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Commerce · I.03 · MMXXVI · daylight

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WORKBOOK — THE CORPORATE EXECUTIVE

Chapter I.03 · The First Instrument

For the person with a P&L, a treasury policy and a board that reads papers. The proposition here is not ethical. It is that there is unpriced capital inside your customer relationships, it is cheaper than your revolver, and reaching it costs one page and two signatures.

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THE PREMISE, STATED COMMERCIALLY

Your cost of capital is not the market's cost of capital. It is yours, and every firm you trade with has a different one. Where your weighted average cost of capital exceeds a customer's return on idle cash — which, for most mid-sized firms trading with larger or more conservative ones, it does by three to six points — there is a surplus sitting between the two balance sheets that neither of you can reach alone.

A customer prepayment reaches it. The buyer earns more than deposit; you pay less than the revolver; the difference is created by the transaction and split by the discount. On £200,000 prepaid against even delivery with a 5-point spread, that surplus is £5,000 a year of genuinely new margin, and it required no new money, no new product and no committee.

Three commercial facts make this worth an hour of your time this quarter:

1. It is not debt. Under IFRS 15 and ASC 606 a prepayment for goods is a contract liability, not financial indebtedness. It does not consume covenant headroom and carries no interest line.
2. It needs fewer permissions than anything else in this volume. Chapter I.01's facility needs your treasurer. This needs a customer and a page.
3. The second one is nearly free. The paperwork is a fixed cost; reusing it drops the minimum viable deal by a factor of six.

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PART ONE — DISCOVERY

Days 1–20: sort the customer list by the column nobody uses

Exercise 1.1 — The tenure sort (half a day with your commercial director)

Pull the customer list and sort it by two fields it has almost certainly never been sorted by: years of unbroken trading and coefficient of variation of monthly order value. Volume is the third column, not the first.

Take the top ten. For each, add:

The finding this usually produces. The customers who would make the best counterparties are rarely the largest, and in most firms nobody has ever looked at the list this way — because until you want to borrow from a customer, tenure has no financial use.

Exercise 1.2 — The reliability audit (one week)

For each of your top three products by volume, compute on-time-in-full delivery across thirty-six months. You are looking for the line you would be comfortable selling a year of in advance.

This exercise has a second output and it is often the more valuable one: many firms discover they do not measure OTIF cleanly by line, only in aggregate. That gap is worth closing regardless of whether you ever write a prepaid offtake.

Exercise 1.3 — The appreciative conversation with your CFO (45 minutes)

Ask, in these words:

"When have we been funded by somebody other than a bank — a customer paying early, a supplier extending terms, a deposit against an order? What made it possible, and what did it cost us compared with the facility?"

Every finance function has at least one such episode and it is almost never written up as financing. Getting it named as financing is the whole purpose of the conversation.

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PART TWO — THE ARITHMETIC

Days 21–45: the window, and the two thresholds

Exercise 2.1 — Compute your own window (2 hours)

For each of your three shortlisted counterparties:

  annualised yield to them       y  =  2d / (1 − d)         (even delivery)
  lower bound on the discount    d  =  their cash return / (2 + their cash return)
  upper bound on the discount    d  =  your WACC          / (2 + your WACC)

At your WACC of 9 percent and their 4 percent, the window is 1.96 to 4.31 percent — 2.35 points wide. Write both numbers down. You are going into a negotiation knowing exactly where it ends, which is not a common condition.

Exercise 2.2 — The two thresholds, on your own numbers (90 minutes)

Threshold one — the smallest deal worth the paper.

  P  must exceed   documentation cost  ÷  (spread ÷ 2)

  £9,000 first time,  5-point spread   ->   £360,000
  £1,500 reused,      5-point spread   ->    £60,000

Get a real quote for the first-time documentation before you size anything. Then make the template a deliverable of the first deal, explicitly, in writing, with an owner — because the factor-of-six improvement is the entire economics of the programme and it evaporates if nobody is responsible for the file.

Threshold two — the reliability the instrument requires.

  tolerable annual failure rate  =  your annual gain  ÷  loss given failure

  no shortfall clause   £2,814 ÷ £1.2m relationship   =  0.235%   (99.8% required)
  with the clause       £2,814 ÷ £30,000 capped loss  =  9.4%     (ordinary)

Compute the relationship lifetime value for each shortlisted counterparty — gross margin times expected remaining tenure. Then compute both rates. If your OTIF for the proposed line does not clear the second number with room, choose a different line.

Exercise 2.3 — Price the alternative honestly (45 minutes)

Put the prepayment beside every other source of funds available to you this quarter: revolver, invoice discounting, supplier terms extension, asset finance, retained cash. Rate, covenant impact, speed to money, and who has to approve.

The prepaid offtake usually wins on three of the five and loses on one — total capacity. State that plainly in the board paper. A funding option presented without its ceiling is a proposal that will be believed once.

