Financial Supply Chain: Developments in Asia

Asia has cemented its position as a key treasury hub, with many high-ranking corporate decision-makers operating out of this region. Global corporate treasurers are now based out of Asia in order to keep a tighter grip on the financials of their subsidiaries.

The region is still viewed as the ‘workshop of the world’, and large buying entities in the US and Europe are aware of the importance of having a firm anchor amid the supplier base. Popular locations for regional treasuries include Singapore, where 60% of the regional treasury centres in Asia are located; Bangkok, which is considered as an access point to a large manufacturing base; and Hong Kong, the gateway to China and northern Asia.

Capitalising on the Budding Recovery

Asia is where the pulse of the global economy can really be felt. It is seeing an increase in production due to the resurgence in global and intra-Asia trade. Worldwide consumer demand and purchasing is rebounding, plus wages across the Asian nations are rising, which is boosting internal demand for commodities.

Many treasurers are asking how can their banks help them ‘upturn the downturn’? How can they capture this growth opportunity in Asia and leverage the potential in their supply chain to monetise the investments they put in during the downturn?

The overarching business objectives must be to improve working capital by extending days payable outstanding (DPO), reducing days sales outstanding (DSO), while at the same time reducing inventory to as low as possible. The challenge for the business is the need to be able to meet service level agreements (SLAs) by delivering goods on time to its customers. Therefore, the company has to maintain a minimal quota of inventory or it won’t be able to fulfil its SLAs.

How can treasurers accomplish these diverging – and at times opposing – objectives to optimise working capital while not being able to reduce inventory level? One can argue that it is similar to walking on a tightrope and balancing between competing goals. This dilemma has led many corporate treasurers to explore a financial supply chain (FSC) solution as an avenue to stay ahead of the curve.

As the recovery picks up pace, a company can start to feel squeezed with increased orders flowing in because it is constrained by an internal credit limit based on the past few years’ trade volume. Its buyers, distributors or channel partners will need more stock. Even if the factory can ramp up production, the company won’t be able to respond immediately because of its internal credit limit. And it can’t change its limit overnight because increasing the credit facility means increasing its risk profile.

In this scenario, the corporate’s procurement will also increase. A good example is where a computer company is looking to increase production because its retailers in Singapore are responding to the latest news that 74,000 employees across the country are expecting to get a year-end bumper bonus this year. They are anticipating that the consumption of high-end goods, such as computers, will dramatically increase following the bonus.

It creates a domino effect: more orders means the manufacturer needs to buy more materials, such as memory chips, casings and computer bags. Will its supplier have the working capital to support the increased number of orders? Unless a company is well positioned in terms of working capital, it will not be able to capitalise on the recovery and may affect others further along in the supply chain.

This is the point where a bank with a FSC solution can help to bridge the gap so the corporate could take advantage of this opportunity to increase its business. The bank’s role is to support both buying and selling activities by helping the corporate, or anchor client, reduce DSO and extend DPO to improve its working capital.

Improving Working Capital

 

Figure 1. Working Capital Management: Competing Objectives

Source: Deutsche Bank

A typical supply chain would normally begin with an order. For example, a buyer – which is the bank’s client in a FSC solution – places an order with the supplier. Supplier confirms the order, buys the raw materials and begins production. Once the production is complete, the goods will be shipped to the buyer. The buyer will normally wait until the end of the payment terms – i.e. 60 days – to make the payment to the supplier, even if it receives the goods much earlier.

It is obvious that in this typical transaction scenario, there are potential areas for efficiencies that can be unlocked.

Procurement

In general, procurement’s main key performance indicator (KPI) is increased DPO. In order to extend DPO, a buyer can increase the suppliers’ payment terms to 180 days, for example. But many suppliers may need payment earlier in order to pay for their raw materials. Instead, the buyer can set up a payables financing programme. This refers to financing given to the supplier based on the confirmed payables of the buyer. Although the term is 180 days, the supplier will receive payment from the bank on the 60th day, with a slight discount.

Suppliers are receptive to this type of programme because they are able to receive their money early and do not have to take out a loan or provide collateral. The funds are given to them on the 60th day without any recourse, which means that the bank will not pursue the supplier if the buyer does not pay the bank at the later date.

The supplier finds it attractive despite the discount because anchor clients are normally investment-grade and the bank’s interest charged in this programme is based on the anchor client’s good credit rating. Suppliers, who are generally a few rating notches below the buyers, would not be able to enjoy such a good rate if they had to approach directly for a bilateral bank loan.

It is a win-win situation. Suppliers get their money early with an interest discount, which is attractive due to the good credit rating of their buyer, and the anchor client gets an improved DPO, which impacts its working capital.

Sales-side

The sales-side is made up of another group of professionals such as commercial directors and commercial or sales managers. Their job is to collect money earlier, decrease DSO and accelerate their accounts receivable (A/R) cycle. They can either do that by selling their A/R in an A/R finance solution or enter into a programme called distributor financing.

