three years after the credit crisis began, corporates continue to apply the key
lessons learnt from the experiences of 2008 and 2009. One of these is the need
to stabilise and optimise working capital. This is the financial lubricant that
makes the corporate business machine work properly on a day-to-day basis,
securing the short-term liquidity needed in the procurement, production and
sales cycle. It was also the area that required the most dramatic attention
during the crisis. The drying up of easy sources of credit highlighted the need
for improvements in the organisation of the financial supply chain, with many
companies having massive problems meeting their commitments towards clients or
The optimisation of working capital is a large topic that
encompasses more than just a rational flow of liquidity along the value chain.
It must also integrate with solutions that secure both operational and pure
payment risks and consider all domestic and international participants in the
procurement and sales processes of a company. In simplified terms, the
optimisation of working capital rests on four main pillars:
- Reduction of days sales outstanding (DSO), i.e. open accounts receivable
- Increase of days payables outstanding (DPO) i.e. open accounts
- Reduction of days inventory outstanding (DIO), stocks
and goods in transit.
- Reduction of operational risks and costs (ROR).
Banks with a holistic
approach to the matter can provide comprehensive advice and consultation via a
qualified relationship manager, who can analyse the key financial ratios on the
corporate’s balance sheet and determine the status of its working capital. By
benchmarking against the ratios of other companies in the same industry, the
customer can discover how well or badly their working capital is performing
against the competitors. The relationship manager can then demonstrate the
benefit potential if the four pillars of working capital optimisation were
raised to the level of the industry leaders.
A highly diverse range of
products can be used to optimise the four areas. For example, DSO can be
converted into liquidity with the aid of forfaiting, discounting or factoring.
DPOs can be structured with the use of modern supply chain finance products to
yield benefits for both buyers and suppliers, combining modern internet-based
technology with some principles of reverse factoring. For DIO, solutions can be
set up for the financing of inventories and goods in transit. Finally,
operational risks and costs can be reduced through cash management and trade
finance tools, modern electronic banking (e-banking) products that automate many
treasury activities and enhance process automation.
In many cases,
however, customers are not completely aware of the combined impact of different
interventions on working capital. At present, the mutual dependencies of all
process participants and the interactions between different banking solutions
are not completely clear. For example, changing the terms of payment from
documentary letters of credit (LCs) to open account may appear an appealing way
to reduce the transactional costs of a corporate, but at the same time it
requires the company to engage in new reconciliation activities that were
managed by the bank beforehand.
The following examples illustrate the
importance of taking a comprehensive view of all aspects of a company’s working
capital and the finance department taking a proactive approach, looking at the
Example One: Switching from LCs to Open
It is common practice for a company to have its foreign business
partner open a confirmed documentary LC to hedge against political and economic
payment risks. The payment coverage by the participating banks comes into force,
however, only when the customer submits delivery documents that correspond
exactly to the terms of the LC. However, these documents often do not match the
LC (more than 60% of LC documentation is not correct at first presentation,
according to International Chamber of Commerce (ICC) statistics). This means
that the costs for settling the LC must be paid, although its actual purpose –
securing the payment – is lost. To retain a relationship of trust, it is
necessary for the bank to explain to the customer how such discrepancies came
about and work on their resolution in a transparent and timely manner.
One solution could be the use of special software that electronically stores
and processes all the information related to a LC that is already available
electronically. This would automatically identify discrepancies or send
reminders to ensure that important deadlines of a trade transaction (e.g.
validity, dispatch and presentation date) are not overlooked. A number of
internet-based process platforms, provided by banks or private software houses,
can be applied for this purpose. If the customer is already using SWIFT access
for handling payments, completely new solutions such as Trade Service Utility
(TSU) can be used. An experienced bank product specialist can point out the best
solutions, reducing both the bank’s and the customer’s operational risk.
Example Two: Supply Chain Finance in the Automotive Industry
car manufacturer’s supplier produces components specifically designed for a
certain model. The billing is based on an open account agreement, with invoice
maturities of 60 days. This supplier credit, seemingly desirable for the buyer,
must be taken into account in the supplier’s liquidity budget. If the supplier
does not have adequate working capital at its disposal, e.g. through bank’s
short-term credit facilities, this may lead to severe liquidity bottlenecks or
even to insolvency, in case of a very negative business cycle. The bankruptcy of
a specialised supplier is a dramatic issue for the production lines of the car
manufacturer, who cannot find an alternative sourcing partner at short notice.
The proactive use of the most modern supply chain finance products comes into
The solution requires that the bank provides an internet-based
platform onto which the car manufacturer uploads his suppliers’ invoices soon
after having accepted them. The supplier can then view the same invoice data
online and sell them to the bank without recourse via a mouse click, receiving a
prompt discount payment from the financial institution. The supplier can
therefore monetise his receivables sooner, while shortening his balance sheet
and reducing his DSOs. The car manufacturer can even extend his payment terms
and increase his DPOs, while being assured that the liquidity of his suppliers
is not at risk: as long as they keep delivering goods and invoices accurately,
the sourcing partners will always have the choice of whether to trigger an
immediate payment from the bank.
Moreover, the bank allocates the
financial risk of such a transaction completely to the buyer. This enables the
bank to leverage the interest rate spread between the higher-rated car
manufacturer and the lower-rated suppliers – usually weaker companies who thus
benefit from better financing conditions through this solution. Despite the fact
that the purchasing bank has to accommodate the risk of the buyer, it is still
possible to generate new liquidity from risk takers (e.g. insurance companies)
that could provide liquidity in the past. Through risk participation agreements,
an experienced supply chain finance (SCF) bank can tap these new liquidity
sources for its corporate customers.
By acknowledging the importance of
the financial needs of its supply chain partners, a corporate should therefore
look for a bank able to make the necessary connections between the physical and
financial value chains. A trustworthy, knowledgeable bank advisor has to work as
closely as possible with the corporate and achieve a comprehensive understanding
of how the company and the entire production chain works, uncovering all
possible improvement areas. At the same time, the financial institution must be
in a position to process large transaction volumes and to fulfil the working
capital needs of foreign business partners distributed across the globe, without
having to deal with the complexities of the globalised real economy. A deep
partnership of this kind is also beneficial to the bank, because it caters for a
better assessment of the corporate risks and a tailor-made approach for the full
range of banking services.
This substantially changes the structural
requirements of modern banking. In the modern world, a bank will have to
maintain an extensive international branch network to be in a position to meet
local advisory needs as well as the international customers and suppliers of the
bank’s corporate client. At the same time, the bank’s central operations will
need to have a global reach in order to offer a single entry-point for
multinational clients in search of comprehensive solutions as well as rapid and
efficient financing alternatives wherever cash is flowing. In a nutshell, an
integrated approach towards all treasury products, including cash management,
e-banking, foreign exchange (FX)- and interest rate hedging, SCF and commercial
foreign trade, is key for optimising working capital needs of corporate
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