Pre-shipment Finance is a loan provided by a finance provider to a seller of goods and/or services for the sourcing, manufacture or conversion of raw materials or semi-finished goods into finished goods and/or services, which are then delivered to a buyer. A purchase order from an acceptable buyer, or a documentary or standby letter of credit or Bank Payment Obligation, issued on behalf of the buyer, in favour of the seller is often a key ingredient in motivating the finance in addition to the ability of the seller to perform under the contract with the buyer.
Definition
Pre-shipment Finance
Synonyms
- Purchase Order finance
- Packing credit/finance
- Contract monetization financing
Distinctive features
Pre-Shipment Financing covers the working-capital needs of the seller, including procurement of raw materials, labour, packing costs, and other pre-shipment expenses in order to allow the seller to fulfil delivery to its buyer(s). Pre-shipment Finance can be provided in any number of structural variations. Financing can be provided against purchase orders (confirmed by buyer or unconfirmed), demand forecasts or underlying commercial contracts.
Although Pre-shipment Financing is most commonly provided in an open account situation, other sources of repayment from the buyer may also be the proceeds of a Documentary Credit or standby letter of credit or a Bank Payment Obligation. Pre-shipment Finance can be provided on a programmatic basis, covering a series of transactions (typically for smaller sellers) or on a transactional basis (typically for larger sellers).
The finance provider is likely to advance a certain percentage of the value of the order, potentially disbursed in stages as the order is fulfilled. Maturity dates for the financing are established between the seller and finance provider and are often tied to the ultimate date on which the buyer will make payment.
Upon shipment, the finance provider may offer post-shipment financing using techniques such as Receivables Discounting, or Payables Finance to cover the period from shipment and the raising of the invoice until the final payment by the buyer.
Parties
A typical Pre-shipment financing transaction involves two main parties: the seller and the finance provider. The buyer is not a party to the financing transaction but depending on the contractual arrangement with the finance provider, the source of the repayment is usually the flow of sales proceeds from the buyer. The history of the commercial relationship is a factor in determining the probability of repayment. Bank and non-bank finance providers are active in this type of financing particularly in Asia.
Contractual relationships and documentation
The seller and finance provider enter into a financing agreement detailing terms of the financing structure. This may but will not always include a security agreement covering assignment of rights (transfer of title or a pledge) to the underlying work in progress and finished goods prior to shipment. The finance provider may require a security interest in the receivables following shipment. The seller may grant inspection rights to the finance provider or its nominated agent for the period of manufacture or conversion.
Security
As described in the previous section, a security agreement will be executed covering assignment of rights (transfer of title or a pledge) to the underlying work in progress and finished goods prior to shipment and to the receivables following shipment.
Risks and risk mitigation
The primary risk is the performance risk of the seller as repayment is dependent on the seller’s performance ability and reputation. Specifically, the seller’s ability to perform against the purchase contract, and the buyer’s ability and willingness to pay on delivery of the goods are the key risks. Mitigation of risk is provided by the credentials of a creditworthy and reliable buyer and the proven performance of the seller in a repeatable and predictable fashion. Security over assets prior to shipment is an important control mechanism, but is not the primary source of risk mitigation.
Transaction flow: illustrative only
Source: Global SCF Forum
Transaction illustration
The finance provider will work with the seller to establish a transaction structure, and will undertake credit assessment of both the seller and of the buyer in order to assess its credentials to meet its purchasing obligations. It will monitor the issuance of purchase orders by the buyer and provide finance to the seller in stages against materials purchases, work-in-progress and invoiced amounts. All subsequent actions and events taken by the seller once the order is received will be closely controlled and monitored in relation to fulfilment of the order. Sequential financing may occur in any chosen form as agreed by the parties.
Benefits
The benefit to the seller of this form of finance is the ability of the seller to obtain finance for the fulfilment of an order from a buyer, in circumstances where it is possible that other forms of finance are financially less attractive or not available.
The benefit for the finance provider is that rather that there is greater control and reassurance based on the trading relationship between the seller and its buyer(s).
Asset distribution
Such financings are typically offered by one provider although in the event of very large amounts distribution techniques might be used.
Variations
There are many variations on the technique of Pre-shipment Finance, such as finance undertaken against a general contractual framework established by a buyer with a seller, and finance extended against a letter of credit established by the buyer in favour of the seller (so-called red and green clause letters of credit- see Glossary).