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Matthew Frohling, Asia Regional Head, Supply Chain Finance at Citi takes a closer look at the dynamics of today’s supply chain finance programmes.

SCF – the strategies you need

There is no question that we have entered a period of sustained economic uncertainty. Macroeconomic,

regulatory and technological developments are driving increased complexity in treasury management.

Supply chain management remains a focal point for companies of all sizes. As commerce becomes ever more globalised and complex, companies are looking for ways to stabilise their supply chains, mitigate the risks of global trade transactions, and create more efficient working capital structures. To do so, they are taking an integrated approach to working capital objectives – leading to increased benefits and efficiencies across the supply chain.

Companies are doing more self-funding to supplement their financing costs and position for growth as the global economy continues to rebound. By extending payment terms, they can maintain a competitive position while improving transparency and creating efficiency in payment processes. As certain sectors move to fixed terms extensions, the market within this sector is aligning.

Previously seen as a financing strategy for small and medium-sized enterprises (SMEs) or as a stopgap for companies during troubled times, supply chain finance (SCF) programmes have been on the increase following the global financial crisis of 2008/09. Yet, despite benefits of such programmes, the number of companies that implement them globally has been relatively small until recently.

The benefits of SCF programmesToday’s procurement and treasury executives seek a unified view of spend

to understand what payments were remitted via ACH, P-card, Dynamic Discounting, etc. They also want an end-to-end solution to resolve inefficiencies in processing and lack of visibility in reporting, and ultimately, to optimise working capital.

More and more large multinational companies (MNCs), especially those with strong credit ratings, are leveraging SCF programmes to help unlock liquidity and increase the resilience of their financial supply chain. This is driven, in part, by liquidity constraints created by Basel III regulations. Companies are concerned that their smaller, lower-rated suppliers may find it difficult to raise capital, thus bringing potential risk to the supply chain.

At the same time, MNCs are seeking

ways to better fund working capital in order to leverage high-growth emerging markets. This includes the challenge of accelerating their cashflow cycle to reduce the need for working capital. Companies recognise that an increase in days payables outstanding (DPO) will hinder their suppliers’ days sales outstanding (DSO), further compounding supply chain risk. SCF programmes provide an effective solution here, enabling companies to extend and standardise payment terms while enhancing suppliers’ DSO.

There is also an increasing trend for highly-rated suppliers to join SCF programmes. They may be able to source financing at an equal or better rate than their customers. By discounting receivables on a non-recourse basis via SCF programmes, suppliers reduce their concentration risks, to further grow their customer base. With the banking industry’s move toward more conservative credit models and more stringent banking regulations, the adoption of SCF programmes is likely to increase as companies continue to seek ways to optimise liquidity and fund investments.

New strategies for developing a successful SCF programmeSo, how can companies be successful in implementing an SCF programme? Working with leading companies to drive many of the world’s most successful SCF programmes, Citi has identified three key strategies these companies typically adopt:

Strategy 1: Benchmark working capital metricsCompanies can learn a great deal by investigating the working capital metrics of their suppliers and customers. With

“THE BEST SCF PROGRAMMES ARE VIEWED NOT AS AN ISOLATED PRODUCT OR SOLUTION.” Matthew Frohling, Citi

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publicly available information, it’s easier for treasurers to gain a high-level view of their supply chain ecosystem and quantify the tangible benefits of their SCF programme.

Bloomberg and Capital IQ are two of many data sources that provide detailed financial information. At Citi, we typically work with clients to analyse key working capital metrics. Some questions to consider include: ●● What are your suppliers’ days sales outstanding (DSO)?

●● What are your company’s terms compared to your suppliers’ average DSO?

●● Are your terms more or less favourable than your competitors’?

●● What are your customers’ days payable outstanding (DPO)?

●● Are your terms shorter or longer than their payment terms with you?

●● Do your competitors also sell to these customers? If so, are you selling on the best terms?

Answers to these questions are important for several reasons. Most critically, if your company’s payment terms are shorter than your suppliers’ DPO, and/or your sales terms are longer than your customer’s DSO, you may be financing your competitors!

Benchmarking working capital metrics can help treasurers assess business competitiveness, efficiency and the chances of meeting their working capital goals. Figure 1 provides an example of a benchmarking exercise for 10 companies in the technology industry, using publicly

available Bloomberg data. This snapshot of overall DPO for these companies helped a leading conglomerate assess their competitive position. We provided guidance for the direction of their working capital goals.

Strategy 2: Create self-funded structures to enhance yieldsMany companies have trapped cash that cannot be easily moved across borders due to regulatory, tax or business process constraints. Or they have huge cash reserves that can become a cost burden. Moreover, returns on this cash can often be very low. By self-funding a supply chain programme, companies have a new avenue to enhance yields on trapped cash and benefit from their reserves.

In this structure, suppliers join the programme at attractive rates. When discounting is requested, the company funds the request, effectively benefiting from an early pay discount. Such solutions are, of course, bespoke, but they are increasingly in vogue because of their win-win nature.

Strategy 3: Leverage currency funding costsMultiple currencies coupled with increasing intra-region trade present unique foreign exchange, regulatory and liquidity challenges for MNCs. But the heterogeneity of the region can also offer opportunities. Cross-border financing can be more attractive than in-country borrowing. For example, US dollar financing may be more expensive now in China than in Hong Kong

or Singapore. To capture this opportunity, companies

need to team with an experienced banking partner who understands the regulatory environment and can help structure an optimal solution for parties involved and compliant with local regulatory guidelines.

Knowledge of these market opportunities fosters more competitive financing rates. This can be leveraged to improve terms or reduce costs for companies, and to gain more cost-effective financing for their suppliers. Importantly, it also deepens the buyer-supplier relationship.

Why some SCF programmes are more successful than othersThe single most important factor to the success of SCF programmes is engagement, especially across multiple corporate functions. While SCF initiatives are generally led by treasury or the CFO, other divisions will be involved as a programme is implemented. Procurement, accounts payable and information systems, each with its own priorities, directives and resource constraints, need to get on board. Strong collaboration between these functions is required for a programme to be successful.

To achieve organisational buy-in for your SCF programme, a best-practices approach is to show both company-wide and division-specific benefits to all involved. Specific examples include:●● Better terms and reduced Cost of Goods Sold (COGS) for procurement

●● Reduction in supplier account maintenance for accounts payable

●● Streamlined system-to-system integration for information systems

In Citi’s experience, the best SCF programmes are viewed not as an isolated product or solution, but as an ongoing, evolving journey. A team with the right leadership and management skills needs to be assembled to advocate the benefits of an SCF programme internally. That team can facilitate cross-functional collaboration, so each department looks beyond its individual responsibilities and is accountable for the programme’s wider objectives.

Figure 1: Benchmark working capital metrics

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Day

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Avg DPO 70 days

Competitors

#1 ABC #2 #3 #4 #5 #6 #7 #8 #9 Company

Source: Bloomberg and Finlistics

The DPO for ABC Company is below average for the industry. There is an opportunity to extend the DPO and generate working capital benefits. ABC Company could be subsidising its competitors, which avail longer payment terms from the supplier.