Financing the End-to-End Supply Chain: A Reference Guide to Supply Chain Finance [2 ed.] 1789663512, 9781789663518

Table of contents :
Cover
Contents
Foreword by Michael Henke
Foreword by Michiel Steeman
Acknowledgements
List of abbreviations
Introduction
PART ONE The background
01 The nucleus – Supply chains and financial performance
Introduction
Supply chain disruption
The importance of supply chains
Supply chain management and financial performance
Porter’s value chain
Supply chain management and financial statements
Return on total assets minus current liabilities aka Return on capital employed
Infinite Return on total assets – current liabilities
Opportunity cost, cost of capital, gearing and weighted average cost of capital
Shareholder value and supply chain management
EBIT after asset charge
The supply chain ratio
Inter-organizational financial performance
Summary
References
Study question
Study solution
02 The big issue – Working capital management
Introduction
The demand for liquidity and net working capital
Net working capital
Liquidity
The cash-to-cash cycle
Working capital management and firm performance
Working capital management
Who owns working capital management?
The limitations of working capital ratios
Financially sustainable supply chains
Summary
References
Study questions
Study solutions
03 The flows – Towards an integrated view of supply chain processes
Introduction
The evolution of supply chain management
Supply chain management levels
Physical flow
Information flow
Financial flow
Orchestrating the three flows
Linkages and dependences
The importance of managing cash flow
Functional integration
Summary
References
Study question
Study solution
PART TWO The current practice
04 The concept – A case for supply chain finance
Introduction
Key definitions and general options
Operating modes of the basic approaches
Scientific background
Transition stages
Network financing philosophy
Economics
Win–win situations
Summary
References
Study questions
05 The ecosystem – Who is involved in supply chain finance?
Introduction
Users of SCF
Logistics service providers
Financial service providers
SCF platform providers
Consultants
Advisers
Industry and professional associations
Governments and other public bodies
Academia
Summary
References
Study question
06 The value proposition – Solutions for supply chain finance
Introduction
Accounts payable solutions
Accounts receivable solutions
Inventory financing
Other solutions
Business case
Selection and decision trees
Supply chain programmes with an SCF impact
Summary
References
07 The implementation – Bringing supply chain finance programmes to life
Introduction
Typical pitfalls
Implementation guidelines
Risk reduction approaches
Summary
References
Study question
PART THREE The future
08 The global setting – Supply chain finance in the context of cultural and geographical dispersion
Introduction
Chinese financing and supply chain finance
Islamic financing and supply chain finance
Western SME financing and supply chain finance
Summary
References
Study question
09 The look beyond – Factors impacting the future of supply chain finance
Introduction
The dark side – tax issues: why direct and indirect taxes should be considered in SCF
The bright side – corporate social responsibility: is there financial fair play in SCM?
The smart side – Artificial intelligence: How can new technologies be harnessed to enhance decision making in SCF?
The tech side – Blockchain technology: Can fintech companies bring SCF to the next level?
The prevision – Possible trends: what to consider in prospective SCF programmes
Recommendations on future prospects for SCF
References
Study question
Index

Citation preview

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PRAISE FOR FINANCING THE END-TO-END SUPPLY CHAIN Supply chain finance has a highly strategic relevance for us, as it substantially ensures a sustainable value generation for our company. The comprehensive understanding of financial synergies across the supply chain is therefore a requirement for shareholder value. This reference guide offers practical methods and recommendations for our daily business. Friedemann Kirchhof, Head of Supply Chain Finance, Siemens Treasury GmbH, Munich It’s good to see such a comprehensive, up-to-date and clearly written book on this vital topic, from authors who combine intellectual understanding of the subject with practical real-life experience. Peter Smith, Managing Editor, Spend Matters Europe Financing the End-to-end Supply Chain is not only an excellent guide for practitioners but also an informative compendium for researchers and students. Supply chain finance provides badly needed financial resources for small and medium-sized enterprises and offers tremendous potential waiting to be identified, explored and unlocked, especially in the Asian region. Zhao Xiande, Professor of Operations and Supply Chain Management, Director, CEIBS-GLP Centre for Innovation in Supply Chains and Services, Co-director, CEIBS Centre for Automotive Research While supply chain finance constantly evolves, poor awareness represents still one of the most significant (if not the most significant) barriers to its wider adoption. Any contribution that provides clarity, use cases and best practices is very much welcome in a world that wants to take full advantage of supply chain finance schemes and instruments to optimize a company’s working capital. Enrico Camerinelli, Chief Analyst, Ermi-Research

