Jon Richman, head of Trade and Financial Supply Chain Americas, Global Transaction Banking, Deutsche Bank, discusses the importance of one day’s workflow and the value that financial supply chain solutions can bring
As recently as 15 years ago, the market was still beginning to become acquainted with financial supply chain programmes (FSC); then came an era of economic turbulence and poor liquidity. The perpetual struggle between buyer wishes – for DPO (days payable outstanding) to be as long as possible – and seller needs – for the shortest possible DSO (days sales outstanding) – became even more challenging than before.
In the following years, the economic and socio-political volatility still felt today emphasised the importance of stabilising supply chains and securing trading relationships. Equally thrown into sharp relief, thanks to the accompanying liquidity drought, is the need for sustainable liquidity and access to working capital at low costs.
Accessing internal sources of liquidity while improving trading terms for both sides – and thereby strengthening counterparty relations and the supply chain as a whole – can be seen as the culmination of solutions to these market challenges.
Strong liquidity from a confirmed and dependable source – as is the case when it comes from within your own cashflow – mitigates the risk of shocks of any kind weakening the supply chain. Such sources of liquidity also address both direct and indirect effects of the new regulatory landscape – such as reduced bank appetite for lending due to Basel III’s mandate for a greater amount and higher quality of capital to be held on bank balance sheets.
It is these factors that contribute to two-thirds of respondents emphasising the importance of supply chain finance in a recent global Chamber of Commerce survey. The way that financial supply chain programmes address the complexities of the trade landscape has meant that what were previously unfamiliar solutions spearheaded by banks have become largely commonplace and actively sought by corporates; a significant about-turn in the course of just a few years.
The current popularity of such solutions – particularly amongst multinational corporates (MNCs) – is undoubtedly set to continue, and is illustrative of a market keen to enhance working capital in a sustainable and mutually beneficial fashion.
With levels of awareness and implementation high, now will mark the beginning of a period of maturation for these solutions: corporates with an FSC programme in place should leverage granular and contextualised metrics to assess how much “added-value” the solution has brought them, how it measures up to industry benchmarks, and where they can extract further improvements.
By looking beyond initial implementation to a more targeted and holistic utilisation of these programmes, the advantages they offer can be maximised to the benefit of the supply chain as a whole.
Turning the spotlight on accurate performance indicators in this way aligns corporates with the current market trend for determining, reporting and leveraging data in increasingly granular and timely ways – all striving for greater visibility and thereby control.
Magnifying treasury functions can uncover opportunities for further cost savings, value generation or efficiencies. It also gives treasurers a clear insight into the quantifiable value of FSC solutions – best achieved by breaking data down into small units of comparable measurement.
For example, by drilling down into a 24-hour period, an exact figure for the additional cashflow generated by an FSC programme can be held up against peer equivalents, industry averages and best-practice benchmarks. At a time when treasurers are increasingly required to achieve more with shrinking resources, such metrics can prove vital. Certainly, treasurers dedicated to best results will quantify and evaluate the enhancements gained, and seek the next possible area for improvement.
The value gained
Two of the most widely implemented FSC programmes are supplier finance and accounts receivables (AR) finance – both support treasurers’ objectives to add value. While the former allows buyers to pay at a later date without disadvantaging sellers, AR finance entails selling accounts receivables to an FSC provider, thus accelerating cashflow and mitigating counterparty risk.
Both essentially work by improving working capital; shortening the length of time it takes to complete the cash conversion cycle (CCC). A CCC is the entire workflow from cash being converted into inventory and accounts payables (AP) through sales and accounts receivable (AR) and back into cash. Accelerating that cycle clearly means that more capital is cash for longer – providing the corporate with an internal source of funding at a far lower cost than external alternatives.
The CCC is calculated by DSO – DPO + DIO (days inventory outstanding). Therefore, to shorten the cycle DPO (the payment conversion period) must be extended and DSO (period of receiving and processing payments) must be reduced, resulting in additional cashflow. FSC achieves this, and the amount of additional cashflow can – and should – be calculated as well.
From this point, treasurers can go on to quantify the average cashflow improvement created within a one-day time period. Of course, treasurers could go on to look at even smaller units of time than this if they wished, but the importance of one day in working capital makes it a key figure for illustrating the difference a supply chain programme can make.
That being done, however, the figure for a day’s additional cashflow can be used to reveal further (and more practical) insight. In order to make these calculations more informative, a treasurer should translate them into a value of “applied worth”. The precise value is dependent, in a sense, on the corporate’s individual circumstances – where the cashflow can best be leveraged to add value, and how the company therefore chooses to use it.
For example, if a treasurer used US$10m additional funding to replace short-term debt valued at “two per cent”, for example, the additional cashflow would have an applied worth of US$200,000 annually, having saved that amount in financing costs.
However, perhaps the treasurer assesses that the additional cashflow is better utilised to invest in capital expenditures or a special project, in this case the US$10m might have an even higher value, for example at the 11 per cent of the corporate’s current weighted average cost of capital (WACC). Leveraging the data in this way can indicate the true value of FSC schemes – and can even be used further to calculate added worth in terms of share prices or returns.
Accessing the benefits
Companies that have yet to implement such a programme, may wish to consider accessing some of this “added value” for themselves. The importance of working capital to corporates of any size cannot be underestimated – it is what allows the day-to-day machinations of business to occur.
Within the considerations surrounding implementing an FSC programme must come the choice of what type of programme is right for that corporate’s individual needs. Supplier finance – which was first taken up by retail corporates – can be better suited to industries where large, creditworthy buyers have access to relatively cheaper capital than their smaller suppliers.
A treasurer considering supplier finance should question to what degree improving DPO from its current state to “best in class” will improve cashflow and to what degree their suppliers are likely to engage with such a programme. They should also consider costs and the complexities of securing stakeholder buy-in, since supplier finance may necessitate changes to the corporates’ IT infrastructure.
AR finance, on the other hand, was initially adopted in the technology industry where large OEMs (original equipment manufacturers) wielded considerable influence over smaller device and chip makers. AR can be implemented with minimal time or financial costs, but a treasurer must still determine the amount by which their working capital will be improved – and the applied value of that improvement.
As well as industry-specific considerations and calculating the benefits, treasurers should be aware of the potential pitfalls of implementation. A corporate that does not lay out clear goals – nor ensure such goals are shared across the group as a whole and between departments, stakeholders and other interested parties – risks a protracted or unsuccessful implementation process; equally possible if there isn’t a clear company-wide mandate stating that the programme is a priority.
Just as damaging can be neglecting to design an FSC solution that is truly “win-win”. If the corporate implementing the solution pushes to receive all the benefit to the detriment of their counterparties, they will soon come up against resistance to on-boarding. Finally, employing a strong banking provider – with significant experience in this area, and prepared to support the corporate throughout the process, from planning to educating the procurement team for supplier engagement – is crucial to successful implementation.
As treasurers further develop their department from being a cost centre to a value creator, FSC programmes are certainly one manner of doing so. But for corporates that have already come to this realisation and implemented such a scheme, the work does not stop there – by producing and leveraging granular metrics, treasurers can continue to explore the extent to which these solutions can be exploited for trading, liquidity and risk mitigating advantages, to the benefits of themselves, their trading partners and supply chains, and global trade as a whole.