Corporates are constantly looking at different ways of optimising and releasing working capital in their financial supply chains. Some of the common strategies include:
- Working with the sales department to shorten credit terms: shorter payment terms for your customers will reduce your need for (and cost of) funding and will free up working capital.
- Ensuring that correct documents are presented under a letter of credit (L/C), so the L/C can be discounted immediately.
- Working with the procurement department so that they understand the importance of quick invoice approval processes, allowing cash discounts for prompt payment where possible.
- Some companies have gone so far as to extend day’s payables outstanding (DPO) into the 120-day range. A supply chain finance (SCF) programme from your bank can help to achieve this.
- Inventories have been streamlined and the supply chain designed to optimise transport hubs and warehouse locations, while reducing the raw materials and finished goods inventories.
In order to put these working capital optimisation strategies into practice, it is necessary for different parts of the company to work together. The first step for many companies is often to gain commitment and a mandate from management for a working capital programme.
Working Together: The Working Capital Council
Many larger multinational companies (MNCs) have set up a working capital council to facilitate the process. The council consists of executives with decision-making mandates from various business units – including treasury, procurement, logistics and sales, as well as global or regional units. This enables the council to review the company holistically.
Working capital councils are recommended for big organisations – they are the ones that tend to work in vertical chains of command – or silos – and sometimes lack cross-departmental oversight. Many MNCs have already made substantial progress with their working capital programme. Once the council has been set up and management is committed, the next step is to identify where the greatest working capital improvements can be made.
While reducing a company’s day’s sales outstanding (DSO) can release significant amounts of working capital, it’s also worth bearing in mind that adjustments to DPO will affect suppliers too. The companies that ensure the financial health of their suppliers will ultimately benefit.
It’s also important to define key performance indicators (KPIs) that enable the different departments of the company to work towards common goals. The treasurer can play a role in planning a joint agenda within the working capital programme, as well as making management aware that working capital is an area that needs focus.
Going Further: Getting Value from the PO
Many companies may already be familiar with the strategies outlined above. But there is much more to optimising your working capital cycle – and more products and capabilities will be introduced to the market in the next few years that will take working capital optimising even further.
Currently the issuance of an invoice is the starting point for most financial transactions. It is the trigger event for various factoring solutions and part of a L/C presentation.
However, the purchase order (PO), which is issued much earlier in the supply chain, also has the potential to trigger financing solutions, only if reliable data could be communicated from the corporate to the relationship bank. When the PO is confirmed by the production unit, or counter-confirmed by a customer, companies store this data. This data is potentially valuable if it is shared with your bank.
Accessing this data will enable the company to create leaner processes, gain a lower cost of capital and improve cash flow forecasts, as well as improve their foreign exchange (FX) hedging and their days inventory outstanding (DIO). By having the data much earlier in the process, companies can gain efficiencies throughout their working capital cycle – by unlocking further DSO and getting discounts in accounts payable (A/P).
Corporates usually retain PO information in their enterprise resource planning (ERP) system. However, the data is not necessarily fed automatically into the treasury management system (TMS). The data may be held on Excel spreadsheets in different departments throughout the organisation; or if the logistics system or ERP system is not up-to-date, the data may not be easily communicated between modules. Companies working with old legacy systems in a siloed structure will find it difficult to access the data at an early stage of the financial supply chain.
One of the challenges of capturing PO data is that there is no standardised process. Instead it varies from company to company, depending on their ERP system, TMS, whether or not they use SWIFT’s Trade Services Utility (TSU), and the company structure.
As many companies invest in electronic invoicing (e-invoicing) infrastructure (particularly in the Nordic region), capturing PO data is something that can be incorporated into this process. Rather than simply converting the paper invoice into an electronic process, companies can take this a step further by adding other documents to the process, including POs.
Early Intervention: Avoid the Bullwhip Effect
As your logistics system starts tracking the PO, so should corporate treasury. Chief financial officers (CFOs) need to capture early warnings about disrupted supply chains. The sales department may need to contact the customer to keep them abreast of the development, while the shipping department will need to cancel or rebook shipments for the goods.
