Using Financial Supply Chain Management to Support Working Capital at Tech Data Corporation

Published: February 01, 2009

by Helen Sanders, Editor

Tech Data Corporation is one of the world’s largest distributors of technology products from leading IT hardware and software producers. Since its formation in 1974, Tech Data now serves more than 100,000 IT solution providers in over 100 countries. Every day, these value-added resellers depend on Tech Data to support the technology needs of end users cost-effectively, including small and medium businesses, large enterprises and government agencies. Ranked 105th in the Fortune 500, Tech Data generated $23.4 billion in net sales for its fiscal year ended January 31, 2008.

The Importance of Margins

Tech Data is a low-margin business with the cost of goods more than 95% of sales revenue. It is therefore vital for senior executives to find ways to preserve margins and retain the firm’s competitive edge. There are a variety of factors which can affect margins - for example, inefficiencies in the physical, information or financial supply chain.

There are a variety of factors which can effect margins - for example, inefficiencies in the physical, information or financial supply chain.

Tech Data actively manages its financial supply chain in order to maintain working capital. The company avoids using financial institutions wherever possible, reducing interest costs and thereby creating benefits for its suppliers, customers and shareholders. Tech Data has provided roughly $600m of net cash through its operating activities over the past three years and sales have increased by almost $3bn. Treasury has had a major part to play in this business transformation. For example, by extracting liquidity by working the financial supply chain harder, Tech Data’s net interest expense fell by $13.4m or almost 50% in 2007 without compromising its customers or suppliers.

Executive Information System

Tech Data’s Treasury has achieved this in a variety of ways. As Wayne Whitaker, Director of International Treasury explains,

“First, we needed to increase our visibility over cash balances, funding needs, and FX exposures across the business. To do this, we implemented an executive information system (EIS), which comprises two elements: cash and FX exposures. The solution is now used across our subsidiaries to gather and analyse data in a consistent and timely way. We now have substantially greater visibility than before, with very little increase in the workload for our subsidiaries. They were already producing this data and using it to manage their own business activities. It takes them only a few minutes to report information to us.”

Cash Management

As well as enhancing its ability to view cash positions and FX exposures, Treasury also wanted to gain better control over the company’s current cash position. For example, in Europe, cash had been dispersed across a variety of banks and accounts in each country, so it was difficult to identify and manage the net position. To address this, the decision was made to select a pan-European cash management bank and implement a physical cash pool in countries with euro cash balances (fig 1).

This solution has proved extremely effective. The number of accounts and bank relationships, which the company needs to maintain, has fallen dramatically so cash is now more visible and accessible to Treasury. In the past, intercompany loans were maintained manually through an in-house bank, but the cash pool has enabled Tech Data to automate many of the intercompany loan processes. [[[PAGE]]]

Cash Days

Tech Data uses cash days as a metric for measuring working capital requirements. The number of cash days is calculated by adding days sales outstanding (DSO) and days inventory outstanding (DIO) and subtracting days payables outstanding (DPO). For example, if DSO = 35 days, DIO is 45 days and DPO is 15 days, the total cash days is 65 days (35 + 45 - 15 days). Therefore, if sales are $5bn a year, daily sales are $13.7m. The cash required to run the business is the daily sales figure multiplied by the number of cash days = $890m. It is of critical importance for Tech Data to keep the number of cash days to a minimum to reduce the company’s working capital requirement. Each business unit is measured and compensated on the individual metrics which constitute cash days.

Borrowing Limits

Treasury establishes internal borrowing limits for each business unit which enables the company to control and forecast its overall borrowing requirement whilst recognising the differing needs which exist across the business. These limits are based on the prior year’s average debt, or the cash position of the same quarter of the previous year, which are therefore reset quarterly. Sales volume, the number of cash days, capital structure and profit/loss of each business unit is also taken into account, adjusted for after-tax non-cash items and purchases of fixed assets. Intercompany borrowings are monitored on a daily basis using the EIS.

