In recent years, pressure on working capital has led corporations of all sizes and industries to focus on metrics such as days sales outstanding (DSO) and days payable outstanding (DPO). The effect of this, however, can be that smaller suppliers become ‘squeezed’ as they lack the negotiating capacity and access to external financing of their larger customers, while distributors and agents – and resellers too – are obliged to meet strict payment terms, which they cannot pass on to their own customers.
Today, however, while working capital remains an essential way of measuring the health of an organisation, corporations of all sizes recognise that squeezing other participants in the supply chain ultimately reduces resilience and hampers growth. Consequently, we are now seeing corporate treasurers and chief financial officers (CFOs) seeking a more holistic approach to cash management and trade finance to increase the robustness of the supply chain and facilitate growth.
Beyond working capital
One of the reasons that the supply chains become disconnected or inefficient is that every party within it tackles their own cash and working capital challenges in isolation, and engages with their banks and external partners on this basis. Banks are therefore organised according to the specific needs of these customers, with distinct corporate banking and commercial banking divisions and dedicated solution portfolios.
However, effective supply chains are those where every participant is strong and versatile, which means breaking down barriers within the supply chain to develop solutions that align the interests of supply chain participants of different sizes and profiles. When a large corporation is seeking growth in a new market, for example, it relies on its supply chain partners – which may be smaller businesses – to have the capacity to facilitate that growth. They therefore need to work with a bank that has the ability and appetite to work with both the ‘anchor’ customer and its often- complex network of smaller suppliers and customers.
Breaking down these barriers requires a new approach, where each supply chain participant needs to be aware of the needs of their critical partners, and those of participants further along the supply chain. While in some cases the traditional forms of supply chain financing, such as post-shipment invoice financing, can help to provide liquidity and manage risk in other situations a more specific approach is required. In some supply chains, for example, the transactional activity between a supplier and its core client is quite complex, rather than simply purchase order – production – invoice.
In the automotive industry, for example, a manufacturer producing a new model needs to build up an inventory of vehicles. Consequently, their suppliers respond by tooling up, purchasing raw materials and increasing capacity accordingly, based on an initial forecast. Should this forecast then change – either upwards or downwards – or new purchase orders are issued, it can be very difficult to reconcile the financing requirements with individual purchase orders.
‘Anchor’ corporations and their banks therefore need to look at new ways to accommodate complex liquidity and financing needs across the ecosystem, and build resilience and flexibility. For automotive or fast-moving consumer goods (FMCG) for example, this could include pre-shipment finance for supplies or machinery to enable a supplier to increase capacity.
From supply to sale
It is not only in production where a more integrated approach to cash management and trade finance is becoming more important. In emerging markets in particular, sales models can differ widely, with a variety of distributor, agent and reseller arrangements, as well as direct sales. While these arrangements may be the best way of achieving market penetration and customer engagement, there may be obstacles to growth for all parties in the ecosystem.
For example, a manufacturer might have a credit line in place with a distributor of, say, US$1m. It can take some time for the distributor to receive sales proceeds from sub-distributors, creating a lag in freeing up credit limits and preventing them from sourcing more goods. This delay, in turn, hampers sales and places a limit on further growth.
To overcome this obstacle, corporations need ways to accelerate the working capital cycle from end to end, and boost working capital for its distributors. Firstly, distributors need ways to collect funds more quickly from sub-distributors or dealers. This relies on efficient cash management services from their banks, particularly to support the ‘last mile’ of the working capital cycle, which is typically the hardest.
An FMCG company, for example, may sell to distributors and retailers, of which there can be a large number. In emerging markets in particular, retailers are often small businesses compared with the larger chain stores in developed markets. These are more difficult to reach, and they have historically had limited access to efficient payment services. Similarly, with the rapid growth of e-commerce, retailers setting up online stores need payment and cash management solutions that facilitate rapid, secure and predictable collections across markets, customer segments and payment systems. While card payments may be the priority in some markets, in others, such as India, there needs to be a mechanism to make payment at the point of delivery.
For both of these situations, whether bricks and mortar or online sales, the ‘last mile’ of the supply chain is typically a cash transaction, which is expensive, slow and risky, and ties up delivery companies’ time in collecting and banking cash. As a result, it is becoming more important to work with banks that can provide mobile money solutions that can then be integrated within a wider cash management infrastructure. This can reduce delays throughout the supply chain, and therefore enable credit limits at the ‘top’ level corporation to sell more goods, fuelling growth across the ecosystem.
A strategic partner
Corporations have different levels of complexity and appetite for cash and financing solutions to manage risk and facilitate growth in their supply chains, from simple cash management and/ or supply chain finance programmes through to complex, bespoke structures. What is key, however, is to understand where the obstacles of growth lie, and the greatest vulnerabilities. While there may be challenges within the business itself, the likelihood is that the biggest constraints exist in other parts of the ecosystem, whether from a sales or supply perspective.
By working with a partner bank that has the coverage, capacity and ability to deliver solutions to large corporations through to small ‘mom and pop’ shops and retail customers, treasurers and finance managers can pinpoint these liquidity and risk challenges and structure solutions accordingly.
Supply chain finance (SCF) at its surface can appear to disrupt supplier relations and the status quo. Thus, it’s critical for treasury to champion the value of SCF cross-functionally, and the strategic value it delivers in way of specific capital allocation commitments, EBITDA guidance, or free cash flow targets previously committed by the CFO.
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