Published: June 16, 2011
Financial supply chain (FSC) management is a concept that has become increasingly familiar since the economic crisis as treasurers have tried to reduce their dependency on external lending by managing working capital more effectively. While the immediate crisis may have passed, the benefits of an approach which fully integrates the relevant financial processes have proved compelling for companies. Treasurers have recognised that they can enhance the value they deliver to the organisation by influencing the elements which contribute to working capital and speeding up the cash cycle, as opposed to simply dealing with operational outcomes. To develop a holistic view over financial processes, and to align the physical and FSC, a new approach to financial management must be defined that is less focused on individual processes and/or departments, and more on the overall needs of the business.
Key to a company’s success is the alignment of the physical supply chain and FSC, which should be connected by an accurate and timely flow of information. The physical supply chain is often considered as a ‘one way’ flow of goods and services. In reality, this only tells half the story, as companies will be sourcing goods and services as well as producing them. This is a crucial distinction when it comes to understanding the FSC and its relationship between working capital and liquidity management. In many respects, it is useful to think of the FSC as being a parallel, but reverse process to the physical supply chain, supporting the flow of goods in two directions. Consequently, an effective FSC approach combines both order-to-cash (i.e., customer order through to collection and reconciliation) and purchase-to-pay (issue of purchase order through to settlement of invoice) processes. By aligning the two, e.g., improving the information flow on which cash and liquidity management decisions are based, will have a dramatic impact on working capital and balance the need for working capital financing.
Despite the potential benefits, treasurers frequently need to justify an investment in optimising the FSC, and their role in doing so, particularly as they do not necessarily have direct responsibility for all the relevant areas such as purchasing or customer collections. In many companies, there has only been an emphasis on optimising the physical supply chain, introducing highly sophisticated processes and systems. In reality, however, investing in the FSC is just as, if not more important. A company’s overriding responsibility is to deliver stable returns to its shareholders, and the goods and services which it provides are the mechanisms to do this, not the other way round. Consequently, investment in the FSC is key to a well-managed business with consistent returns and a competitive margin. Furthermore, while the treasurer often influences, as opposed to directly controlling, many of the elements involved in the order-to-cash or purchase-to-pay process, s/he is ideally positioned to oversee how these processes contribute to an effective cash and liquidity management strategy.
Since 2008, awareness and expertise in FSC management has developed considerably as more and more companies have achieved tangible successes. Working with the right banking partner, with the solutions, organisational structure and collaborative approach is crucial. It has become apparent to many companies that the traditional structure within banks, with the business organised around product silos, does not accommodate the holistic approach that they require. Instead, the bank partner that supports an FSC optimisation programme needs to be organised around the needs of the customer from end to end. The bank needs to facilitate solutions that integrate disparate processes and departments, and promote internal and external collaboration.
Secondly, the bank needs a deep understanding of the full order-to-cash and purchase-to-pay cycle, how these connect with the physical supply chain and how to align the two. By doing so, financial events linked to the receipt of orders from customers or the issue of orders to suppliers can be initiated as efficiently as possible. Similarly, financial events (such as late customer payments) can be used to influence decisions dynamically, such as customer credit lines or payment terms. To achieve this, the partner bank needs to combine the right skills, and adopt a disciplined approach to understanding, prioritising and recommending solutions to customers’ FSC challenges. At ING, we start by conducting a two to three hour interview with all the departments in the client organisation that are engaged in order-to-cash and purchase-to-pay processes, from customer credit through to purchasing. This ensures that all departments are engaged, with each department’s individual challenges incorporated, as well as the overall financial objectives of the company. Once this process has been completed and priority areas identified, we then conduct a ‘deep dive’ with the client to determine realistic solutions to these challenges.[[[PAGE]]]
Every company’s FSC differs, from the rudimentary to the highly complex, not least according to industry, business model, diversification and degree of centralisation. This results in considerable variety in FSC optimisation projects, with every client having slightly different challenges, priorities and solutions. With one client, for example, ING conducted a detailed analysis of days sales outstanding (DSO) in each country, revealing dramatic differences that were hampering efforts to optimise working capital. Consequently, ING embarked on a project to centralise collections and achieve consistent processes, standardise DSO and improve intelligence on customer behaviour and credit risk. In addition, as the company extended its geographic scope, and risk to customers and suppliers became more difficult to quantify, we helped them to extend the use of letters of credit (LCs). The result of this project has already been considerable and the company expects to improve working capital by 30%. While this degree of improvement is unusual, a well-implemented FSC project should always deliver working capital benefits.
System integration or consolidation of different IT platforms is frequently an important part of an FSC management project.
In another client situation, a variety of solutions are being implemented in parallel. An e-Invoicing project is underway, which will be integrated in the wider FSC optimisation initiative. Ultimately, this will comprise a comprehensive payment factory. With different elements to the project, different teams have worked on each solution, co-ordinated within a single management and project structure to ensure alignment with the overall project goals. The company is on target to achieve its efficiency, automation and cash acceleration objectives and deliver reductions in costs and administrative overheads.
A third client has focused more on the efficiency of processes and transparency of information. This has allowed treasury to replace local, bespoke working capital financing tools with a central financing capability. This approach is delivering considerable improvements in the discount rate achieved, and reducing overall financing costs by enabling cash surpluses in one part of the business to be netted against deficits in another.
An FSC management project is frequently complex, not least due to the variety of departments, systems and processes that are involved. Senior managers need to be convinced of the benefits to their own department as well as to the company as a whole. The project also needs to be balanced against other priorities, projects and calls on resourcing both at a department level and overall. Achieving this is not easy, and means that the partner bank needs to work with the key decision-makers across the client organisation to understand concerns, articulate the benefits, create a cost benefit analysis and design a realistic project plan. Furthermore, the project needs a high-level sponsor within the organisation to help identify and prioritise projects and resourcing.
Technology is frequently a key factor in the success of an FSC project, both specialist technology for specific processes such as e-Invoicing, bank connectivity, payments or collections, as well as more general financial systems. Achieving the right degree of integration between the physical and FSC requires effective information flows between the two, so system integration or consolidation of different IT platforms is frequently an important part of an FSC management project.
The need to accelerate the cash flow cycle and reduce costs by increasing operational efficiency and control are firmly positioned amongst treasurers’ top priorities. Opportunities presented by technology to automate processes, encourage further collaboration with suppliers and customers as well as with banks, and enhance the information flow across the organisation will also act as enablers for further progress in FSC optimisation.
Basel III will increase the cost of funding and encourage both banks and their corporate customers to seek new ways of financing the business and de-risking the FSC. Consequently, this area will become an even higher priority for companies of all sizes and in all industries. Once the processes that make up the FSC have been enhanced, the opportunity to implement alternative forms of financing such as supplier financing and receivables discounting is increased. The better the information flow, the higher the proportion of receivables that can be discounted, for example, and the better the rate. Techniques such as dynamic discounting are also becoming more popular as companies seek to automate financing decisions and events and to reduce administration. FSC optimisation is now well established but its potential remains largely untapped. Companies who will be most successful in an ever-changing economic and competitive environment will be those that have automated, and optimised the transaction and information flow to make dynamic decisions and reduce reliance on working capital financing.
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