Published: September 01, 2013
Treasurers have been at the forefront of corporations’ efforts to centralise, automate and optimise their financial activities in recent years. As companies have extended into new territories, treasurers have become increasingly adept at using centralised structures, such as regional or global shared service centres (SSCs), payment factories, treasury centres and in-house banks to maximise process efficiency, reduce costs and achieve visibility over cash flows through best practice cash management. In addition, however, treasurers are also leveraging these centralised structures to create working capital benefits, generate new income streams, increase the resilience of their supply chain and minimise counterparty risk on an unprecedented scale.
Liquidity and risk management have become the watchwords of the global treasury community. Although external financing may not be a priority for cash-rich, or large highly-rated companies that have easier access to capital than their smaller, lower-rated peers, optimising working capital is a priority for all companies. Put simply, this involves managing functions that impact payables and receivables so that there is sufficient cash available to fund obligations as they fall due. There are a variety of levers that treasurers and finance managers can use to influence working capital, reduce costs and minimise supply chain risk, not least the way in which they pay suppliers. These range from more efficient processing of traditional electronic payments, to innovative structures such as supplier financing, dynamic discounting and purchase and virtual card settlement.
Most large multinationals have a diverse supplier base, in terms both of the size, location, the type of goods or services offered and criticality of suppliers, and also the payment terms, value of spend, frequency of payments. Each supplier will also have a different need for and access to short-term liquidity. To identify the right strategic spend solution, companies need to establish a detailed understanding of their suppliers, which then informs proper segmentation and spend analysis.
Each technique brings different benefits and affects working capital and returns in different ways. For example, use of payments instruction warehousing, which ensures settlements are made on invoice due date and not earlier, preserves cash and therefore maximises returns or minimises financing required. For a company spending $5bn annually, every day’s improvement to days payable outstanding (DPO) represents a $13.5m working capital saving. By adding better controls to payments processes, a company can also avoid late payment charges and take advantage of early payment discounts where appropriate.
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Some of these techniques, particularly supplier financing, bring benefits to both the buyer and its supplier (see figure 1). For example, by enabling suppliers to access the invoice amount before its due date, typically at a competitive financing rate, suppliers’ liquidity positions are enhanced. This in turn increases the resilience of the supply chain and may enable the buyer to achieve better commercial terms without negatively impacting suppliers. The working capital benefits to the buyer can be substantial: a $500m annual spend supplier finance programme combined with a days payable outstanding (DPO) increase of 30 days represents $41m of free cash flow.[[[PAGE]]]
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As supply chains extend and become more complex and geographically diverse, managing counterparty risk has become an important priority for companies across a wide variety of industries. Treasury already plays an essential role in financial counterparty risk management. With both the skill sets and technology already in place, it makes sense to extend this expertise into financial supply chain risk management. Consequently, we have seen substantial growth in the use of supplier and distributor financing programmes to manage supply chain risk; similarly, companies may also offer customer financing and accept card payments, for example, to support their customers’ liquidity positions.
For companies with surplus cash, dynamic discounting is a technique to take advantage of early settlement discounts on invoices, along a sliding scale, whenever the discount rate is more favourable than holding cash to the invoice settlement date. The discount gained typically ranges from 1-2% of invoice value, equivalent to 18-36% APR and can be considered a risk-free return. At the same time, companies need to weigh the financial return of the discount received against the impact of a decrease in DPO and therefore extended working capital cycle. A self-funding enabled supplier finance programme can achieve similar benefits to dynamic discounting, while preserving a company’s balance sheet.
Purchase and virtual card settlements enable companies to replace payments to multiple suppliers with a single known payment on a defined date. This lowers costs, generates extra income out of traditional cost centres, enhances purchasing controls and creates benefit from float days associated with statement cycles without impacting suppliers’ cash flow positions. According to RPMG Research’s 2012 Purchasing Card Benchmark Survey, administrative cost savings of up to US$74 per transaction can be achieved by replacing purchase order payment methods with purchase cards. Post-invoice virtual card settlements enable organisations to capture additional spend on their card programme to generate further rebates, and can be integrated into accounts payable process and systems. Suppliers benefit from faster access to cash, robust remittance data and greater control and visibility over incoming payments. A company can expect to capture up to 5% of total spend through card settlement, which often represents over 60% of invoice volume.
Depending on its cash flow dynamics, industry, payments culture and technology infrastructure, a company will select one or more techniques according to their working capital and counterparty risk management needs. The challenge, however, arises when a company’s cash flow profile and therefore working capital requirements are subject to a temporary or permanent shift, such as leading up to, or following major cash flow events e.g. M&A, share buybacks, entering new markets, dividend payments etc. or in the case of a business with seasonal cash flows. A company’s suppliers will also vary in their need for cash, which again may change over time. Switching between different payment techniques for supplier payments can be time-consuming. Multiple technology platforms are often required, and supplier payment solutions may be delivered by different providers and/or under separate contracts, all of which add to the time, cost and complexity of adding or changing techniques for paying suppliers. Furthermore, supplier payment methods need to be integrated as part of a single solution to avoid conflicting priorities.
To address this challenge, and enable treasurers and finance managers to be more precise in their choice of working capital payment techniques, Citi has devised a more holistic approach to supplier spend analysis and supplier payment execution that combines the portfolio of techniques within a standardised framework. This includes helping customers to segment their supplier base and identify optimum payment methods using detailed analytic tools, specialist advisory services and an in-depth knowledge of each company’s business, industry and supplier spend profile. This enables companies to control their cash positions more specifically by using the right payments lever to optimise their working capital and mitigate supply chain risk.
It is far more achievable today than at any time in the past, not simply to implement supplier payment solutions, but to integrate these within a more strategic framework:
In contrast, it is far more difficult to take a strategic approach to using supplier payment techniques for working capital and supply chain risk management in a decentralised or partially centralised environment, where data sources may be fragmented or inconsistent, payment programmes are difficult to scale up to generate sufficient return on investment, and there may be a lack of synergy between the objectives of different departments whose activities impact on working capital.[[[PAGE]]]
Citi’s approach to supplier spend solutions for its customers builds on techniques and platforms that are already in place, but harmonises our offering to provide greater flexibility and consistency to our customers, across a wide range of markets. Customers can implement one or more techniques initially, and then ‘plug in’ additional solutions quickly and easily as their needs evolve, with a single platform and common formats effectively providing a single fulcrum for a whole range of payment levers. This is supported by sophisticated analytics and tools to enable treasurers and finance managers to determine and select the most appropriate supplier spend solution for a given time and supplier.
Several companies that have achieved significant centralisation, digitisation and standardisation in their cash management and payments function are starting to take a more integrated approach to working capital and supply chain risk; however, this is typically done manually and switching readily between techniques may not be feasible. These companies are therefore seeking to automate their supplier spend strategy, and target the use of these techniques more specifically. We anticipate that this trend is likely to continue as a growing number of companies achieve a high degree of processing and data centralisation, including smaller companies and those that have expanded their international operations more recently. The ability to take a strategic approach to supplier spend, and viewing accounts payable spend as an income generating and working capital optimising asset rather than a cash flow liability, is poised to become an essential capability for treasurers to create competitive advantage and add further value to the organisation.
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