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The authors have addressed a significant need with a timely book on an important subject. Supply chain financing uses the supply chain to fund the organization, and the organization to fund the supply chain. Companies and decision makers who want to find out how to capture these funds will find concrete assistance and helpful guidance in this second edition. Dale S Rogers, Professor, Logistics and Supply Chain Management, Co-director, Internet Edge Supply Chain Lab, W P Carey School of Business, Arizona State University In today’s maturing SCF market, it is critical to access resources that can give us the knowledge required to face SCF challenges, with the right mix of supply chain management, finance and practical evidence. This book is one of those resources. Luca M Gelsomino, Senior Researcher in Supply Chain Finance, Windesheim University of Applied Sciences, The Netherlands With supply chain financing, companies are able to de-risk the balance sheet and improve free cash flows, thereby enhancing return on capital. This reference guide paves the way to generate great potential in global trade and supply chain financing. Parvaiz HH Dalal, Head of Supplier Financing EMEA, Global Head of Strategy and Solution Working Capital Finance, Citigroup, UK

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Financing the End-to-end Supply Chain

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THIS PAGE IS INTENTIONALLY LEFT BLANK

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Second Edition

Financing the End-to-end Supply Chain A reference guide to supply chain finance Simon Templar Erik Hofmann Charles Findlay

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Publisher’s note Every possible effort has been made to ensure that the information contained in this book is accurate at the time of going to press, and the publisher and authors cannot accept responsibility for any errors or omissions, however caused. No responsibility for loss or damage occasioned to any person acting, or refraining from action, as a result of the material in this publication can be accepted by the editor, the publisher or the authors.

First published in Great Britain and the United States in 2016 by Kogan Page Limited Second edition published in 2020 Apart from any fair dealing for the purposes of research or private study, or criticism or review, as permitted under the Copyright, Designs and Patents Act 1988, this publication may only be reproduced, stored or transmitted, in any form or by any means, with the prior permission in writing of the publishers, or in the case of reprographic reproduction in accordance with the terms and licences issued by the CLA. Enquiries concerning reproduction outside these terms should be sent to the publishers at the undermentioned addresses: 2nd Floor, 45 Gee Street London EC1V 3RS United Kingdom

122 W 27th St, 10th Floor New York, NY 10001 USA

4737/23 Ansari Road Daryaganj New Delhi 110002 India

www.koganpage.com Kogan Page books are printed on paper from sustainable forests. © Simon Templar, Erik Hofmann and Charles Findlay, 2016, 2020 The right of Simon Templar, Erik Hofmann and Charles Findlay to be identified as the authors of this work has been asserted by them in accordance with the Copyright, Designs and Patents Act 1988. ISBN Hardback 978 1 78966 351 8 Paperback 978 1 78966 348 8 eBook 978 1 78966 349 5 British Library Cataloguing-in-Publication Data A CIP record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Names: Templar, Simon, author. | Hofmann, Erik, author. | Findlay, Charles, author. Title: Financing the end-to-end supply chain : a reference guide to supply chain finance / Simon Templar, Erik Hofmann, Charles Findlay. Description: Second edition. | London ; New York, NY : Kogan Page, 2020. | Includes bibliographical references and index. | Identifiers: LCCN 2020009025 (print) | LCCN 2020009026 (ebook) | ISBN 9781789663488 (paperback) | ISBN 9781789663518 (hardback) | ISBN 9781789663495 (ebook) Subjects: LCSH: Business logistics–Finance. Classification: LCC HD38.5 .T46 2020 (print) | LCC HD38.5 (ebook) | DDC 658.15/5–dc23 Typeset by Integra Software Services, Pondicherry Print production managed by Jellyfish Printed and bound by CPI Group (UK) Ltd, Croydon CR0 4YY

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CONTENTS Foreword by Michael Henke xi Foreword by Michiel Steeman xiii Acknowledgements xv List of abbreviations xvi



Introduction 1 PA R T O N E   The background 11

01

The nucleus – Supply chains and financial performance 13 Introduction 14 Supply chain disruption 17 The importance of supply chains 17 Supply chain management and financial performance 20 Porter’s value chain 22 Supply chain management and financial statements 24 Return on total assets minus current liabilities aka Return on capital employed 27 Infinite Return on total assets – current liabilities 35 Opportunity cost, cost of capital, gearing and weighted average cost of capital 37 Shareholder value and supply chain management 40 EBIT after asset charge 43 The supply chain ratio 43 Inter-organizational financial performance 45 Summary 46 References 47 Study question 50 Study solution 50