Alternative Financing

Alternative financing is an area which has grown dramatically in recent years, and trade finance divisions of financial institutions have a range of offerings for their corporate customers. For example, receivables financing, such as asset-backed commercial paper, on- or off-balance sheet factoring and various forms of vendor financing are becoming increasingly common. Tech Data has an asset-backed commercial paper (ABCP) programme in the United States backed by its accounts receivable. There are also similar schemes available in Europe, but Treasury has not yet taken advantage of these due to their higher cost relative to other sources of funding available to the company. Recently, since the high profile problems in mortgage-backed programmes, investor interest in ABCP has fallen, even those with very reliable collateral. Whitaker gives his advice on alternative financing,

“We have two off-balance sheet factoring programmes; one in Europe and one in the United States. These programmes require significant preparation up-front, including negotiation with the financial institution and working with the lawyers and auditors. An important issue to look at is pricing. To achieve the most competitive rates, it is important to sell

receivables from counterparties with a stronger credit rating. Credit insurance is a significant issue. We found that with credit insurance in place, we could achieve far more favourable pricing as the credit rating of the insurance company could replace a weaker rating of a customer. Although credit insurance has a cost, in the form of the premium, the incremental difference in the cost of the financing programme significantly outweighed this. In reality, without this insurance, the economics were significantly reduced.

The overall structure also needs to work operationally, supported with the necessary reporting etc. Once the programme has been negotiated, an upfront audit of credit and collection processes takes place to ensure that these are reliable. There are sometimes surprises, which may need to be resolved creatively. For example, as part of our European programme, we sent details of 25,000 invoices, which were to be sold to the financial institution. The spreadsheet was too large even when compressed, so it could not be processed. We sorted the invoices by value, deleted the bottom 10,000 invoices and then re-sent it. The file was 40% smaller so it could be processed, but there was only a 2% drop in the value of the invoices sold.

An alternative to off-balance sheet factoring is vendor financing although Tech Data only does this to a limited degree with one large vendor. Vendor financing typically works best with vendors who have a lower credit rating. The bank advances funds to the vendor in advance of receiving the money from the customer (fig 2) so the bank takes on the payment risk.

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Vendor financing brings additional benefits to vendors. Amounts are generally paid without debits, so reconciliation is easier, and as payments are made on time, cash flow forecasting can be performed more accurately. Vendors can reduce customers’ credit line usage (and can therefore sell more to them) as payment is quicker, which is a benefit for both vendors and their customers. Credit insurance can also be reduced or eliminated, which reduces costs further.

Successes and Challenges

Tech Data has made significant progress in optimising its financial supply chain and therefore improving working capital. There have been a variety of factors, which have contributed to this success, as Whitaker explains:

“We had initial buy-in from senior management and spent time planning up-front. We took care in selecting the right banking partner who was willing to develop new services for us, and approach issues in an innovative way. We used tangible metrics to help us measure performance and identify progress and scope for improvements.

Tech Data has made significant progress in optimising its financial supply chain and therefore improving working capital.

A project like this requires significant resources, and it can be difficult to free up the necessary individuals’ time from the business units and IT. As a long and involved project, it is important to maintain momentum including buy-in from management and business units throughout the process, which is not always easy alongside other priorities. Interfaces between the bank’s systems and a firm’s ERP system need to be set up, which takes time and resources. The legal processes can eat up a great deal of time as well.”

Conclusion

Now more than ever before, corporates need to make their balance sheets work harder, particularly by sourcing liquidity internally and freeing up working capital. Although a project to optimise the financial supply chain may be resource-intensive, maintaining liquidity is key and there are potential savings to be made in interest costs. If there is no further capacity within the financial supply chain, or the company needs cash faster, then financial institutions and trade finance groups can help to use assets and liabilities efficiently as a source of working capital. With difficult times now affecting all companies, optimising the financial supply chain has become a vital way not only to maintain liquidity, but also to support vendors and customers.

With many thanks to Wayne Whitaker, Director of International Treasury, Tech Data Corporation, for his assistance with this article, based on a presentation delivered at the EuroFinance Conference, Barcelona, October 2008.

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Article Last Updated: May 07, 2024

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