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Managing cash flow for a small and medium-sized enterprise (SME) is not easy. Unlike managing our own personal finance, business financial management is a much more complicated process. Knowing the financial products we can utilise to improve our business cash flow is an important aspect of business finance management that entrepreneurs need to be familiar with.
One such product that we may have heard of but have never used is a Banker’s Guarantee. A Banker’s Guarantee (BG) is a trade financing tool issued by a bank, on behalf of a company, that promises to fulfil the payment or obligations of a transaction/contract to the beneficiary of the BG if the company is unable to pay. It’s sometimes needed to guarantee a business transaction or forms part of a contract agreement.
How Companies Use Banker’s Guarantees For Financial Guarantee
For buyers, it allows them to bypass the need for a security deposit or an advance payment requested by the seller for protection against non-payment. The BG can be accepted as an alternate form of a deposit. This gives the company additional cash flow that they can use for their business operations.
For example, a company renting an office space at a rate of $100,000 a month may need to put up a 3-month rental deposit ($300,000), depending on the tenure of their lease. They may find it more effective, from a cash flow point of view, to use a BG instead of paying the deposit. This also gives them the added security that a substantial amount of money is safe with the bank.
Suppose a company is buying raw material that is needed for their goods production. In that case, it may take a while before the material can be processed into a completed product and sold by the company. Even if their suppliers are willing to give them favourable credit terms to pay for the materials, the suppliers may also want some assurance that the company will not default on the payment.
This is where a BG becomes useful in guaranteeing the payment while not laying out a large amount of funds upfront. It gives suppliers the confidence to let the company have the material first, without worrying about whether future payment would be fulfilled.
For sellers, a BG may be preferred compared to getting cheques from buyers as it provides greater assurance that the payment is guaranteed. For example, if an SME issues a cheque as a security deposit or advance payment, the seller needs to be wary of the cheque bouncing. However, if it receives a BG issued by a bank instead, the company will be more confident that it will be paid because the bank is much more trustworthy and is obliged to make the payment if the buyer fails to do so.
How Companies Use Banker’s Guarantees For Performance Guarantee
In certain industries such as construction, the need for a performance guarantee is common when tendering for a project. For example, if a contractor fails to deliver the completed project by a certain date, or the quality of the work is not up to agreed standards, the developer may be contractually allowed to make a financial claim against the contractor.
In such scenarios, the contractor would typically need to get a Banker’s Guarantee before undertaking the project. If the project is not completed in accordance with the contract requirements, the developer can claim for losses and this may be paid out from the BG.
OCBC Business Banking has a simple step-by-step guide for us to understand exactly how a Banker’s Guarantee work.
Very often, particularly for bigger contracts, a BG can be a vital tool to help companies complete a transaction or embark on a business deal with their clients and suppliers.
This is particularly important for SMEs that want to undertake larger contracts with bigger companies but do not want to tie up their operational cash flow in the contract.
How Much Do Banker’s Guarantees Cost?
Like most financing solutions, getting a bank to issue a Banker’s Guarantee involves a fee.
For example, according to the OCBC pricing guide, a BG will cost companies between 1% to 2% per annum (p.a.) depending on whether it’s a financial guarantee or a performance guarantee. If you need a $100,000 BG for a period of 1 year, you may pay between $1,000 to $2,000 per year for it.
How To Apply For A Banker’s Guarantee
If your company already has an existing trade facility with the bank, it will be easier to get your BG application processed and approved. But even if you don’t have a current trade facility with the bank, you can still get an ad-hoc BG as and when you need it.
With most business banking solutions now available online, applying for an ad-hoc Banker’s Guarantee (BG) can be done quickly and conveniently. As an entrepreneur, you can do it on your own without needing the help of a designated finance person.
Even if you do not have a trade facility with OCBC currently, you can download the application form and a standard format form and either submit an email application or do a walk-in application at one the OCBC locations. You can find out more details here.
Read Also: Entrepreneurs Share How Taking Business Loans Helped Them Grow
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