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What is distributor finance?

Distributor finance helps distributors get credit to buy products from manufacturers

distribution finance

There are countless distributors in India’s sprawling business landscape, and securing the financing to buy inventory from manufacturers is usually a constant source of anxiety.

Distributor finance helps businesses with just that – securing the capital needed to keep their supply chains moving. In this article, we’re going to explore the pros and cons of distributor financing, and the things you should keep in mind before applying for one.

What is distributor financing?

Distributor financing helps you to stock up on popular products that you know are going to be in high demand. This type of capital helps you to load up on highly-demanded inventory and make upfront payments for the same.

While most distributors would like to keep up with inventory well in advance, most times this is not practical due to a lack of cash. If your customers pay you in a month’s time, it is understandable that you won’t have the financing you need to buy more products before a month.

Distributor finance helps to bridge this gap by issuing credit directly to distributors, who can then pay manufacturers for goods in real time.

Financing like this allows businesses to:

  • Scale operations: Purchase larger quantities of goods and work on expanding market share without worrying about depleting inventory.
  • Improve cash flow: Avoid large upfront payments and free up working capital for other business needs.
  • Enhance negotiation power: Manufacturers could give you special discounts only because you have the capacity to buy in much larger volumes now.

You may also like: Working capital – the what, how, and why of business lifelines

Top 5 risks associated with distributor finance

Here are the top 5 risks you need to keep in mind every time you think of securing a distributor capital loan:

It’s debt and you have to pay it back

While this might seem obvious, most people don’t realise that the longer you keep that money, the more interest you have to pay. Make sure that you’re financing inventory that you’re confident you can sell in a particular time frame. Keep reassessing your repayment capacity and projected sales in the near term before jumping into large capital deals.

Manage your inventory well

Just because you have the ability to finance your inventory stocks doesn’t mean you always should. Distributor finance hinges on inventory management, which means that slow moving goods can hold up your turnover and cost storage costs as overhead.

Defaulting is a real risk

From a manufacturer’s standpoint, if a distributor fails to make financing payments on time or defaults on those payments, they’re the ones who are liable. Hence, if you’re a manufacturer, make sure that you’re approving these loans only for distributors that have a proven track record, or ones you trust.

Interest rates

Changing interest rate environments can change the cost you have to bear for distributor financing. This is especially true if the profit margins of your product are slim and depend heavily on volume sold. Make sure you (or your distributors) understand the interest rate agreements and the repayment schedule before the money gets disbursed.

Reduced receivables and sales

The concept of stocking up on inventory is predicated on the assumption that it will, sooner or later, sell out. However, because you’re on a financing structure where the cost of debt depends on time, you need to ensure that your inventory sells sooner rather than later. Make sure that you not only get products sold but also get the money that’s owed to you (from customers) collected on time.

Also read: Navigating the legal maze: The consequences of personal loan default

How the structuring works

When working with a financing provider, both the manufacturer and the distributor are part of the agreement. This is done to ensure that the major manufacturer, also referred to as the “anchor party”, is invested enough in the agreement to encourage its success.

Risk-sharing agreements like these could be used as an additional means of participation by the anchor party. Instead of obtaining this loan based solely on the cash of the company, the distributor could also use the strength of the manufacturing company to secure this financing. This is dependent, however, on whether the distributor is itself a well-established business or not.

Arrangements

Normally, the distributor and the financial provider make a financing agreement or “facility letter” to acknowledge the solicitation of the capital. Additionally, a master Distributor Finance Agreement between the anchor party and the finance provider is usually signed. 

This agreement will typically include the operating model that applies to the anchor party, distributor, and finance provider, as well as the terms of engagement for the finance provider to provide facilities for multiple distributors in global territories.

Here are some documents that will usually be signed during distributor financing:

  • A master distributor finance agreement.
  • Stop-supply letter.
  • Buy-back guarantee.
  • Comfort letter.
  • Risk-sharing arrangement.

Typically, rights to inventory or accounts receivables are placed as collateral in case the distributor defaults on the principal of the loan.

Also read: What is FOIR? How does it impact personal loan approval?

Conclusion

Distributor finance, when carefully navigated, offers a powerful tool for growth in India’s supply chains. By addressing existing challenges and leveraging new opportunities, distributors, manufacturers, and the wider economy can collectively get access to easier capital. This helps small businesses, particularly MSMEs, to launch their own businesses to greater heights, generate consumption and employment for society.

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Devansh Sinhal

I am passionate about stock investing and have a knack for simplifying complex market concepts. Providing readers with valuable insights and empowering them to make informed investment decisions is my jam.

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