In the market it is possible to distinguish four different trends, which are of particular interest for treasury at the moment. First, the liquidity gap between cash-poor and cash-rich companies is widening; default rates and liquidity problems among cash-poor companies are increasing while, on the other hand, more and more companies are cash-rich. For the latter, cash and cash equivalents now form a significantly larger part of total assets than they were previously.
Secondly, from a finance perspective, corporates face a low- and potentially negative-yield environment for the investment of cash due to historically low interest rates. Cash-rich companies therefore look for alternatives to bank deposits or money market funds in order to achieve a higher yield on their excess cash.
The third noticeable trend is that cash-poor companies are unable to benefit from the low interest rates to attract funding with favorable terms, since banks have to adhere to increasingly strict capital requirements. Lending volumes have in fact fallen drastically in recent years. This is particularly true for small and medium-sized enterprises (SMEs) with a lower credit standing, for which it is difficult to attract cost-efficient funding from banks. Lastly, SMEs face continuously increasing payment terms towards their multinational clients, which consequently result in a credit squeeze. Against the background of these trends, supply chain finance (SCF) solutions have increased in popularity.
Current Supply Chain Finance Market
Technological innovation in the financial supply chain, such as electronic invoicing (e-invoicing), is driving initiatives in the SCF market. When referring to SCF, people generally mean reverse factoring. With reverse factoring, the (large) buyer sets up the programme and enables its smaller suppliers to gain attractive funding based on the bigger buyer’s superior creditworthiness. This means that the supplier is paid earlier at a discount, while the buyer typically extends the payment date of the invoice. The bank funds the programme and receives a spread without much risk, since the creditworthy buyer backs the invoices.
Both buyer and supplier can benefit from a reverse factoring programme. Advantages for the buyer include the ability to lower working capital requirements by extending payment terms, which makes more funds available for other projects such as investments or the redemption of costly financing. Moreover, the buyer increases supply chain resilience by granting access to additional funding for strategic suppliers, reducing the risk of costly supply chain disruptions. Some of the advantages for the suppliers include reduced working capital, the possibility of tapping into alternative funding sources, and redeeming expensive funding facilities.
Next to reverse factoring, which usually involves banks, there are also bank-independent initiatives such as platforms for dynamic discounting. Those initiatives optimise working capital management by developing a platform that helps the accounts payable (AP) department optimise the payment process, while at the same time the yield on cash is improved. By means of a dynamic discount optimiser, buyers can receive variable discounts on their invoices based on the exact time of payment. This means that the sooner the invoice is paid, the higher the discount. This differs significantly from the static discounting methods in which principles such as ‘2/10, net 30’ are maintained (in which, where an invoice with a payment period of 30 days is paid within 10 days, a 2% discount is provided).
Both supplier and buyer benefit from this kind of solution. The supplier benefits from free e-invoicing, invoice status visibility and access to cash, while the buyer is able to eliminate non-productive tasks, maximise supplier discounts with no additional risk and strengthen supplier relationships by providing suppliers with quick and easy access to cash.
Besides the opportunities, it is important for companies to also think about the challenges. SCF initiatives require close internal cooperation between the treasury department and procurement as well as in the supply chain between buyer and supplier. Moreover, these initiatives can increase the (financial) dependency of the supplier towards the buyer. Thirdly, there are many SCF initiatives offered, both by banks and independent platforms. So how does treasury select the initiative which best suits the company’s requirements, while also taking the related costs into account?
Supply Chain Finance Developments
The SCF market is developing in two ways. Firstly, there is an increasing number of corporates that set up, and banks that support, a reverse factoring programme. Although some of the large corporates have had such programmes up and running for quite a while, they are mainly supported by a limited group of banks. Currently, more banks are in the process of setting up SCF programmes.
Besides the increase in market participants, a technical development can be observed. This second development will lead to greater efficiency in funding the total supply chain. Currently, most companies in the supply chain fund their total spend instead of their added value. As a result, the total supply chain is funded multiple times. Technical developments drive initiatives which increase efficiency in the supply chain. Firstly, technical developments enable SCF solutions to evolve into products that shift, from first tier supplier solutions (e.g. reverse factoring), upstream the supply chain to second-, third-, etc. -tier supplier solutions. This means that financing will take place further upstream. In other words, it will become possible to finance the suppliers of suppliers, whether it concerns inventory, semi-finished products or raw materials.
This development will be more risky for banks, when compared to the conventional reversed factoring programmes, due to the fact that banks have to take the entire supply chain into consideration rather than just one company. Many will be more reluctant to fund these SCF products and therefore corporates might tap into the capital markets instead of banks to finance their supply chain. Secondly, technical development makes it possible to standardise the infrastructure in the purchase to pay (P2P) process (e.g. e-invoicing) and thereby reduce the costs and broaden the reach of SCF solutions.
The current environment is an opportunity for treasury to take a more active role in working capital management. Platforms enabling a more dynamic management of receivables and payables experience high growth rates. Corporate treasury is well positioned to take a leading role within the organisation and help work towards a more efficient allocation of cash within the supply chain.
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