Getting financial and physical supply chains to meet is a treasurer's age-old problem. While technology has sped up the movement of goods, money still travels faster, creating headaches when bills come due before merchandise can hit the shelf.
Eric Leung, chief financial officer of China Gas, fixed this problem. In 2008, when the builder and provider of natural gas infrastructure acquired an 83% stake in liquefied petroleum gas (LPG) provider Zhejiang Zhongyou Hua Dian Energy (renamed Shanghai Zhongyou Energy last year), Leung discovered a glaring irregularity in the new subsidiary's trade finances. The company was buying as much as 50% of its gas imports from the Middle East with 30-day letters of credit (LCs), but not receiving shipments until after the documents matured, requiring it to dip into its own working capital to make payments.
Prior to being acquired by China Gas, Zhongyou Energy posted annual revenues of Rmb5.48 billion ($802.7 million) on LPG sales of one million tonnes in 2007.
"Zhongyou Energy's shipments would take at least 35 to 40 days to arrive," said Leung. "That meant the 30-day LC would mature before the cargo arrived and they would have to pay off the LC before they could sell the cargo. This put big strains on their working capital."
Dipping into working capital is not only a drain on a company's finances it also inhibits business. Cash in the bank is necessary to secure loans, finance expansion and place orders for additional goods. The less a company has, the less it can do. In Zhongyou Energy's case, having to pay bills before it could sell LPG shipments limited its ability to increase sales and grow.
"After we acquired the company we defined a very interesting LC mechanism so that China Gas would not need to put up any working capital," said Leung. Here was his solution. The company would have its Chinese banking partners -- including Bank of China, Industrial and Commercial Bank of China and Agricultural Bank of China -- issue 90-day LCs for LPG imports. Those were sent to Hong Kong where China Gas's financial partners -- the aforementioned Chinese institutions as well as ANZ, Societe Generale and Standard Chartered Bank -- would issue 30-day documents for suppliers in the Middle East.
This arrangement kept suppliers in the Gulf happy and gave China Gas roughly 60 days before the 90-day LCs needed to be settled.
"When we get the cargo on day 35 or 40, we don't need to pay off the 90-day LCs," said Leung, adding that they did pay interest on the documents of around Libor plus 1%. "We are then able to sell the cargo before the 90-day LCs mature and can use the cash to place another order to the Middle East for LPG."
"We are essentially leveraging on the credit lines between banks to mitigate our working capital requirements," he concluded.
In the six-months to September 30, 2009, Zhongyou Energy sold 435,900 tonnes of LPG and posted revenues of HK$1.7 billion ($219 million).
While Leung came up with the 90-day LC for 30-day LC idea specifically for the accounts payable discrepancy at Zhongyou Energy, the solution is by no means exclusive to his company or industry.
"The solution is a very effective way of avoiding the working capital requirements of subsidiaries," said Leung. Any firm with subsidiaries that import goods in substantial numbers -- other energy conglomerates or firms dealing in grains and staple foods, for example -- could employ a similar trade finance solution to reduce the impact of payments on their working capital.
Ironically, by slowing down his financial supply chain, Leung in effect sped up his physical supply chain -- Zhongyou Energy can now pay for two LPG imports where before it could only pay for one. Cash management ingenuity like this is what's needed for Asia's burgeoning businesses to grow.
