A Source of Liquidity16 November 2010 Enrico Camerinelli
With access to finance through traditional channels difficult to come by, Enrico Camerinelli, FDE’s financial supply chain consultant editor, reveals the ways corporations can find liquidity within their own operational processes.
In a tough economic environment it is not always easy to access funds through traditional channels, and with banks tending to lend less, corporations are finding alternative ways to source funding.
Innovation and flexibility are resisted in the new ecosystem, which is especially true for corporations that establish their competitive advantage with structured networks of supplies, where the flow of physical goods and information triggers equivalent monetary flows.
In this scenario, supply chain management practices will play a strategic role in corporate growth and sustainability. The true value of a supply chain resides in the way its processes are managed, rather than only in the physical products exchanged. The profit of the goods distributed across a globalised economy is rooted in the effectiveness and efficiency of the underlying processes used to plan, source, make and deliver them.
The behaviour of corporations in response to the credit crisis is forcing banks to turn away from their traditional product oriented approach, towards being more careful and conscious of their customers' needs and expectations. That is, to become more customer-centric. This demands that banks focus on how corporations are freeing up cash, and where they are increasingly concentrating on running supply chain management practices as a source of generating extra cash flows and freeing up liquidity.
Corporations, however, cannot afford to wait for banks to make up their minds in such a competitive environment. During this transformational process, they will find sources of precious liquidity within their operational processes, once they are capable of analysing the impacts of supply chain management practices on the components of working capital.
Significant value can be derived from financing supply chain procure-to-pay and order-to-cash process flows, with banks supporting working capital management by improving their clients' cash utilisation. This is supply chain finance (SCF).
Lack of a common definition
SCF is the function of aligning the execution of trade finance instruments with the movement of goods and payments along the supply chain.
The expectation is that this area of trade finance will continue to grow rapidly as it aligns itself well with the growth of open account trading and maximises efficiency gains made from the introduction of improved IT-driven supply chain management monitoring.
For instance, managing the supply chain more efficiently (most obviously through the use of online data management platforms) has reduced corporate inventories and brought industries closer to just-in-time production. This has meant smaller, more frequent shipments replacing single larger orders.
The first step, therefore, is to overcome the constraint tied to the lack of a common definition of 'supply chain finance' among banks. The lack of a standard definition actually makes an SCF solution elusive. The premise of SCF is to reduce finance costs of the entire supply chain, not only one part of it, but the reality is quite different.
Banks tend to concentrate their attention and efforts mostly on the buyer side of the trade equation. What banks offer as SCF platforms are, in reality, 'supplier finance' platforms focused on payables, typically related to buyer-centric processes. This appears to be the heritage of the initial supply solutions engineered and provided by banks' trade finance teams, which are focused on servicing the more significant buyers at international trading companies.
The typical processes of sourcing are, indeed, part of the supply chain manager's duty. Yet there are additional activities, such as network planning, production planning, scheduling of supplier deliveries, forecasting customer demand, new product introduction, inventory management, distribution planning and managing returns.
These processes all expand the reach of the supply chain manager's responsibilities, and trigger equivalent processes in the financial chain. For example, distribution planning demands the ability to manage letters of credit, get Incoterms financing, or plan for foreign exchange transactions. Forecasting customer demand triggers a cash forecast capability, while production planning looks at investment and asset-based lending services as the natural counterpart from the financial value chain world.
These few examples introduce the notion that SCF must extend its reach way beyond where it is, mistakenly, positioned. If SCF relates only to the buyer-supplier relationship, what should the customer-centric relationship be called? Some say that this is a 'demand chain' and, therefore, the correspondent financial services should be tagged as 'demand chain finance'. Next comes the need to also finance internal manufacturing operations and inventory. Would these be referred to as an 'operations chain' financed by an 'operations chain finance'? The story could go on endlessly.
The point is substantial. The more terms are used to indicate the various corporate processes being financed, the more barriers are created. The more terms there are, the more silos exist. And each silo will be served by a discrete set of niche products.
Each group of offerings, be it trade finance, payments and cash management, securities service, structured finance or insurance and risk management, is still managed by a separate unit within the bank. The corporate client interfaces with multiple relationship managers, each responsible for their own product line. The nomenclature is evidence of such a silo approach. While corporate users ask for 'solutions', banks offer 'products'.
So much for banks that are vocal in manifesting their willingness to stop selling products and start selling solutions to their corporate treasury clients.
Implementing SCF programmes
The objectives of an SCF programme are to provide visibility and resolution of discrepancies in financial supply chain events, from source to payment and from customer-order to cash. They also want to enable access to liquidity, while mitigating risk, and unlock the working capital.
In the majority of cases an SCF programme is launched by a corporate buyer to financially support its strategic supplier base. While the aims are clear, there are still significant challenges that buyers and suppliers must overcome, especially regarding implementation. It is very important for corporate treasurers to team up with their procurement office peers and understand the best practices regarding the identification of the right financing suppliers and the roll-out and implementation processes.
The most common reasons that delay the implementation of SCF programmes include:
- Banks cannot communicate well. Proper education is one of the most important factors for the effective implementation of an SCF programme. There is still a distance between corporate users and banks.
- Corporations do not have full information. This is a direct consequence of the above. There are signs, however, of companies' readiness to disseminate knowledge organically and prepare its resources.
- There is a lack of internal corporate culture. Internal dissemination and external communication can do nothing if the higher levels of the corporation do not commit the necessary support, sponsorship and guidance.
The awareness and readiness factors must be assessed prior to undertaking any initiative. Supply chain and finance personnel must be aware of the objectives.
The role of the financing partner is also important for the success of the initiative. Corporate finance executives must enrich their portfolio of evaluation and negotiation skills to include areas of investigation that can unearth the partner's ability to follow them. For example, if the buyer is targeting a significant number of suppliers in a low cost country, it must check the bank's ability to manage the legal requirements of buying receivables in that country. The bank must prove to have done this before with reference cases and evidence.
Knowing the limits of SCF is another important aspect. SCF is not a panacea for all problems, therefore proper expectations and realistic targets must be established.
A company that has not undergone a serious programme of cost-containment or launched a review of its business operations to reduce waste and unnecessary activities cannot expect positive results through the adoption of some financial 'magic'.
The programme does not end with selecting the right financial partner and then getting suppliers on board. A SCF programme has the characteristics of a change management programme and, as such, entails the involvement of people, process and technology:
- The 'people' factor accounts for internal organisation restructuring, the new governance structure required to manage the programme, and the chain of command that regulates the relationship between traditional silo units (for example, procurement and finance on the corporate side; cash, trade and payments on the banking side).
- The 'process' elements identify the areas dedicated to running the operations of the physical and financial supply chains (for example, order-to-cash, source-to-pay, settle-to-fulfil) supported by the programme.
- The 'technology' cost elements capture costs associated with the construction of the software infrastructure, the adoption of new applications and the re-engineering of existing IT systems. SCF, under the terms of a series of practices and technologies that support the financial processes of an end-to-end supply chain, is still in development. However, there are factors corporations should focus on to plan, implement and execute an SCF programme:
- Establish a communication plan to explain SCF, along with its scope and prerequisites.
- Ensure management commitment.
- Create a cross-functional project group, for the initiating company and the financing partner.