02

The big issue – Working capital management 51 Introduction 52 The demand for liquidity and net working capital 52 Net working capital 54

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Contents

Liquidity 57 The cash-to-cash cycle 59 Working capital management and firm performance 63 Working capital management 68 Who owns working capital management? 74 The limitations of working capital ratios 77 Financially sustainable supply chains 80 Summary 83 References 83 Study questions 86 Study solutions 88

03 The flows – Towards an integrated view of supply chain processes 89 Introduction 90 The evolution of supply chain management 90 Supply chain management levels 92 Physical flow 97 Information flow 98 Financial flow 101 Orchestrating the three flows 102 Linkages and dependences 105 The importance of managing cash flow 109 Functional integration 113 Summary 116 References 116 Study question 118 Study solution 119

PA R T T WO   The current practice 125 04

The concept – A case for supply chain finance 127 Introduction 128 Key definitions and general options 135 Operating modes of the basic approaches 141 Scientific background 145 Transition stages 147 Network financing philosophy 149 Economics 158

Contents

Win–win situations 162 Summary 171 References 172 Study questions 175

05 The ecosystem – Who is involved in supply chain finance? 179 Introduction 180 Users of SCF 183 Logistics service providers 190 Financial service providers 193 SCF platform providers 201 Consultants 207 Advisers 208 Industry and professional associations 209 Governments and other public bodies 213 Academia 217 Summary 218 References 219 Study question 224

06 The value proposition – Solutions for supply chain finance 225 Introduction 226 Accounts payable solutions 228 Accounts receivable solutions 238 Inventory financing 244 Other solutions 251 Business case 251 Selection and decision trees 265 Supply chain programmes with an SCF impact 270 Summary 271 References 279

07 The implementation – Bringing supply chain finance programmes to life 281 Introduction 282 Typical pitfalls 283 Implementation guidelines 285

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Contents

Risk reduction approaches 314 Summary 316 References 317 Study question 318

PA R T T H R E E   The future 319 08 The global setting – Supply chain finance in the context of cultural and geographical dispersion 321 Introduction 322 Chinese financing and supply chain finance 323 Islamic financing and supply chain finance 334 Western SME financing and supply chain finance 344 Summary 356 References 359 Study question 362

09 The look beyond – Factors impacting the future of supply chain finance 364 Introduction 364 The dark side – tax issues: why direct and indirect taxes should be considered in SCF 366 The bright side – corporate social responsibility: is there financial fair play in SCM? 380 The smart side – Artificial intelligence: How can new technologies be harnessed to enhance decision making in SCF? 387 The tech side – Blockchain technology: Can fintech companies bring SCF to the next level? 392 The prevision – Possible trends: what to consider in prospective SCF programmes 404 Recommendations on future prospects for SCF 414 References 415 Study question 417 Index  420

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FOREWORD Supply chain finance: an even more important part of integrated supply chain management Four years after the first edition the topics of supply chain finance are more important than ever before. So it is time for a second edition of this book to give an update on the state of progress and innovation. Integrated supply chain management – where n-tier suppliers are connected to end users via the different stages of the value chain – ideally necessitates the analysis and management of not only material and information flows but also financial flows. Although this fundamental truth has existed ever since the supply chain management debate was ignited, it has been neglected in the day-today investigation of the topic by researchers and practitioners for years or even decades. In research the financial aspects of supply chain management have only been analysed systematically for about a decade. The topic evolved in a number of research institutions worldwide under generic terms such as ­‘financial supply chain management’. FSCM embraces the planning, management and monitoring of all processes and transactions associated with financial flows along the entire value chain. In business practice, too, financial flows within supply chain management and the concepts, methods and tools available to manage them (often provided by researchers) are being discussed more and more intensively. Supply chain finance in particular is a popular topic for various entities of the valueadding process, for the buyers, for the suppliers and, at the same time, for the financial and logistics services providers involved. The multiple benefits that this concept yields for all parties involved are often referred to as ‘win–win–win’ situations. However, particularly in business practice, the terms supply chain finance and financial supply chain management are not always used coherently. Consequently the differences compared with traditional approaches such as factoring, and hence the advantages of FSCM, are not always immediately apparent. This dilemma was the starting point for this book in its first ­edition,

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Foreword

which has been created by fellow members of the supply chain finance ­community and has now been updated. This comprehensive overview of the past, present and future of supply chain finance can be warmly recommended to all researchers and practitioners involved in managing and financing the end-to-end supply chain. I hope it will be highly popular and reach a wide audience. After all, if the financial challenges along supply chains are not tackled using an active, integrated approach, we will soon be no longer able to cope with the requirements – physical, information and increasingly digital – placed on supply chain management in the future. And I am sure that within the next years we will see innovative technologies like blockchain take supply chain finance to the next level.

