By Bryan Richardson
In-house banks and supply chain finance can refine corporate liquidity, and although they take time and patience to get them up and running, they’re worth the cost.
The treasurer’s top priority is to ensure that the company always has sufficient liquidity to fund its operations and strategic initiatives. There are many tools and approaches to achieving this priority, which is mostly accomplished through the big hammers of an investment portfolio, debt portfolio or both. However, in recent years companies have turned the screws to squeeze more liquidity out of their operations and this has generated innovative new tools or modifications to old tools to aid the process.
But much like real tools, where one would use a skill saw for framing, they might also use a Dremel tool for very small and fine cuts that require skill and patience, but significantly enhance the beauty of the project. A recent Neu Group Assistant Treasurers’ Group of Thirty (AT30) meeting included two sessions on tools used for improving liquidity. The first session was on in-house banks (IHB), the other session was on supply-chain finance.
The IHB Goes to China
The IHB is not new and many members are using them to centralize liquidity, intercompany funding and risk management. But recent regulatory relaxation in China is offering new opportunities to further expand the utility of the IHB to a country that historically has disallowed cash from leaving the country. But recent liberalization of rules on moving currency across borders is making China cash much more accessible.
One AT30 company, a European pharmaceutical, has taken advantage of rules relaxation and incorporated its China entities into the IHB, allowing it to utilize all IHB functionality except for making tax payments on behalf of other entities and utilizing virtual bank accounts.
These two functions are utilized only by Europe and North America. Consequently, the IHB is now able to execute “payments on behalf of” (POBO) and “receipts on behalf of” (ROBO) their Chinese entities. But so far they have confined that activity only to inter-company transactions. According to the treasury director, the company pools its onshore renminbi or CNY into Hong Kong and makes full use of the cash. “China pooling is much simpler than before but you still have to physically settle inter-company payments with cash.
Another large global technology company with nine China entities has also extended its IHB into China. The new rules allow the company to move cash in and out of China more freely. When taking cash out, they convert it to USD and move it to the IHB, utilizing a Shanghai Free Trade Zone entity as an IHB header.
The assistant treasurer notes that cash belonging to China entities must remain owned by those entities. She also notes that the documentation for setting up the cross-border pooling is onerous, but only necessary for the set-up process. On the other hand, the tax documentation required for POBO and ROBO is continuously onerous, having to remain compliant with the many local tax authorities.
Regulatory relaxation in China is offering new opportunities to further expand the utility of the IHB to a country that historically hasn’t been friendly to cash management tools.
On the surface, the changes in China seem very positive and consistent with the country’s overarching goal to become a global financial player on par with the US and Western Europe. But given China’s history of oppression and their other tactics of unfair business practices, many are suspicious of their motives, believing the relaxation provides an incentive to draw more business to the country only to later somehow pull the rug out in favor of local competitors.
Developed countries have supported IHB and pooling structures for a long time, which has allowed MNCs to utilize cash very efficiently. Conversely, using IHBs in undeveloped countries has often resulted in cash being trapped or severely restricted. With Asia, and specifically China, being the source of most global growth, the relaxation of currency controls is welcome news and most expect the evolution to continue favorably for the foreseeable future.
Getting wise to Supply chain finance
Supply chain finance (SCF) is evolving and growing in popularity as a cash management tool. It can be a life-saver for a company’s key vendors, but is also a tool for improving working capital/liquidity.
But to make any meaningful impact the program needs to be large and when it is large, it is complex.
The same treasury director from the global European pharmaceutical firm reviewed his SCF program with the peer group and noted that this tool does not come with an owner’s manual so there is a lot of learning as you go. But the wonderful thing about peer group meetings is that everyone benefits from the experiences of others.
Following is a checklist of key things to consider when contemplating an SCF program:
- Know what you are getting into. This product is so pervasive and simple in concept it is easy to underestimate the magnitude of an SCF project. There is much to consider, not the least of which is aligning SCF with other paymentoptions such as the purchasing card and traditional payment terms.
- Ensure you can measure for success. When stepping into such a project, you need to clearly understand what your goals are and what metrics you have or need to have to determine if you are achieving success. Goals might be improvements to DPO, working capital, operational efficiency with AP and procurement, or aiding key vendors. Whatever they are, there should be metrics in place that are tracked and reported and apply to the project rollout globally.
- Key stakeholders must be aligned and roles made clear. Stakeholders in this project will often have different and conflicting operational objectives. It is important that the measurements determined in the above bullet be shared across all key stakeholders so everyone is marching to the same beat. In our example, the treasury director sharedthat their SCF project was not well-received by the procurement team because it was going to have an adverse impact on their incentive metrics. Without changing their incentive they would clearly remain an obstacle to the project. Further to the above, stakeholders need to have a clear view of their role in the project. In this case, procurement is leading the rollout of the program but treasury ensures enforcement of terms.
- Suppliers should be properly bucketed. Companies have many ways to pay suppliers depending on the type of product or service, the size and frequency of the transactions, the type and size of the supplier. In some cases the supplier is strong and in no need of financial assistance from supplier financing. In other cases, contracts may allow for early payment discounts which can be meaningful. And there might be the concern that one payment method could be more disadvantageous to a supplier than another method.
This was the case with our example’s US subsidiary which worried there could be exposure by putting some suppliers on a P-card program when there was a better SCF program available. The point being that suppliers need to be reviewed and carefully assigned the appropriate payment method, or perhaps even be given appropriate options.
- Use a standard master agreement. The corporate culture of our example company is that of a shared services world and projects therefore need to fit into that environment as much as possible. The SCF program needed to be standardized and easily scalable. A standard master agreement is recommended with an addendum where needed. This will roll into AP operations with the most ease and is also more easily supported by procurement.
- Integrate SCF with IHB and payment factory. Perhaps it is a no-brainer, but a program of this nature with such implications for cash flow and payments should be completely integrated with the other key processes impacting payments, cash pooling and cash flows.
- There are improvements to be had even without SCF. If you are not yet prepared to roll out an SCF program, a review of your current procurement and disbursement processes will likely reveal some surprising opportunities. One AT30 member noted that they began looking into an SCF program only to discover that they had some keen inefficiencies in their current process, specifically that invoices weren’t being received for 20 days, causing them to miss out on the 10-day payment discount.
- Develop a pitch for target suppliers. The treasury department of our example company developed a two-page summary of the program highlights to share with suppliers. In certain key supplier relationships, meetings were held with procurement and treasury staff of both companies to talk through the details and benefits.
As with any project, it is that last 5 to 10 percent of the work that can take the longest to complete because of the tedious nature of the work. Neither of these tools will be the foundation of liquidity management, but they both serve to bring extra polish to the finished product.