Introduction
In times of changes in the agricultural business where companies are facing changing markets and stiff competition, many buying companies are trying to strengthen their relationships with suppliers / farmers to secure their supply chain. To achieve this, some companies may offer different types of services to support the farmers and to foster this relationship management. Specifically in regions that are typically strong on the agricultural origination side one of the mentioned provided services is to offer prepayments (form of a down payments), which will help the farmer and give him more flexibility in his financial planning.
Example: the agricultural buying company is pre-paying the farmer a certain amount a few months prior to harvest season, so that the farmer can buy needed equipment, seeds or fertilizer. The repayment of this amount will happen later during harvest through the harvested crops with no or partial monetary payment.
This blog looks into some of the different supported types and features on a high level of the prepayment solution in SAP Agricultural Contract Management.
Prepayment Agreements
The prepayment agreement is a type of contractual agreement between the company and a farmer or group of farmers which specifies terms and condition of the prepayment. This includes information like prepayment amount, repayment information, charged interest rates or collection of collaterals to secure the prepayment. Additional credit information and credit limits can be captured as well to determine if the request for a prepayment should be approved or declined.
Prepayment Agreement categories
To support different types of requests that the producer may have, the solution provides prepayment agreement categories to reflect the different business scenarios.
Advance
Advance is typically a short-term payment just prior to or during harvest season for which the company is not charging an interest. Example: a farmer requests a prepayment on short notice which he needs to repair broken harvesting equipment or trucks.
Pre-finance
Contrary to the advance, the pre-finance is a prepayment that is made to the farmer for a longer period in advance. These pre-finance payments can be made months (or longer) prior to harvest and the start of the repayment. The company is typically charging an interest to the farmer.
Barter
Many companies also offer their farmers the ability to purchase certain products like seeds or fertilizer directly from them. Instead of paying for the goods directly the producer may opt to pay for them via a prepayment. In this case the farmer will not make a payment at the time when he receives the products, but the owed amount will be transferred into a prepayment agreement. Repayment will happen through the producers’ harvested crops. The company may choose to charge interest for this type of transaction.
Prepayment Request
Contrary to the other prepayment categories this type is between two commercial entities or trading partners and not between a buying company and a producer. One company can make a prepayment request to another company on either contract or nomination level prior to the logistical execution of the trade. Interest rates are not charged in these scenarios.
Example: Trading company #A and #B have a contractual agreement to deliver a commodity via vessel. Due to the high cost in this transaction, the selling company may request a prepayment to be made before they start with the physical execution. Only after they receive the requested prepayment amount, the selling company will start loading the vessel.
Financial accruals
Until the full prepaid amount is recovered from the counterparty, the company has the option to accrue the open balance to have it correctly reflected in their books. This is specifically important for agreements that include interest because the producer owed amount is increasing every month by the calculated interest charges. The accrual functionality delivered in ACM can be used to automate these calculations and have them posted into journal entries, for example, as part of the financial month end closing process.
Impact of Prepayments to the Commodity Settlement
As referenced in the previous chapter, repayment of the loaned amount will typically not happen through monetary payments, but through harvested crops and is therefore integrated into the commodity settlement.
Example:
- Producer has a prepayment of $50,000 (assuming no interests are being charged)
- During the first invoice period of the harvest season the farmer delivers crops for $15,000 and an invoice / settlement for this amount is created.
- Based on the agreement with the producer, the company has two options:
- The company will map the full invoice against the prepayment agreement and will not pay the farmer. After this invoice, the farmer will still owe $35,000 to the company.
- The farmer and the company have negotiated an agreed percentage of the invoice is paid to the farmer. Example: 10% of the invoice amount (= $1,500 in this example). The farmer will therefore still receive a payment of $1,500 and the remaining amount of $13,500 will be applied against the prepayment for a new open amount of #36,500
Credit limits
Credit limits are obviously a factor for the company to decide, if a prepayment can be made to a producer and for which maximum amount. The solution supports the credit limit validations against two different levels:
- Counterparty: the counterparty (a specific farmer/producer) has a defined credit limit which will be reviewed to approve or decline his request for a prepayment.
- Group of several producers: In this example the entire group of farmers has a maximum credit limit that applies to the group and also all individuals. This can be a common construct in certain regions like Latin America. Example:
- Brazilian farmers #A, #B and #C form a group (i.e. Brazilian economic group). These three farmers may for example be family members but are legally categorized as different entities.
- The credit limit for the entire group is: 120,000 BRL
- At no point in time can the group or a single entity receive a bigger prepayment than this credit limit. Example: if farmer #A received a prepayment of 100,000 BRL, the other farmers cannot receive more than the remaining 20,000 BRL. To note: there can be exception scenarios where a single farmer of a group negotiated a higher credit limit; this higher credit limit would then only apply for him, but not other members of the group.
- The request for a prepayment may be declined, if the credit has been reached or breached.
Renegotiation
Renegotiation of prepayments may occur, if the producer is not able to repay the full amount within the timeline and parameters of the agreement. In this case the open amount may be closed in the current agreement and transferred into a new renegotiated agreement. The ACM solution offers tools and dedicated Apps to support this process.
