SUPPLY CHAIN FINANCE

Supply Chain Finance is the optimization of both the availability and cost of capital within a buyer-centric supply chain. The availability and cost of capital is usually optimized through the aggregation, integration, packaging, and utilization of all of the relevant information generated in the supply chain in conjunction with cost analysis, cost management, and various supply chain finance strategies.

A Supply Chain Finance Solution, in comparison, is a combination of trade financing provided by a financial institution, a third-party vendor, or an enterprise itself, and a technology platform that unites the trading partners and the financing partners electronically and provides visibility into the various supply chain events that can serve as financing triggers. (These include the issuance of the purchase order, work in progress payments, Vendor Managed Inventory or VMI, inventory in transit, proof of delivery via Forwarder Cargo Receipt (FCR), and invoice approval by the buyer.

Supply Chain Finance is not a new concept. "For decades -- maybe centuries, in developed economies -- supply chain finance has existed in various forms. In the past, the most basic legitimate form of supply chain finance on the payables side was called factoring. Factoring is essentially a loan-shark arrangement where a financial institution or third party buys receivables from a supplier at some material -- read: often outrageous -- discount relative to the face value of the obligation." However, it's a lot more than just factoring, early payment discounting, or inventory shifting. It's balancing credit, financing options, inventory management, and other supply chain variables to optimize working capital, and much more.

Supply Chain Finance is gaining in importance for a number of reasons. When one combines downward cost pressures with steadily increasing raw material, energy, and labor costs globally, total cost of ownership strategic sourcing is no longer enough. Companies need to wring as much value out of their working capital as they can, especially in a market where many large corporations are moving away from physical assets to mostly working capital. Moreover, in their rush to implement low cost country sourcing programs, many companies have implemented non-optimal global sourcing and outsourcing programs that are plagued with one or more unintended consequences which often remain hidden until the programs, and fundamental strategies, are examined from a Supply Chain Finance perspective.

Supply Chain Finance is effective. According to a Hackett study, 1000 of the largest US Companies were able to free up $72B in 2005 by reducing working capital requirements through "improvements in collecting bills, turning over inventory and stretching out the amount of time they take to pay their own suppliers". Improvements in bill collection, days payable outstanding, and inventory turnover barely scratch the surface of what supply chain finance is or what it can do for an enterprise.

Furthermore, Aberdeen has found that Best-In-Class companies in supply chain finance, who are six times more likely to have gained a competitive advantage, are able to process twice as much volume (measured as annual dollar turnover) and three times as many invoices.

To get the maximum benefit from Supply Chain Finance strategies and solutions, a company will require a significant amount of technological capabilities. It will require e-Procurement and e-Payment software to send purchase orders, track good receipts, receive invoices, and automate the settlement processes to the greatest extent possible. It requires inventory management and tracking solutions to appropriately track and manage inventory throughout the supply chain. It requires collaboration and event tracking software to track supply chain events and permit early detection and resolution of potential problems. It requires cash flow management and modeling tools to make sure the right financial decisions are being made at each stage of the chain. And all of this technology needs to be integrated. For example, information relating to transactions and payments needs to flow from the company's e-Procurement and e-Payment systems automatically into a company's accounts receivable (A/R) and accounts payable (A/P) systems and then, ultimately, into it's cash flow modeling and working capital optimization tools.

Parties Involved

There are four primary types of players in supply chain finance. There is the buyer, the supplier, the technology provider, and the financing institution.

Buyers are the primary drivers of supply chain finance. As the builder of brands, and associated advertising campaigns, they are largely responsible for shaping consumer demand for the products they wish to sell. They're also the first in the chain to feel the pressure to reduce costs in a market where raw material prices keep rising but consumers expect prices to keep falling in the Walmart Rollback era.

Suppliers need good supply chain finance the most. As the company that manufacturers the goods, they not only feel the current increases in raw material, energy, and labor costs the most, but traditionally hurt the most since they need to bear the brunt of the cost and typically go the longest between the initial outlay for raw materials, overhead, and labor and the day they finally get paid for producing the product.

Technology Providers are the enablers of supply chain finance. They provide the technology that connects all of parties together, and enables the visibility and communication required to support modern supply chain finance strategies.