Professor Dr Michael Henke Chair of Enterprise Logistics, TU Dortmund University Head of Enterprise Logistics Section of the Fraunhofer Institute for Material Flow and Logistics IML

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FOREWORD Supply chain finance more relevant than ever In my foreword to the first edition I opened with the statement that Supply Chain Finance has found its permanent place in the world of finance, procurement, treasury and supply chain management. Indeed we find that the vast majority of large multinationals have adopted supply chain finance programmes in their supply chains. However, this year criticism of supply chain finance has increased in the media. The bad press is not new – we are familiar with similar accusations against multinationals taking their SCF programmes to extreme levels and insisting small suppliers take large discounts to receive payment on time. The latest headlines revolve around the now widely-reported case that Australian mining company Rio Tinto and telecoms firm Telstra ditched their SCF programmes in late January 2020 after press articles said that a dynamic discounting programme was “forcing” small suppliers to accept discounts on invoices of up to two per cent to receive payment in a timely way. Though Rio Tinto responded saying its programme was voluntary and that smaller suppliers were able to be paid within 30 days, such was the degree of media and government pressure that both companies cancelled their SCF programmes in an attempt to salvage their reputations. Since then Rio Tinto and Telstra have moved to 20-day payment terms for their smaller suppliers. Both decisions have been welcomed by the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) Kate Carnell who advocates for the interests of small businesses – the organization is now conducting a supply chain finance review and published its position paper in early February 2020. It includes draft recommendations about more enforceable payment terms legislation and calls for further consideration as to whether SCF should be considered a regulated ­financial product. Where does this leave our industry? The stories of Rio Tinto and Telstra are not the first and won’t be the last examples of media criticism of SCF – the fallout from Carillion’s collapse in 2018 has far from been forgotten.

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Foreword

Yet, the two cases act again as a reminder for us all that SCF programmes should not be misused solely for the benefit of the buyer, where discount levels and payment terms are pushed to “extreme” levels. These problems often boil down to the culture of the multinational as to whether they use the programmes ‘fairly’ or to generate maximum financial benefits to the buyer at the cost of smaller suppliers. I see too many treasury departments wanting to use reverse factoring or dynamic discounting as a way to make as much money as possible from their payables portfolio. This may be due to high or unreasonable KPIs set by senior management, ensuring they become overly concerned about return on cash rather than how SCF can be used to support suppliers. We in the industry know that, when used correctly, SCF has a myriad of benefits to support businesses throughout the supply chain, providing muchneeded certainty of payment and additional early liquidity if the suppliers need it. In this book the authors do a great job of explaining the world of supply chain finance: its background, its current practice and its potential future. Especially treasury, procurement and supply chain managers should treat this book as their guide to exploring the field of supply chain finance. But also make sure to check in regularly with the Supply Chain Finance Commu­ nity for the latest updates and developments. www.scfcommunity.org.

Professor Dr Michiel Steeman Chairman of the Supply Chain Finance Community Professor of Supply Chain Finance, Windesheim University of Applied Sciences

