The Financial Supply Chain
Corporates set the benchmark for trade finance best practices
As a response to the financial turmoil in 2008 and the subsequent economic downturn we have seen a strong increase in corporate focus for the cash that is ‘caught up’ in the financial supply chain (FSC). Due to limited credit availability in financial markets, companies had to find ‘new’ sources to unlock cash and improve working capital. One of those sources was found within the strategic relationship between buyers and suppliers.
The overarching business objectives for all parties in the supply chain are improving working capital by extending day’s payables outstanding (DPO), reducing day’s sales outstanding (DSO), while at the same time reducing inventory (DIO). However, customers and suppliers demand punctual delivery, which requires a minimum inventory level and on-time payment of goods and services. Many corporate treasurers explore the opportunities of FSC solutions to deal with the diverging (and often contradictory) objectives of optimizing working capital without reducing the inventory level. In their dire need for timely payment, suppliers offer an early-payment discount to their buyers. This poses the buyer with a trade-off between net income and free cash flow. By paying a supplier early with a discount, the operating margin will increase whereas available working capital is reduced. Early payment discount programs are focused on reducing this trade-off.
A buyer can use the treasury reserves or non-working capital cash surpluses to fund the program. However, most programs are financed with external funding based on the credit rating of the buyer. This solution will not benefit the buyer by the full amount of the supplier discount because of the cost of funding, but it will ensure that the supply chain is supported financially and reduces the risk of key supplier failures. Basically, a buyer initiates a lifeline for strategic suppliers with access to lower short-term credit terms. From a procurement perspective, a FSC program actually eliminates the ‘financing gap’, since suppliers get paid on time, while the buyer can extend its DPO and therefore improve working capital. From a sales perspective the objective can be to decrease DSO and/or accelerate the account receivables cycle. This can be achieved through similar early payment discount programs or the sale of receivables, through for example factoring and forfeiting programs.
Shifting corporate objectives
Today, we see that corporate objectives are slowly shifting from optimizing working capital towards optimizing the buyer-supplier relationships and generating short-term returns on available liquidity. Especially cash-rich companies do not search for sources of cash, but rather on how to best use the free cash flow that is available in the supply chain. These ‘pioneering’ corporates, such as Volvo, Siemens and HP are triggered to support the liquidity management of their (strategic) suppliers to ensure a reliable flow of necessary supplies. Their quest for sustainable and long-term buyer-supplier relationships push for both solutions and technology that give them the opportunity to deal directly with suppliers, and therefore they cut out banks that are unwilling to provide credit to ‘unknown’ or low rated suppliers. Although financial and economic recovery is picking up slowly, trade finance and the integration of the financial supply chain is high-ranking on the treasurer’s agenda and we might see a paradigm shift where corporates, and not banks, will set the benchmark for dealing with trade finance.