Financing institutions play the role of lender in supply chain finance and offer various types of financing, including Global Asset Based Lending (GABL), inventory financing, and insurance, and may offer payables discounting and receivables management services.

Benefits

This section discusses the benefits to buyers, suppliers, and both parties.

To Buyers and Suppliers

The great thing about supply chain finance is that, when done right, it benefits parties all along the supply chain. The benefits described in this section, divided into financial, automation, and general categories, apply to buyers and sellers alike.

Financial

Supply Chain Finance brings a host of financial benefits to the supply chain. Most of these cannot be obtained through more traditional methods, or at least not to the same degree that Supply Chain Finance enables them.

Lower End-To-End Costs

The primary benefit is lower end-to-end supply chain costs. By automating most of the transactions, including approvals and payments when multi-way matching between purchase orders, good receipts, invoices, and contracts lead to non-disputed invoices, supply chain finance removes a lot of manual processing, and its associated administrative overhead and transaction costs from the chain for all affected parties. This results in an instant cost reduction.

Unit Cost Reduction

Proper Supply Chain Finance, unlike basic sourcing, inventory shifting, or early discounting, actually takes cost out of the chain instead of just squeezing profit margins or shifting cost from a buyer to a supplier.

Shorter Cash-To-Cash Cycles

By automating transactions and enabling third party financing at various points of the supply chain through additional event-based visibility, cash-to-cash cycles can be converted for buyers and suppliers alike. This can substantially reduce costs of financing and, thus, overhead costs.

Increased Cost Transparency

Effective Supply Chain Finance programs not only point where the costs are, but what they are for. This allows an organization to compare its cost to market averages and increase focus on the areas of the supply chain that are truly ineffective from a cost perspective. No more guessing.

Reduced Cash Flow Uncertainty

With appropriate Supply Chain Finance solutions, buyers know what they owe, to who, when, and for how much as soon as the invoice is created and suppliers know when they are going to be paid, how much, and what opportunities they have for discounted early payments or third party financing and how much it will cost.

Working Capital Optimization

When a holistic Supply Chain Finance program is put in place, and all areas that impact the supply chain appropriately aligned and connected, for the first time an organization, with the proper tools, can truly being to optimize its working capital. No more excessive hoarding of cash or borrowing to hedge against the unknown.

Through the enhanced visibility and collaboration that results from a sound supply chain finance program, as discussed in later sections, treasurers will have direct knowledge of sourcing strategies, payment terms, seasonal variations, and transport methods and this will allow them to plan cash requirements with greater precision and take advantage of more investment opportunities.

Automation

Supply Chain Finance brings a host of automation benefits to the supply chain. Although many of these can be obtained through more traditional supply chain technology solutions such as e-Procurement, e-Payment, and inventory management, the benefits are greatly enhanced when these traditional technology solutions are integrated into a Supply Chain Finance Framework.

Reduced Paper

Automating the processing and payment of purchase orders, goods receipts, and invoices when there are no discrepancies in a multi-way match considerably reduces the amount of paper that must be manually processed.

Minimization of Data Errors

Every time something is manually entered, and re-entered, another opportunity for human error creeps in. Since human error is usually the major cause of discrepancies, that only results in considerable man hours being invested to clear up the confusion, it's easy to see how improved automation can substantially reduce data errors.

Reduced Transaction Processing Time

Automation allows non-disputed transactions to be processed in a seconds, not minutes, hours, or days.

Faster Dispute Management

Since discrepancies are brought to light faster, as well as their root causes, they can be clarified and resolved much faster using automation-enabled Supply Chain Finance solutions than they could be resolved using purely manual methods.

Increased Inventory Visibility

Automation, and the increased visibility that it offers, allows you to query where your inventory is at any time. It enables an organization to instantly know when it hits a checkpoint, clears customs, and changes ownership.

General

The increased supply chain visibility enabled by good Supply Chain Finance solutions lead to more than just the automation and financial benefits discussed in the previous sections. This section overviews some of the additional benefits Supply Chain Finance solutions enable.

Improved Agility

With an integrated end-to-end Supply Chain Solution, an organization can more quickly respond to demand changes, transportation delays, production short-falls, and unexpected changes in cash-flow.

