EXPLORING THE GROWING POPULARITY OF FINANCIAL SUPPLY CHAIN PROGRAMS

Since their introduction a mere 15 years ago, Financial Supply Chain (FSC) programs have matured from being a relatively unfamiliar concept to a solution that is widely leveraged, even commonplace, for multinational corporations (MNCs) in particular.

By extending Days Payable Outstanding (DPO) and reducing Days Sales Outstanding (DSO), FSC solutions can significantly improve a corporation’s working capital, in turn reducing dependence on comparatively expensive alternative short-term funding resources such as loans. Greater market recognition of this fundamental benefit has also led to a sea change in how such solutions are rolled out. Just a few years ago, the market still relied on banks to spearhead progress—but now it is corporations, exhibiting greater interest, that are calling for further development.

This behavioral change is largely the result of the 2008 financial crisis, which sharply emphasized the importance of sustainable access to liquidity and made internal sources (such as those unlocked by FSC programs) particularly attractive. Similarly, the flood of regulatory changes that followed the crisis—for example, Basel III’s capital adequacy ratio demanding higher levels of capital to be held on banks’ balance sheets—reduced bank appetite for lending. The post-crisis landscape also amplified the perennial tug-of-war between buyer and supplier—their contradiction in both hoping to increase DPO and reduce DSO—and underscored the importance of strength and stability throughout supply chains.

By circumventing this fundamental buyer/supplier disconnect, the “win-win” scenario created by a well-planned FSC program is attractive to corporations for many reasons—including the resultant improvement in liquidity, decrease in funding costs, strengthened trading relationships and greater stability throughout the supply chain. And as these solutions become relatively commonplace, corporations should now embark on the next evolutionary stage of these programs; fine-tuning their use through the application of detailed, targeted metrics. Not only will this help corporate treasurers squeeze optimal liquidity from their FSC schemes—and ensure they’re strongly positioned to roll out broader, more holistic solutions—but it also responds to the growing market pressure to determine and leverage data at increasingly detailed levels of granularity.

MEASURING THE CASHFLOW BENEFITS

For both Supplier Finance and Accounts Receivable (AR) Finance (the most popular FSC schemes), previously trapped or idle liquidity can be unlocked by contracting the cash conversion cycle (CCC); the movement of cash through inventory and accounts payable (AP), sales and accounts receivable (AR) and back into cash. A shorter—i.e. more efficient—CCC, calculated simply by the difference of DPO and DIO (Days Inventory Outstanding) from DSO, means more cash available for use at any given moment.

While this underlying rationale for FSC management is now widely acknowledged, it is important that treasurers ensure they quantify the monetary benefits—not just to fine-tune their use but also to be able to compare against alternative (external) sources of liquidity and industry benchmarks. Such comparison—against both previous internal data and their industry peers, averages or highest standards—enables a treasurer to identify areas for further improvement. By drilling down into the specific detail of a 24-hour measurement, for example, corporations can gain insight into the exact benefits of these schemes.

The formula to calculate the cash-flow improvement gained over a one-day cycle is straightforward: total annual sales/purchases multiplied by the number of days of improved DSO/DPO divided by 365 (days of the year).

However, such a figure is only indicative of the cash directly generated. To translate this into its worth for that particular corporation, the “applied” value must be considered. For example, where short-term debt has previously been used to maintain liquidity, the cash flow generated from one day’s improvement in DPO/DSO can be used to pay down this debt and is therefore worth “x” dollars’ worth of cost reduction.

Alternatively, if a treasurer chooses to use the liquidity generated to invest in capital expenditures, the “applied” worth could be valued even higher at the corporation’s weighted average cost of capital. Key in all of this is that treasurers use a measurement that best suits their strategic aims.

IMPLEMENTING AND EXPLOITING FSC PROGRAMS

Whether it is Supplier or AR Financing that can best achieve these benefits for a corporation depends largely on individual circumstances. In essence, though, where large, concentrated buyers exist in a field of smaller, fragmented suppliers—e.g. in retail or consumer product industries—the buyers, by virtue of their size and creditworthiness, enjoy lower costs of capital relative to that of their suppliers. In an industry or market with these characteristics, Supplier Financing is more likely to be successful and add the greatest value. In contrast, supply chains where corporations that sell through distributors or those in emerging markets striving to improve sales growth, AR finance (or distributor finance) is often more suitable.

For both schemes, however, uncertainty around the potential costs of implementation remains the most common barrier to adoption. Broadly speaking, with the correct banking support AR schemes can be introduced within very short timeframes. Supplier Finance programs can be more protracted and costly, mainly due to work involved in IT integration and supplier onboarding.

Indeed, for Supplier Financing in particular, implementation must begin with a well-thought-out plan. Once both benefits and costs have been weighed, treasurers must ensure the support and cooperation of all teams and departments internally, as a lack of clear and shared objectives or company-wide alignment can endanger such a project. Secondly, they must ascertain whether trading counter-parties will participate; the procurement team—briefed in the specifics by the supporting bank—must talk to their suppliers about the new financing terms on offer and gauge interest, ensuring the proposed FSC solution provides “win-win” benefits.

Certainly, these programs can only be successful if they improve the terms of trade for both buyer and supplier; one that fails to do so will struggle to onboard trading partners.

That said, the widespread rise of Financial Supply Chain schemes in the past 15 years speaks for itself—testament to the benefits (in regard to both working capital improvements and supply-chain stability) outweighing the complexities of implementation.

Corporations that have yet to implement such programs should certainly explore their potential. But even corporations that have embarked on FSC schemes often have more benefits to squeeze from them—possible only with accurate data, applied to the specificities of their situation. With the right bank guidance, such programs will continue to bring improvements to corporations of all sizes—and strengthen global trade as a whole.

Jon Richman is Head of Trade and Financial Supply Chain Americas, Global Transaction Banking at Deutsche Bank, with previous trade and transaction banking experience in sales, risk and product management.