As companies become increasingly global in scale and physical supply chains are gaining in complexity, financial supply chains are also becoming more complex. The result is an increase in risk of supply chain disruption that companies need to proactively manage. Supply Chain Finance programs have become a popular way for leading corporates to protect their supply chain and minimize the risk of disruptions.
Companies recognize the importance of working capital management to support their business in difficult times, and many have begun to look across the financial supply chain for opportunities to unlock trapped cash. In fact, generating additional cash flow through better management of working capital is a route that is being adopted by most leading organizations. With enough examples of successful implementations in the marketplace, Supply Chain Finance has emerged as the most popular solution for working capital management.
With Supply Chain Finance or also known in Europe as Reverse Factoring, a buying organization invite its suppliers to the program to obtain early payment at low financing costs based on the buyer's credit risk, rather than their own. In some cases, suppliers may get access working capital financing at a funding costs as low as 2 percent APR (Annual Percentage Rate) instead of paying 10-20 percent by sourcing funding through their own financing channels.
This sounds all good maybe too good. Indeed, the pricing mechanism is great but to really benefit fully from a Supply Finance program it is important to focus on the following four success factors.
First Success Factor: Set out your target and what you want to achieve
Any organization, setting a financing program, should therefore have a clear understanding of what they are trying to achieve—whether that's injecting liquidity into the supply chain in order to remove financial risk, extending supplier payment terms to improve their working capital, deploying their company cash in the program to pay their suppliers early to generate returns via a Dynamic Discounting program or a combination.
Each target as significant implication on the selection of the Supply Chain Finance provider or external funder, the program design, the selected suppliers and various other aspects such legal structure, accounting treatment, etc.
Second Success Factor: Understand and analyze your opportunity
Some companies may have a clear objective, however without really understanding how they stack up against a benchmark and whether their supply chain can support that objective. Additionally, some companies lack the internal support from top management and the procurement team to fully launch a large-scale program. Other buyer organization may not have sufficient leverage over their vendor or the negotiating power to extend payment terms with their supplier base. Others simply do not have the negotiation culture to achieve their true potential in payment term rationalization, the fundamental driver for buyer side cash flow gain.
Therefore, it is crucial to analyze first the macro and micro environment of each organization and it individual supply chain. This include also a detail spend and working capital analysis, with a terms benchmarking exercise to understand what payment terms or discounts the market can bear and what can be achieve in which time frame.
Third Success Factor: Involve the right stakeholders
The collaboration across the various business functions within a buyer organization, is crucial for the implementation of a successful financing program as the potential for competing stakeholder interest exists. Supply Chain Finance is often an “afterthought” - a reaction to an initiative by treasury or finance departments to extend payment terms. However, to deploy a Supply Chain Finance program successfully, it is important that cross-functional teams involving treasury, procurement, accounts payables, legal, accounting and the IT department work closely together.
In order to succeed, a program needs to be implemented in consultation with multiple different stakeholders within the company. The first recommendation is to bridge the information gap on Supply Chain Finance with the alignment and coordination of the business functions under a common language, supported by relevant common KPIs and incentives. While each department within an organization wants to achieve overall company goals, they will also push to ensure that their specific objectives and needs are met as well. This can cause conflicts between various departments, as their individual drivers do not always align, especially if the benefits of the program are not properly communicated to each department.
Thus, there may be reluctance by these departments to alter their processes if the reasons for the changes are not clearly understood or if the benefits of the program do not seem to pertain to them. For any Supply Chain Finance program to be successful, every department that is involved must be able to clearly recognize the benefits that the program will provide them.
Fourth Success Factor: Selecting the Right Structure
Once the decision is made to start a Supply Chain Finance program, the company is left with the decision about the structure, which can have implications on which financial institutions will fund and support it, the legal documentation, the time required to setup a program, and many other aspects. There is no simple decision.
A corporate has four main options when selecting the structure for its Supply Chain Finance program. The buyer can setup its own Supply Chain Finance platform, work with the platform managed by his relationship bank, use a multiple bank platform or select a bank-independent solution.
Many banks present to the to their clients the benefits of using their balance sheet and credit to fund the suppliers using their proprietary platform, which in most cases has been white-labelled from another bank or service provider. In the end, what really matters depends on what the buying organization is setting out to do, and how the company would like to do it based on its long-term view. Because once the structure of the program is selected, the company will not change for the next years as it takes time to implement a new program and for the suppliers to move from one structure to the another.
When focusing on the four success factors, corporates setting up a Supplier Finance program can create the targeted results for their organization and their suppliers. Financing costs and the technology platform are important aspects in Supply Chain Finance program. However, a successful rollout and ongoing management of a financing facility requires much more.
The team at SCF Strategies help companies implementing financing facilities or improve existing ones with long-lasting results and benefits for all parties involved. Contact us to learn more how we can help your organization with your Supply Chain Finance initiative.