Published: June 02, 2012
Over recent years, the focus of financial supply chain management (FSCM) has been directed towards supply chain finance (SCF). It would almost appear that SCF and FSCM have become synonymous, but this is a misnomer. FSCM refers to a wider concept, of which SCF is just one part. By reverting to the original meaning of FSCM, and applying new techniques and solutions, treasurers have a powerful new opportunity for optimising working capital and process efficiency.
The term FSCM first became popular in around 2000, when innovative banks started looking at the financing and risk mitigation opportunities within the physical supply chain.
By that time, the manufacturing industry in particular had made substantial progress in automating the physical supply chain, with highly sophisticated sourcing, production and distribution.
The financial supply chain is a parallel, but reverse process to the physical supply chain. As a company purchases goods and services, cash passes from the company to its suppliers. Similarly, as the company sells goods to its customers, cash passes from the customer to the company. The financial supply chain encompasses the full spectrum of financial processes within and between companies. FSCM aims to optimise these processes by improving working capital management, reducing processing costs or mitigating risk. It therefore aims to deliver a comparable degree of automation and transparency in financial processes and flows as companies had achieved in their physical supply chains. While traditional banking had focused on the bilateral relationship between the bank and a customer, FSCM extends this focus across the different parties that comprise the supply chain, from suppliers through to customers. This includes the distribution of cash in the supply chain, passing demand of liquidity from the supplier down to the customer, thus providing liquidity when and where it is required during the supply cycle.
One early initiative by banks to achieve these objectives was to increase transparency and control over data and flows by connecting to shipping or logistics companies more closely, in order to accelerate the flow of information, enable consistent data to be shared across each party, and ultimately ensure more rapid payment. While this approach had some success, banks turned their attention to the direct financial participants in the supply chain i.e., buyers and suppliers. This resulted in a greater emphasis on purchasing and sales activities, from a balance sheet, financing and working capital perspective, with particular focus on the timing of cash flows between buyers and suppliers.
The financial crises of the last decade have underlined the importance of a robust balance sheet; this is accentuated further by regulatory requirements such as Basel II, and going forward, Basel III. With constrained market liquidity, smaller companies in particular have become more vulnerable, which in turn jeopardises their customers’ supply chains. Buyers and sellers are therefore increasingly recognising the symbiosis of their relationship, as opposed to pursuing a more combative approach that has characterised the vendor-buyer relationships in the past. Smaller companies or those with a lower credit rating find it more difficult, and more expensive, to source credit, the cost of which is then passed on to customers through the cost of their products and services. Consequently, it makes sense for their financially stronger counterparties to support them, as they have a lower cost of funding and are able to increase resilience in their supply chain by reducing supplier risk.
This change of perception, and the growing recognition of the interdependency between buyers and sellers, has led to rapid growth in the popularity of SCF programmes. Buyers have the assurance that their supply chain is more robust, whilst also benefitting from extended payment terms. Relationships with suppliers are also enhanced, with the potential for better price negotiation. Sellers can receive payment promptly and are able to reduce the uncertainty in their cash flows. This leads to improvement in their working capital positions, since the uncertainty of predicting cash flows is the reason that companies need wasteful cash reserves in the first place. In a well-structured programme, this liquidity is made available without impacting on other credit facilities. Credit risk to customers is reduced considerably, and by freeing up limits to customers more quickly, they are able to do more business, which is attractive to both highly rated as well as smaller sellers.[[[PAGE]]]
However, it would be wrong to assume that SCF is the ultimate evolution of FSCM. SCF is a highly valuable solution, but it is just one element of an optimised financial supply chain. By leveraging the experience of successful SCF programmes, and combining these with the wider FSCM concept, new opportunities for both buyers and sellers emerge. One such example is pre-shipment financing. The period between order and delivery can be very lengthy in some industries, often at considerable cost to the producer, who must in turn pay his own suppliers, before being in a position to invoice their customer. This presents a working capital risk for the producer, and a supply risk for the ultimate buyer. Some buyers have sought to address this through advance payment, but this is unsatisfactory in that it creates credit risk and has a negative cash flow implication. Pre-shipment financing enables suppliers to alleviate working capital concerns between order and delivery, and ensures that suppliers remain liquid during the production period.
To implement pre-shipment financing successfully involves not just the buyer’s bank, but the supplier’s bank too. Typically, while the buyer’s bank may be in a position to offer SCF, the same cannot be said for pre-shipment financing, as it is further removed from the supplier, and the financing period could extend across both the 3-6 month period between order and shipment, and the 60-90 day invoice payment terms. Consequently, a better solution is for the buyer’s and supplier’s banks to work together. The supplier’s bank is in the best position to finance the pre-shipment period, while the buyer’s bank is better able to finance the invoice period.
At RBS, we have seen considerable interest amongst our customers to find pre-shipment financing solutions for their suppliers. To achieve this, we are in the process of establishing arrangements with partner banks to facilitate financing across the entire period from order through to ultimate payment for goods by the customer. For example, we have formed a partnership with a bank in China that enables our customers to obtain pre-shipment finance for their suppliers in China, while RBS provides the post-shipment financing once the goods have been delivered. This seamless and convenient arrangement is growing in popularity, particularly as few equivalent arrangements exist.
Another way in which we see the FSCM concept evolving is in the area of einvoicing, i.e., the replacement of paper invoices with electronic data that can be transmitted and processed by both suppliers’ and buyers’ systems. There are a variety of benefits to e-invoicing, such as:
The value of e-invoicing is widely recognised, with technology vendors and banks investing in e-invoicing initiatives. Dialogue and collaboration between users and providers is being promoted at European Commission level through the European Multi-Stakeholder Forum on e-Invoicing, with a view to extending the benefit of standardised, XML-based formats offered by SEPA payment instruments further across the financial supply chain. There are still some questions in terms of whether one format for e-invoices will ultimately exist, or whether we will see multiple formats, but RBS, one of the very few banks with its own e-invoicing business, is actively engaged in discussions with customers to promote and enable e-invoicing adoption. Coupled with MaxTrad™, our award-winning SCF portal, RBS has a competitive, end-to-end proposition that encompasses not only working capital management solutions through ‘traditional’ supply chain finance, but also offers cost reduction through process efficiencies; and transparency by converting data into information.
Companies should not be focusing on optimising their financial supply chain only during periods of economic uncertainty: the benefits are apparent during good times and bad. During difficult times, FSCM, including techniques such as SCF and pre-shipment financing, offers vital access to liquidity and reduces supply chain risk. As economic conditions improve, however, companies often need to invest in raw materials and increase production capacity, which can frequently create even greater liquidity issues. RBS is an innovator in FSCM, providing the expertise, solutions, technology and funding to support buyers and sellers, whether through stormy or calm economic conditions. By leveraging this expertise, companies can optimise working capital, enhance financial processes and increase the transparency of cash flows and information.
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