedchallengesingettingclientstosubmitrepeat invoices. There was a high drop-out rate after clients had submitted theirfirst invoice..Banks had required that the first invoice to be discounted go throughthe lengthy full approval process, discouraging clients that did not want to gothrough the same process again. The solution lies in making a clear distinctionbetweentheapprovalofalineandaccesstoit.NewIDFclientswillexplicitlyapplyforalineofacertainamountforacertainbuyer.Theproposedlinewillgothroughthe full approval process with an invoice that is more of an example than the realIDF application. Once the line is approved, client invoices will require just hours forapproval within the IDF section.Fast turnaround goes hand-in-hand with the capture of repeat invoices.Focus on buyer rather than supplierThe hat-trick of IDF is completed by successfully focusing on the buyer.Most participant banks in FSD Kenya’s SCTF Facility required time to get used toassessing one party (the buyer) for creditworthiness while serving another party(the supplier) as their client. Once this was embraced, things started moving.At first, all banks took the suppliers as their departure point and served theseaccording to their needs.This typically resulted in IDF assessing several buyers foreach supplier, requiring a lot of effort for small volumes.Over time it was realized that the departure point should be the buyers, and thatbuyers ideally introduce suppliers, rather than the other way round. In fact, theideal process for successful IDF is as follows:IDF without buyer-focus results in serving one supplier and allhis/her buyersBank makes explicit that full approval processdone once for a periodINVOICE INVOICE INVOICEBuyer BuyerSupplierBuyerINVOICErejectedLineapplicationClient informedof rejectionapprovedLine of buyer-suppliercombination goes throughfull approval processINVOICEINVOICEINVOICEINVOICEINVOICEclient submitsinvoiceAchieve buyer“buy-in”Assess maximumIDF line for buyersomedecide“no”Explain process andbenefits to buyersDue diligence ofbuyerExplain process andbenefits to suppliersSuppliers submitinvoice fordiscountingAchieveunderstanding andgood volumesProvide instantservice to ensurerepeat invoiceBuyer decidesRisk dept decidesSuppliersdecidesSTOPSTOPSTOPSTOPSTOPnononoyesyes3 • SUPPLY CHAIN FINANCE SUPPORT FACILITY: PROJECT BRIEFING NOTE
  5. 5. IDF demand-side issues – low awarenessamongst buyers and even suppliersSuppliers’weak demand due to lack of awarenessDemand for IDF required a lot more attention and effort than expected. Whileoverall,suppliersmentionshortagesofworkingcapitalandcashflowastheirmainproblem, they do not necessarily know about IDF as an appropriate solution.Theyrarely request IDF, only becoming clear about the opportunities through in-depthdiscussions with the bank.Buyers’unwillingness to cooperateBuyers do not automatically see the benefits of IDF for their business. Their firstreaction is often mistrust. Many view it as charity to their suppliers and added riskand uncertainty for themselves.Buyers require well-considered, dedicated awareness raising that demonstratesbenefits to their bottom line.Buyers hesitant due to fraudFear of fraud is another factor preventing buyers from cooperating in IDF. Buyersworry that when their certified invoices are passed on to third parties, multiple(and therefore fraudulent) invoices may be presented and accidentally honoured,leavingbuyersresponsibletopayfortheoriginals.Thisisalegitimatefear,andIDFproviders must carefully ensure that such practices are impossible.IDFproviderscanaddressthisthroughcarefullydevelopedprocedures.Thesimplestmethodisforbuyerstosignandcertify(withaseal)aspecificform,togetherwiththe original invoice, in which the buyer approves the transfer of the invoice to aspecificIDFprovider.Theinvoicecanonlybegrantedwhentheoriginalispresentedtogether with the attached paper authorizing the transfer. The IDF provider willalso send an email to both the original issuer of the invoice (the supplier) and thebuyer confirming the submitter and submission date of the original invoice. Suchprocedures should deal with most buyer concerns of fraud.The IDF provider should carefully draw up terms and conditions to safeguardagainst any risks on the buyers’side.A buyer’s business is only as good as the products they are supplied.Suppliers’ cash-flow issues put pressure on quality. A buyer withsufficient working capital can: order goods on timeƒƒ deliver on timeƒƒ hold some reservesƒƒ deliver varying quantities on short noticeƒƒ select providers according to quality rather than paymentƒƒscheduleA needy supplier negatively impacts a buyer’s business. One precariouslink results in an ailing supply chain.Box 2. How IDF contributes to buyer profitsSUPPLY CHAIN FINANCE SUPPORT FACILITY: PROJECT BRIEFING NOTE • 4Buyers do not automatically see the benefits of IDF for their business.Their first reaction is often mistrust. Many view it as charity to their suppliers and added risk anduncertainty for themselves.