The ‘Bullwhip Effect’ means that any small delay at an early stage in production could have a longer delay further down the chain – for example a production delay of one day may mean the shipment date is missed, incurring a prolonged delay of two weeks, for example. From the financial point of view, the sooner the CFO’s office knows about the delay in production, the sooner financing can be put in place for any extended period of production or shipping.
By sharing data from the financial supply chain with their relationship bank from the PO stage, companies may have an opportunity to access bank financing earlier on in the process. Banks are more likely to provide financing because they have more information about the assets against which they are lending. Transparency of the corporate financial supply chain allows the bank to provide the right advice for its corporate customer, increase the risk it mitigates for the company, extend financing, FX hedges and perform cash flow forecasting based on the trigger events in the physical supply chain.
Waiting for the BPO Revolution
Work on a new trade finance instrument is underway – the International Chamber of Commerce (ICC) Banking Commission is developing rules for the bank payment obligation (BPO), which will impose a legal obligation for the customer’s bank to pay the supplier a specified amount as soon as various trade documents (invoice, PO, transport documentation or other certificates) prove that certain pre-agreed conditions have been fulfilled. The BPO will not replace the L/C, but will be an additional instrument. It will be an open system that will function through multiple platforms as well as SWIFT’s TSU matching engine.
The BPO will ensure that the supplier is paid if the agreed trade conditions are met, but it can also be used as collateral for financing. The BPO will reduce DSO and will reduce the cost of delivering important legal documents while also reducing the risk of discrepancies. The ICC Banking Commission aims to introduce the rules for adopting BPO in early 2013.
Credibility is Key: A Case Study
Data is available at each step of the financial supply chain – one well-known technology manufacturer identified 253 such steps in the production of one computer, each of which has to be signed off. However, corroborating this data in a credible and trusted way is essential. Some of these data ‘events’ can be verified by third parties, providing credibility.
Here is an example of how third parties can confirm data at various stages of the financial supply chain:
- Customs inspects seven containers of sport shoes to be shipped from Asia. All certificates are present in the logistics platform.
- The containers are on board an ocean carrier. That is verified by the shipper directly in the logistics platform and a bill of lading (B/L) is sent either by courier or in digital format.
- Five containers reach the Spanish port of Valencia, the other two are delivered to Amsterdam in the Netherlands, waiting to be dispatched to retailers all over Europe. Pack lists are extracted from the original purchase orders.
- As the goods leave the regional hubs, invoices are dispatched.
- At the moment when the invoice is sent, the banks are able to help submit it as an electronic invoice (e-invoice) and it can be financed through a factoring or supply chain finance programme. Banks are now focusing on how they can provide financing at a much earlier stage – by having access to data stored in the logistics systems. The bank may, for example, consider financing the purchase order by 30% or, when the goods are being shipped (even under open account terms), an additional 20% financing could be released.
The Way Forward with Standard Formats
As more players begin to understand the intrinsic value of the data in the logistics and planning systems of companies, different market players are developing their own tactical steps. SWIFT’s TSU and private initiatives are moving into the PO matching arena. ERP systems providers are joining forces with banks, while logistical platform providers are openly advertising their ability to finance supply chains.
The best results will be achieved if these parties work together to define the standard formats. Without the standardised electronic communication formats, developments in functionality cannot be achieved. The current situation in working capital bank-corporate communication is in some ways analogous to the early stages of the mobile phone market. Some 15 years ago, there was much discussion of what we would be able to do with our mobile phones, while most of us were restricted to plain texts and calls because the infrastructure did not support more complex functionality. Only more recently have we been able to make payments, video calls and use the Internet on our mobiles – because the infrastructure is now in place.
The financial community must now work to develop the infrastructure and formats to allow more complex functionality in the working capital communications space.
Several initiatives are already underway: the Euro Banking Association (EBA), together with the European Commission Expert Group on E-invoicing, are working towards harmonising the tax, legal and operating environment so that e-invoicing can become the most widely used invoicing method in the next five to eight years. Meanwhile the International Organisation for Standardisation (ISO) is involved in the development of standard formats for factoring.
There is a long way to go, but one thing is certain: once corporates optimise the wealth of logistics data they possess, there will be savings in efficiency and cost throughout the whole working capital cycle.
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