Published: October 01, 2014
As the use of financial supply chain tools for optimising working capital has become increasingly prevalent over recent years, these techniques are now becoming more mature and the benefits more predictable. This article considers the factors that are contributing to the growing success of financial supply chain solutions and how they are likely to evolve in the future.
Today, treasury performance is frequently measured using working capital metrics, and working capital objectives are now an essential element of corporate strategy. As a result, treasurers and finance managers are far more specific in their working capital objectives than in the past. For example, many treasurers are now seeking alternative forms of liquidity to diversify access to funding and mitigate liquidity risk, and increase the resilience and efficiency of their supply chains. These are in addition to, and often conducted in tandem with, more traditional payment and collection centralisation and automation initiatives, but the focus is now more on improving days payable outstanding (DPO) and days sales outstanding (DSO) metrics in addition to cash management efficiency.
We are seeing a particular interest in two categories of working capital solutions among corporate treasurers: supplier financing and distributor financing. Looking first at supplier financing, while these programmes have become increasingly popular over the last few years, they are now growing in both size and geographic reach. For example, cross-border, multi-currency programmes are becoming more popular, fuelled by greater confidence and expertise in design and implementation, and a growing investor base in these types of programmes, which is in turn creating further capacity.
Treasurers are also becoming more ambitious in the terms extension that they are seeking when establishing or expanding a supplier financing programme. While improving DPO remains the primary consideration, there is growing awareness of the need to create a ‘win win’ for both the corporate and its suppliers, in order to maintain strong supplier relationships and increase supply chain resilience.
Conversely, receivables and distributor financing aim to improve DSO, improve top line growth and enhance the company’s risk profile by offloading credit risk to banks and therefore, enabling them to do more business. The growth of these techniques reflects banks’ evolving role as a strategic working capital partner to their customers. For example, they are becoming vital third parties in the relationship between customers and their often thinly capitalised distributors, allowing them to work more closely together and generate top line growth. In the past, securitisation was often used as a way of achieving the same DSO objectives, but these can be difficult to set up and manage in practice. In contrast, accounts receivable and distributor financing programmes are more flexible and easier to implement, and have the advantage of achieving a ‘win win’ for all participants.
One of the challenges of early financial supply chain programmes was that suppliers and distributors were unfamiliar with these programmes, so onboarding suppliers was difficult with relatively low adoption rates in some cases, therefore, limiting the working capital benefits. Today, there is far greater market awareness of the opportunities that these programmes offer, and onboarding processes have become more efficient, quicker and straightforward, with a higher proportion of suppliers choosing to participate.
Similarly, better market awareness of the potential complexities of setting up a programme, particularly cross-border, means that companies are better prepared. For example, there is often a large number of stakeholders involved across different departments. A supplier finance programme might include procurement, treasury, IT, accounts payable, legal and tax, with the number of parties increased significantly where some of these functions are decentralised. As each of these departments needs to be engaged, share objectives and priorities, and allocate the necessary resources, senior management sponsorship is essential in ensuring that objectives are aligned and organisational roadblocks are avoided.[[[PAGE]]]
A small number of global trade banks have developed significant experience in designing, implementing and supporting financial supply chain programmes, which can be instrumental in ensuring the success of a new programme. In particular, the right bank can help to define quantifiable objectives, involve the right people in the organisation and categorise suppliers in a structured way, thereby helping to tailor onboarding to target supplier groups, and increase adoption.
For example, the first critical step for a financial supply chain project in which Deutsche Bank is engaged is to work with customers to analyse existing working capital metrics, such as DPO and DSO, and compare these with best-in-class and average performance for the relevant industry. Based on these results, we identify the gap and recommend pragmatic improvements. It is very important to outline quantitative and qualitative benefits to senior management to secure their active support. Therefore, we calculate the value of each day’s reduction in DSO or increase in DPO in terms of cost savings, freed up working capital and reduced borrowing levels or improved investment returns, providing customers with a clear and compelling senior management proposition. Consequently, we are now in a position to support customers in delivering annual working capital improvements that can result in savings of as much as tens or hundreds of millions of dollars.
Changes to capital adequacy rules resulting from Basel III will have an impact on financial supply chain programmes. However, as a low-risk trade finance solution, these programmes will still attract relatively favourable treatment under Basel III compared with balance sheet lending. We envisage that alternative financing solutions, such as supplier financing and accounts receivable or distributor finance, will become more important in the coming years. For corporations too, diversifying funding sources brings advantages in managing liquidity and counterparty risk, both of which are primary considerations for companies of all sizes. During the global financial crisis, while some companies experienced credit difficulties as some banks had to withdraw financing in certain situations, trade finance remained a reliable source of liquidity throughout that period.
Financial supply chain programmes, whether for DPO or DSO, are reaching the next stage of maturity, with larger, more geographically extensive programmes now emerging, with strong participation by suppliers and distributors. While Basel III will be a factor for both traditional and alternative financing solutions, it will not hold back the market traction and growing success of financial supply chain solutions. To achieve the degree of value that many programmes are now delivering, treasurers and procurement managers need the support of an experienced global bank that offers specialist local knowledge and insights within an established global framework. By selecting a global provider, corporations can maximise the working capital benefit, build closer financial supply chain relationships and deliver demonstrable as well as sustainable value to their organisation.
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