- Kuresh Sarjan
- Head of Trade Finance, Global Transaction Services, Asia Pacific, Bank of America Merrill Lynch
by Kuresh Sarjan, Head of Trade Finance, Global Transaction Services, Asia Pacific, Bank of America Merrill Lynch
Working capital management occupies a foundational role in sophisticated treasury management. With a backdrop of brewing cash pressures, challenged growth from moderating economies and fluctuating commodity prices, working capital management has seen its strategic value expand and treasurers subsequently move up the value chain.
Given its ability to increasingly influence top line growth, working capital management is now a more firmly entrenched area of the treasury function across Asia Pacific. As such, many treasurers across the region have driven a convergence of credit functions to better harness working capital opportunities. They have linked global sales teams with procurement expertise to gain greater influence and control over their organisations’ working capital strategies. Technical innovation has also been leveraged to achieve greater efficiency in their payments and collections – whether at the local or regional level. The list goes on and on, but the bar has evidently been raised.
Clearly, an awareness of the benefits of deeper and more strategic working capital is forcing corporations to transition areas of their corporate treasury to take advantage of a changing industry. But as is the case for many sophisticated finance platforms, for companies to fully harness the power of working capital management and broader supply chain finance programmes, a back to basics approach is an advisable starting point.
Back to basics
Simply put, a company’s working capital position is determined by its performance in the three key areas of payables, receivables and inventory. In practice, organisations may or may not focus closely on all three of these areas at the same time. The chosen approach will typically be determined by which of the three areas is regarded as the most strategically important.
Accounts payable is a logical starting point for enhancing a working capital strategy. From a working capital management perspective, the goal is to increase days payable outstanding (DPO) by extending the time taken to pay suppliers. However, this may be less than ideal from the supplier’s point of view. Why is this? Suppliers will typically be looking to optimise their own working capital by getting paid sooner and reducing their days sales outstanding (DSO).
In our experience, supply chain finance programmes often present a workable solution to these conflicting goals. Payments are reconciled using supply chain finance programmes, where the buyer asks its bank to finance suppliers’ receivables based on the buyer’s own credit profile. This structure also enables the buyer to extend its payment terms, thereby boosting its own DPO. Elsewhere, technology is playing a major role in pushing the boundaries of accounts payables within the supply chain. Card solutions, including T&E and, increasingly, electronic payables have made the transition from niche to sophisticated working capital solutions, and appear to indicate how the payments space is evolving.
Bank of America Merrill Lynch was recently involved in a landmark supply chain finance transaction that illustrates the benefits. A Hong Kong-based manufacturer was able to extend its supplier payment terms to 105 days by adopting supply chain finance. As well as extending its payment terms, offering supply chain finance to its suppliers helped this client improve its relationships with key suppliers, who may be able to access funding at a more attractive rate or in a preferred currency than it may be able to achieve on their own.
Accounts receivable is a major area of focus for companies in Asia Pacific and is playing a transitional role in further developing a wider working capital management environment. In essence, working capital solutions allow receivables to be collected more efficiently. The benefits are clear: the sooner cash can be collected, the sooner the company can benefit from that cash.
Control over this area is typically held by a company’s sales team and/or credit function, which will be responsible for determining whether or not credit can be extended to specific counterparties. Times are changing though. In our interactions, companies are gradually adjusting the way in which these decisions are taken and treasurers are beginning to get directly involved in this dialogue as companies seek to achieve greater visibility and control across their accounts receivable.
As they play a more strategic role in this area, treasurers are working more closely with sales teams and/or credit teams in managing account receivables. They are asking how cash flows can be enhanced. They are questioning how risk profiles can be managed more effectively. They are focusing more attention on the foreign exchange implications of their accounts receivable strategies. In the past, the level and frequency of this dialogue would have been unthinkable.
Thirdly, inventory is a large consideration. A more recent focus of treasurers, the influx of working capital management structures has ensured that a significant amount of attention is being paid to the area of inventory.[[[PAGE]]]
Programmes are also taking a local flavour. In Australia, for example, borrowing-based financing structures are being widely adopted. These structures have gained prominence whereby companies are looking to create a level of liquidity as they bring relatively homogenous goods, such as grain or certain types of metals, into their warehouses. We expect this area of working capital management to gain in prominence, especially as supply chain finance programmes become more advanced in Asia Pacific.
Supply chain finance in Asia Pacific
Although supply chain finance programmes are used around the world, the types of solutions available vary considerably across Asia Pacific and corporations are forced to adapt. In some countries, such as China and India, large domestic markets exist for the sale and purchase of goods and services. As a result, local solutions have been developed which can help support the needs of buyers and suppliers during trade transactions. In India, for example, a domestic bills-based system exists for the sale and purchase of goods, allowing companies to access invoice-based supply chain finance.
In China, meanwhile, there is a mature market for bank acceptance drafts. These are effectively promissory notes: when A sells to B, and B asks its bank to accept the draft on its behalf, the resulting instrument can be used and traded by A. In recent years, the People’s Bank of China has also launched the Electronic Commercial Draft System (ECDS), which enables drafts to be sent and received electronically. The advantage of this is that the new system is more efficient than the previous, paper-based system and significantly reduces the risk of fraud.
Regional variations mean that some companies will have a variety of different programmes in place across different markets. Companies with deep local market requirements in China, for example, can work closely with the ECDS. Other companies may aim to create a programme which can cover the entire region and establish a regional hub in one of the countries with more open exchange controls, such as Australia or Singapore. Companies with a fully international footprint might aim to put in place global programmes in order to support suppliers from Europe, the Middle East and Asia Pacific. The chosen approach will depend very much on the specific needs and geographical footprint of the company.
Local and regional approaches are not mutually exclusive. A company might have specific in-country needs which can be met using local programmes. However, that same company might also create an Asia Pacific hub in order to adopt a more regional approach for other countries.
Innovation and development
As supply chain finance has become more mainstream, technical innovation has inevitably seen its influence spread. In addition to government mandated systems, such as China’s ECDS, banks are creating channels which enable their banks to use supply chain finance through their proprietary bank systems. Select banks are also working to electronify the underlying documents associated with trade transactions, such as letters of credit. Some external providers offer a range of services which can support companies with the preparation of documents.
As digital solutions begin to play a more significant role in regional trade and supply chain structures, it is likely that corporations in Asia Pacific will increasingly turn to agnostic platforms which can support the move from physical to electronic trade finance. For example, corporations in the region are showing significant interest in electronic document presentation solutions which can provide additional security while supporting companies’ working capital goals.
In a more recent development, companies are adopting solutions which do not include a bank finance component. With many companies in the region currently holding significant levels of liquidity, and reluctant to take on bank debt, greater interest is being shown in the buyer-funded supply chain finance model. Using this model, the buyer funds early payment to suppliers using its own liquidity – effectively financing its own accounts payable. The bank, meanwhile, provides the infrastructure, systems and discipline on which the supply chain finance programme is based.
Conclusion
With companies focusing on the full range of activities relating to working capital management, supply chain finance is the game changer. It continues to show its mettle as a transitional solution capable of helping companies achieve their goals. At the same time, technical innovations at the local and regional levels are enabling companies to manage working capital more effectively. Treasurers looking to take advantage of these opportunities should aim to work with experienced banks which can help them adopt suitable structures across the region.