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PART THREE — DESIGN

Days 46–70: the instrument, drafted

Exercise 3.1 — The term sheet (one page and a half)

Exercise 3.2 — The covenant, agreed with the operating unit (90 minutes)

The second tranche releases if the named stock metric is flat or improving against a signed baseline. Choose the metric with the people who will be measured by it, and write the release rule in a single sentence a warehouse manager could apply.

Flat must release. A covenant requiring improvement every period is a ratchet, and a ratchet ends the relationship in year three — the same failure that kills gainshare schemes, and for the same reason.

Exercise 3.3 — The auditor conversation (one hour, early)

One narrow question, asked before you draft rather than after you sign:

"We are contemplating a customer prepayment for twelve months of goods, evenly delivered, at a discount. We read this as a contract liability under IFRS 15, recognised as delivery occurs, with the discount reducing the transaction price. At this size and term, do you see a significant financing component requiring separation?"

That is a conversation they have every year. A fifteen-page brief asking them to design something is a conversation they charge for.

Exercise 3.4 — The legal review, scoped correctly (one hour)

Send the page and a half and ask for review, not drafting. Name the two clauses you want tested: the trigger and the shortfall remedy. A brief that asks a firm to design an instrument returns fifteen pages, and the fifteen pages will not be read by the person who signs.

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PART FOUR — DESTINY AND DELIGHT

Days 71–90: sign, bank, file

Exercise 4.1 — The meeting (one, prepared for)

Bring three things and nothing else: the window with both ends, the workings, and the draft page.

Open with their side. "At your cost of cash this returns 6.2 percent annualised, which we think is ahead of your alternatives; at our cost of capital anything above 4.3 percent is worse for us than borrowing. So the deal lives between here and here."

What arrives in the room at that moment is not agreement — it is relief. Somebody has brought the whole picture including the part that favours the other side, and the negotiation can be about the thing rather than the framing.

Exercise 4.2 — The three rots, countered in writing (45 minutes)

Write the treasury policy amendment now, while the cap is theoretical. It is unwritable once it is inconvenient.

Exercise 4.3 — File the template (half a day, and it is not admin)

The template, the workings, the auditor's answer, the two clauses as reviewed, and one page of what you would change. Stored where the next person finds it, with a name.

This is the deliverable that makes deal two, three and four possible at £60,000 rather than £360,000. Treat the file as the asset and the first transaction as the cost of producing it, and the programme's arithmetic changes completely.

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WHERE YOUR OWN NUMBERS ALREADY SUPPORT THE MOVE

Nothing in this workbook requires a new data collection. Five figures you already have decide the whole case, and they sit in five places your team can reach this week.

Two of those five are usually the sticking point, and both are informative rather than obstructive. OTIF held only in aggregate means you cannot yet evidence reliability on the specific line, which is a reporting fix of a few days. Gross margin by customer rather than by product is, in many firms, simply not computed — and a firm that cannot say which customers it makes money from is carrying a larger problem than this instrument, and has just found it cheaply.

The commercial point to make internally. You are not asking the business to believe anything new. You are asking five existing numbers to be put on one page together, which is precisely the move Chapter I.02 made with the counterfactual appendix, applied now to the funding side rather than the operating side.

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THE BOARD PAPER

One page. Six headings, in this order.

1. The proposition. One sentence: a named customer prepays £X for twelve months of a named line at a discount of d, and the cash funds a named change.
2. The economics. Their yield, our cost, our alternative, the surplus and its split. Four numbers.
3. The accounting. Contract liability under IFRS 15; no covenant impact; working-capital effect stated; the auditor's view, already obtained.
4. The protection. The shortfall clause and the capped exposure, with the tolerable failure rate beside our actual OTIF.
5. The limit. Total capacity available through this route across the customer base, and the concentration cap. State the ceiling before anyone asks for it.
6. The ask. One signature, and the treasury policy amendment.

What to leave out. Any adjective. Any reference to what the instrument signifies. The paper is a financing paper and it should be indistinguishable in register from one about a revolver, because that is precisely the claim being made.

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THE NINETY DAYS ON ONE PAGE

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APPRECIATIVE QUESTIONS FOR YOUR LEADERSHIP TEAM

1. Which of our customers has traded with us longest, and what have we never asked them for?
2. When has this business been funded by somebody other than a bank, and what made that possible?
3. Which of our lines do we deliver so reliably that we would happily be paid a year in advance for it?
4. If our board pack carried a page headed Capital from trading relationships, what would we want it to say in three years?
5. What would change in how we choose customers if we valued tenure the way we value volume?
6. Who on our side could draft a page and a half that a customer would sign — and have we ever asked them to?
7. What is the smallest prepayment worth writing for us, once the template exists?
8. How will we know if our financing discount has quietly become our price?
9. Who verifies the covenant next year, and how do we ensure it is not the same person as this year?
10. What share of our working capital are we willing to have one customer fund, and who decides that before the answer is forced on us?
11. What would we want still running here ten years after everyone in this room has moved on, and does it have a counterparty?
12. Where else in our supply chain does this same instrument apply — with us as the buyer rather than the seller?