By Geri Westphal
New regulatory frameworks are giving supply chain finance a higher profile.
Large global multinational companies continue to review and improve their strategies for managing working capital and seek new ways to more efficiently manage the flow of funds through the entire supply chain.
That’s why the concept of supply-chain finance (SCF) is once again gaining favor as a practical way for banks to meet buyer and supplier liquidity needs within a tighter regulatory framework. It is expected that the implementation of Basel III and other post-crisis regulatory reforms will continue to raise the cost of capital of asset-based strategies for banks, and consequently, the cost of trade finance will remain a top strategic concern for businesses of all sizes. Indeed, there was speculation that some banks might exit the market altogether as the tighter regulatory environment made it that much harder to make any profit. This would have made SCF a little harder to execute although other global, non-bank solutions were ready to step in. This means SCF remains in a position to grow.
And that is an important consideration for corporates that have come to view the financial health of their strategic partners as a primary operational risk and that view the implementation of an SCF program as a competitive tool to offer to their best clients; this while at the same time improving their own liquidity by delaying payment to these same suppliers as long as possible.
Different types of programs
There are various types of SCF programs available depending on the overall program objective. According to a recent study by McKinsey, three of the most popular programs include:
1) Reverse Factoring. This program combines domestic trade finance with supply chain management through an invoice financing arrangement using a three-way agreement between the bank (or third party service provider), the buyer and the seller. The provider purchases the receivables of the supplier with legal recourse to the buyer. This alternative is a form of credit arbitrage that allows the supplier to rely on the stronger credit rating of the buyer.
2) International Reverse Factoring. This second model of SCF has emerged as many large companies have begun to source their raw materials from suppliers around the world. This alternative connects global suppliers to a specific buyer’s platform and helps to facilitate faster payment with a favorable discount.
Suppliers are required to join the buyer’s specific platform with the promise of that quicker payment, along with greater automation when compared to standard check or ACH processing.
3) Fully integrated working capital platform. The third and most promising model is still evolving and could represent the ultimate holy grail of supply chain financing. With this model, all pieces of an organization’s financial supply system could be fully automated, including the buyers’ procure-to-pay and the suppliers’ order-to-cash cycles. The full integration of procurement, invoicing and financing within a single platform would provide the highest level of automation and process efficiency. This model takes straight-through processing to a higher level.
Is it really a Win/Win/Win?
According to McKinsey a SCF program can prove to be a win/win/win for the buyer, the seller and the bank, with each participant seeing significant improvements in cost and processing efficiencies. But is that really the case?
While implementing a SCF program has proven advantages in unlocking cash from the supply chain, an important first step in the initial setup of a new program is to carefully consider the accounting treatment of the specific program.
According to takeaways from recent meetings of several of The NeuGroup’s peer groups, it is important for the debt associated with the management of the program to be classified as trade debt and not bank debt and that there not be a direct link between the contract the buyer has with the bank and the contract the bank has with the supplier.
It’s important carefully consider the accounting treatment of the program.
Without the ability to classify SCF debt as trade debt, an organization’s balance sheet would show an exceptionally high amount of bank debt and may be considered slightly or extremely over levered.
Other Considerations
As is true with any cross-functional, company-wide initiative, it is critical to begin the project with a clear direction and executive management support. Each organization should clearly outline the program objectives and obtain strong senior level support to help drive accountability and achievable timelines. Key leaders should be identified in all appropriate functional areas to ensure cross functional coordination and communication.
Find a strong provider, be it a bank or other third-party provider. Understand their experience in implementing these types of programs and evaluate each of the key technical aspects of the project, including supplier documentation and onboarding processes. Based on estimates, a corporate should strive for 60 percent or more participation from its supplier base.
Finally, establish dashboard metrics to identify and capture cost savings. Companies can realize signifiant savings from a buttoned up supply chain finance program because it will allow buyers to extend payment terms while providing suppliers access to better financing rates.