  6. 6. legal form Advantages Disadvantagesgeneralcommercial bankoften good liquidity positionƒƒcorporate client base that could provide entrance toƒƒcorporate buyersseen as most trustworthy by corporate buyersƒƒaccess to low-cost funds (deposits)ƒƒoften strongly risk-averseƒƒoften bureaucraticƒƒdifficult to introduce new products with distinct requirementsƒƒpossible need for high capital adequacy rateƒƒspecializedSME bank good understanding of needs of final client, the supplierƒƒ often more flexible processes, quicker to adopt new productsƒƒ somewhat less risk-averse than general banksƒƒ regulated, hence trustworthyƒƒ reasonable access to low-cost funds (deposits)ƒƒno access to corporate buyers within own portfolioƒƒpossible need for high capital adequacy rateƒƒnon-bank SMEfinancial housegood understanding of needs of final client, the supplierƒƒmost flexible processes, quicker to adopt new productsƒƒhigh risk appetiteƒƒno access to corporate buyers within own portfolioƒƒusually unsupervised, so less trustworthyƒƒhigher fund costs than deposit-taking banks/more difficultyƒƒaccessing fundsspecialized IDF/factoring housegood understanding of needs of final client, the supplierƒƒfully specialized in specific product, with dedicated sales forceƒƒmost flexible processes, and ability to introduce new relatedƒƒcash flow productshigh risk appetiteƒƒno access to corporate buyers within own portfolioƒƒusually unsupervised, so less trustworthyƒƒhigher fund costs than deposit-taking banks/more difficultyƒƒaccessing fundsmore vulnerable to seasonal fluctuations of IDF demandƒƒdeposit-takingmicrofinanceinstitutionsgood understanding of needs of final client, the smaller supplierƒƒproficiency in quick, efficient processes for highƒƒvolume/low marginhigh risk appetiteƒƒregulated, so trustworthyƒƒaccess to funds: deposits and international investorsƒƒno access to corporate buyers within own portfolio and probablyƒƒhigh threshold for MFIsclients are generally micro enterprises, if pursuedƒƒpossible need for high capital adequacy rateƒƒOrganisational set-up – the mostappropriate legal formsIn Kenya, invoice discounting is primarily provided by banks. There are also twodedicated non-bank institutions, one fully concentrating on invoice discountingfinance and another with a significant portion of its SME finance portfolio ininvoice discounting.A sectoral development approach isrequired for IDF to thriveIDF proves to be another financial product that requires balanced development ofthe different levels of service provision. A healthy sector could be presented withthe following graph:The advantages and disadvantages of the different legal forms can be summarized as follows:5 • SUPPLY CHAIN FINANCE SUPPORT FACILITY: PROJECT BRIEFING NOTE
  7. 7. Kenya’s SCTF Facility first concentrated on the micro-level of the enablingenvironment (i.e. the supply side of IDF). However, it soon became clear thatmeso-level and macro-level equally require attention.At the macro-level, lack of regulation is a current obstacle to IDF. As invoicesare not recognized as legal title papers, they cannot be sold. As a result, buyersare under no obligation to pay an invoice presented by an entity other than theoriginal issuer.This means that IDF can only function when the buyer cooperates.In countries with regulations, buyers are legally bound to pay whoever presentsthe original invoice. If such regulation existed, IDF would likely grow faster.ProvisionofIDFmightalsobeenhancedbyseparatereportingofIDFfinance(and/or factoring), as this would help those active in the sector to monitor its growthand development.At the meso-level, the sector would benefit from a number of interventions. If allthoseactiveinprovidingIDForfactoringorganizedthemselvesintoanassociationto represent their interests and work on self-regulation, IDF could gain betterstanding and become better known. Such an association would provide a jointvoice to influence government regulations. Credit bureaus should receive separatereporting on IDF, including data on both the buyer and supplier per invoice. Creditbureaus should also receive reports from unlicensed entities which may representa substantial portion of IDF/factoring. Awareness-raising among both buyers andsuppliers may prove another valuable intervention.At the micro-level it is important to look at the full spectrum of IDF/factoringproviders.These explicitly include dedicated IDF houses, which may be the typicalfirstmoversincountrieswithanunderdevelopedIDFsector.Commercialbanksareunlikely to step into IDF before it is a proven business opportunity. Microfinanceinstitutions(MFI)mayalsobeimportantforaflourishingsupplyofIDF.Sincetheseinstitutions commonly deal efficiently with low-margin, high-volume processes,they are well placed to provide IDF. However, they may have more challengesbuilding relationships with buyers. They can be expected to specialize in bothsmaller suppliers and smaller buyers.A healthy IDF - enabling environment has mature and functioning micro-, meso- and macro-level componentsmacromessomicroGeneral commercial banksSME banksNon-licensed FIs (SME finance or factoring)Mircofinance Institutions (Licensed and non-licensed)Association of IDF/factoring providers for self-regulation,coordination and lobbyingTraining centres/Certification trainingTA/ConsultantsCredit Bureau (incl. reporting on IDF/factoring)Knowledge of best practisesBuyer awareness of importance/opportunitiesFinancial awareness of SME/suppliersRegulation of factoring or at least invoicesSupervision (incl. seperate reporting of IDF)Licensing (or certification of unregulated finance houses)SUPPLY CHAIN FINANCE SUPPORT FACILITY: PROJECT BRIEFING NOTE • 6
  8. 8. ABOUT FSD KENYAEstablished in early 2005, FSD Kenya aims to support the development of inclusive financial markets in Kenya as a means to stimulate wealth creationandreducepoverty.Workinginpartnershipwiththefinancialservicesindustryourgoalistosignificantlyexpandaccesstoservicesamonglowerincomehouseholds and smaller scale enterprises. FSD operates as an independent Trust under the supervision of professional trustees, with policy guidancefrom its programme investment committee. Finance is provided by a number of development partners including the UK’s Department for InternationalDevelopment (DFID), theWorld Bank, the Swedish International Development Agency (SIDA), Agence Française de Développement (AFD) and the Billand Melinda Gates Foundation together with the Government of Kenya.info@fsdkenya.org • www.fsdkenya.orgFSD Kenya is an independentTrust established to support the development of inclusive financial markets in Kenya4th Floor Kenya KMA Plaza • Off Ragati Road, Upper Hill • P.O. Box 11353, 00100 Nairobi, KenyaT +254 (20) 2718809, 2718814 • M +254 (724) 319706, (735) 319706FSD KenyaFinancial Sector DeepeningGovernment of Kenya THE WORLD BANK

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