In this programme, the bank purchases the receivable from its anchor client. When this receivable comes off its books, they can record the external revenue. For example, if a receivable is due in 60 days, but the bank purchases the receivable on Day 10, they can book the revenue at that point on Day 10 instead of 60 days later.

If their objective is reduced DSO, then this is the ideal solution. But if their objective is to increase revenue and sell more, then the bank can set up a customer finance programme, effectively giving a loan directly to the buyer so that it can buy more.

On behalf of the buyer, a bank will pay its anchor client so that its DSO is not affected. This means that the anchor client is still getting paid on time but the bank is taking a risk on the buyer.

Rolling Out a FSC Programme

There are two trends illustrated by corporates that roll out a FSC programme on a regional basis, depending on whether the corporate has a centralised or decentralised internal structure.

First, clients with a centralised procurement model are more inclined to roll out a centralised FSC programme. For example, a client based in Hong Kong would roll out a programme from Hong Kong, providing financing to suppliers in the other countries in Asia. Normally there is harmonisation in the purchasing currency in a centralised programme, for example in US dollars or euro, where the company would negotiate one price with the bank and apply this pricing throughout.

However, some clients have a decentralised treasury operation, so the decision-making takes place in-country. Decentralised programmes are usually at regional shared service centres (SSCs), where the corporate has more purchases in local currency.

Another indication of the type of approach is if the globalisation of sourcing is important to a certain industry, for example the garment industry where the sourcing of cotton has to be centrally controlled. Those corporates that deal with raw materials that are traded in a controlled manner tend to have a much more centralised approach.

Aligning KPIs

To this end, the approach adopted is not pivotal to the alignment of the KPIs, given that the main aim of a FSC solution is to help improve a corporate’s working capital management. However, often the ramp up takes longer than expected – predominantly due to competing KPIs of the different business units.

For example, the procurement organisation may be trying to reduce costs. In order to achieve this, procurement managers would try to negotiate a discount with a supplier. On the other hand, the treasurer may be trying to expand the DPO. Both objectives can’t be at a maximum because in order for a procurement manager to get a significant reduction, the supplier would ask for earlier payment.

It takes some effort to get a successful FSC process going, not because the values or the benefits are difficult to see, but because the corporate must have buy-in from the various functions across the organisation. Fundamentally, procurement and treasury need to converge in terms of their objectives.

From the start, the anchor client needs to have collaboration and convergence in terms of targets or vision within their own organisation because there are many touch points when it comes to buying and selling. It is quite common for the many different functions to meet for the first time during a FSC programme meeting.

Before the supply chain came into the picture, each one was working in isolation: one was solely focused on DPO, another on DSO, for example. In getting everyone around a table, they would gain a better understanding on how working capital impacts DPO and DSO.

Identifying Benefits

The FSC solution is particularly beneficial to corporates with numerous product lines, such as in the hypermarket, retail, garment or consumer sector. Companies in these sectors have a very large supply base. They may have a few Tier 1 suppliers, which could stand on their own credit rating and will not be interested in a FSC programme. However, the Tier 2 or 3 supplier base, which could potentially be a few thousand suppliers, may find such a solution appealing because they will receive early payment.

When rolling out a FSC programme, the anchor client needs to co-ordinate closely with the bank because it is providing its credit rating to bring about a low interest rate for its supplier. The bank can use a cost/benefit analysis to show suppliers – particularly if they are small and medium-sized enterprises (SMEs) – how their balance sheet and profit and loss (P&L) will be improved by being a part of the programme.

There are also a number of more intangible benefits to be gained from a FSC programme. In the fast-moving consumer goods (FMCG) industry, many brands want to demonstrate that they are a socially responsible corporate. They would launch a supplier finance programme to show that, even though they are asking their suppliers to extend payment terms, they are not leaving them to struggle alone.

Another benefit is the strengthening of the relationship between the large buyer and its suppliers. In addition, a large buyer could use this as opportunity to renegotiate terms with its suppliers to reduce pricing and extend payment terms.

Hypermarket Case Study

Hypermarkets are normally faced with having to work with a very large supplier base. A single hypermarket could easily have 2,000 to 5,000 suppliers in China.

To be successful, the bank providing the hypermarket’s FSC solution needs to have in-depth knowledge of how the Tier 2 and 3 suppliers operate, because their behaviour is normally quite different from the Tier 1 suppliers. Under the vendor management programme, a bank can gain a thorough knowledge of the supplier base and behaviour. It can develop profiles of each supplier and integrate them into a risk management analysis.

Through this programme hypermarkets gain significant financial benefits; for example, due to the lower interest rate that the hypermarket has brought to its suppliers, the suppliers are now able to either sell the goods to the hypermarket at a lower price or give a rebate.

A company with a better credit rating can technically lend its credit ranking to offer a better interest rate pricing to its counterparty that has a lower credit rating. This is called arbitraging of interest rates, and could be a useful tool to employ in such a scenario. This also means that the anchor client may potentially benefit from a lower cost of goods as a result.

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