Increased Analytics Capability

The additional data made available through end-to-end Supply Chain Solutions enables additional analytics. This allows for the continual refinement of demand forecasts, inventory optimization, and working capital plans.

Enhanced Productivity

Supply Chain Finance reduces the amount of time an organization needs to spend on tactical manual processes such as invoice approval, payment, and data collection, and frees up an organization's resources to spend their time on more strategic activities. This allows for a significant leap in productivity.

Improved Customer Service

Less time on manual transaction processing, better demand forecasting, and improved productivity will allow any organization to make great strides in its customer service.

Improved Supply Chain Reliability

Having timely information on a regular basis naturally leads to improved supply chain reliability. An organization knows where it's inventory is, what its suppliers are working on, and if they are currently experiencing problems that could lead to a slow down. It even allows parties to work together to detect, and resolve, potential problems before they appear.

To Buyers

In addition to all of the benefits outlined in the previous section, Supply Chain Finance also brings some specific benefits to buyers that can not be achieved through more traditional supply chain improvement programs.

Off-Balance Sheet Financing

Knowing precisely where inventory is at any given time allows a buyer to securitize it's assets and obtain off-balance sheet financing using a number of different options that might include early receivables programs (where a buyer can ensure early receivable payments to its supplier for as little as 0.5% to 2.0% per annum against non-disputed invoices), toll manufacturing and netting programs (where off-trade positions between Original Equipment Manufacturers (OEMs) and Contract Manufacturers are netted), and inventory financing programs (using consignment). This allows it to obtain additional capital at low cast without negatively impacting its balance sheet.

Increased Supplier Interest

A buyer with a strong supply chain finance program becomes considerably more attractive to a supplier than the average buyer since most suppliers are constantly in a capital crunch in a market where the average buyer is trying to improve their financial position at the supplier's expense by increasing Days-Payable-Outstanding (DPO) terms.

More Days-Payable-Outstanding flexibility

By enabling a multitude of financing options for it and its suppliers, the buyer has a lot more control over its DPO options and the cost associated with each option.

More Control Over The Procure-To-Pay Cycle

An integrated Supply Chain Finance solution gives the buyer more control over the Procure-to-Pay procedure than a traditional e-Procurement, EIPP (Electronic Invoice Presentation & Payment), or P2P (Procure-To-Pay) solution which does not take the broader financial picture into account.

In addition, properly managed supply chain finance will help a company treat its payables as an asset. In some cases, this will mean trading on their credit to reduce the amount of cash they need today to pay their suppliers. In others, it might be using a dynamic bid/ask marketplace that offers early payment discounts down to the specific day that the supplier wants to get paid.

To Suppliers

The great thing about Supply Chain Finance is that, when done properly, it provides as much advantage to the supplier as it does to the buyer, which truly allows costs to be taken out of the chain without unreasonably impacting profit margins or shifting costs to the parties least capable of bearing them.

Below Market Financing Rates

A good SCF solution, by increasing visibility into supply chain events throughout the chain, gives the supplier the ability to leverage the buyer's credit rating against their receivables. This is an enormous benefit to a supplier whose normal cost of short-term financing is 20% to 40% when their buyer has a much lower cost of capital, often under 12%.

Reduced Cash Flow Uncertainty

If a supplier does not know that a payment will be late(r than expected) until the payment fails to materialize on the expected date, the supplier could end up scrambling for cash and be forced to accept very costly short-term capital financing (in the 20% to 40% range). This will ultimately drive up the cost of the products they make by a significant amount. A good SCF solution allows the supplier to see posted payables, with the payment date, as soon as they are posted.

On-Demand Access to Funding and Financing

A good Supply Chain Finance Solution will include an on-demand software-as-a-service payment or intermediation platform that will connect all parties, buyers, suppliers, and lenders, together in a manner that will allow suppliers to instantly take available of the low(er)-cost lending options available to them (as enabled or co-negotiated by the buyer) at any time.

More Days-Sales-Outstanding Flexibility

The supplier now has much greater control over it's Days-Sales-Outstanding as it can choose to convert receivables from the time the invoice is approved until the maturity date into cash using early payment discounts from the buyer or through low-cost sales of such receivables to third party lenders.