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ACKNOWLEDGEMENTS The authors would like to acknowledge the collective body of Working Capital Management and Supply Chain Finance work produced by the many students we have had the pleasure of supervising, mentoring and supporting: –– Cranfield School of Management, UK: the work of Marion Cosse (in Chapters 2, 6 and 7), William Extra (in Chapter 5), and Chunxuan Yi (in Chapter 5), also Remco van den Berg, Daniel Kohlmann, Olorunkemi Odunola, Harshal Trivedi, and Xuanmiao Wang; –– Politecnico di Milano, Italy: Claudia Molon (in Chapter 6); –– University of St Gallen, Switzerland: David Schmid (in Chapter 2), Olga Grigoreva, Adrian Stephan Knöpfli and Moritz Hansen (in Chapter 4), Christopher Lebreton (in Chapter 7), Gregor Stadelmann (in Chapters 8 and 9), as well as Nicolai E Brandt and Alexander Maier (in Chapter 9). The diagrams and explanatory notes for many of the solutions presented in Chapter 6 were prepared by Philipp Wetzel, research associate (PhD candidate) and project manager of the Supply Chain Finance-Lab at the Institute of Supply Chain Management, University of St Gallen, Switzerland. Philipp Wetzel also supported the sub-section ‘The prevision – Possible trends’ in Chapter 9. A special thanks goes to Jörn Volk, Member of the Executive Board of see finance Switzerland AG, for his piece ‘SCF risk mitigation via credit insurance’ in Chapter 5. We are grateful to Kaplan Publishing for their permission to use the accounting definitions from the CIMA Official Terminology (2005). We would also like to thank Bureau van Dijk for giving us permission to use the finance ratios from their Fame database. Thank you to Gartner for allowing us to include their list of the top 25 supply chain companies for 2019. We would also like to thank Enrico Camerinelli for his encouragement and the use of his diagram in Chapter 3. Last but not least, we would like to express our gratitude for the support as well as the very fruitful inputs and discussions of the Supply Chain Finance Community (http://www.scfcommunity.org/), particularly the Board Members Michiel Steeman, Pieter Klapwijk, Luca Gelsomino and Ronald de Boer (The Netherlands), Frederico FA Caniato and Antonella Moretto (Italy), Viktor Elliot (Sweden), Michael Henke and Axel T Schulte (Germany), Hervé Hillion (France) and Robert Alard (Switzerland).

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LIST OF ABBREVIATIONS 3PL Third-party logistics 4PL Fourth-party logistics ACT Association of Corporate Treasurers AP Accounts Payable AR Accounts Receivable AT Acid Test Ratio BAFT-IFSA Bankers’ Association for Finance and Trade – International Financial Services Association BL Bill of Lading BPO Bank Payment Obligations BS Balance Sheet C2C Cash to Cash Cycle CA Current Asset CBI Confederation of British Industry CCC Cash Conversion Cycle CE Capital Employed CFO Chief Finance Officer CILT Chartered Institute of Logistics and Transport CIMA Chartered Institute of Management Accountants CIPS Chartered Institute of Procurement and Supply CL Current Liability COC Cost of Capital CP Commercial Paper CPFR Collaborative planning, forecasting and replenishment CPO Chief Procurement Officer CR Current Ratio CS Consignment stock CSD Central Security Depository DCF Discounted Cash Flow DD Dynamic Discounting DIH Days Inventory Held = Inventory Days DPM Du Pont Model DPO Days Payables Outstanding = Accounts Payable Days DSO Days Sales Outstanding = Accounts Receivable Days

List of abbreviations

EAC EBA EBIT ERP EV EVA FC FP FS FSC FSP FTE FX GRN GSCFF IAS ICAEW ICC ID IF IFRS IM IRR IS ITFA JIT KPI KYC LC LSP MNC MRP NCA NCL OPEX P2P PO PPE RF

EBIT After Charge Euro Banking Association Earnings before Interest and Tax Enterprise Resource Planning Enterprise Value Economic Value Added Focal Company Financial Performance Financial Statements (IS and BS) Financial Supply Chain Financial Service Provider Full-time Equivalent Foreign Exchange Goods Received Note Global Supply Chain Finance Forum International Accounting Standards Institute of Chartered Accountants in England and Wales International Chamber of Commerce Invoice Discounting Invoice Factoring International Financial Reporting Standards Inventory Management Internal Rate of Return Income Statement International Trade and Forfaiting Association Just in Time Key Performance Indicator Know Your Customer Letter of Credit Logistics Service Provider Multinational Companies Material Resource Planning Non-current Assets Non-current Liabilities Operating Expenses Purchase to Pay Purchase Order Property, Plant and Equipment Reverse Factoring

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List of abbreviations

ROCE Return on Capital Employed ROTA-CL Return on Total Assets – Current Liabilities S&OP Sales and Operations Planning SC Supply Chain SCF Supply Chain Finance SCFC Supply Chain Finance Community SCFG Supply Chain Finance Guarantee SCM Supply Chain Management SCR Supply Chain Ratio SEPA Single European Payments Area SG&A Selling, General and Administrative Expenses SLB Sale-and-Lease Back SME Small or Medium Enterprise SOF Sales Offer Financing SPV Special Purpose Vehicle SV Shareholder Value SWIFT The Society for Worldwide Interbank Financial Telecommunication TA Total Assets TA-CL Total Assets – Current Liabilities TCO Total Cost of Ownership USAID US Agency for International Development VC Value Chain VMI Vendor-managed Inventory WACC Weighted Average Cost of Capital WC Working Capital WCM Working Capital Management

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Introduction A second edition Our first edition was published in July 2016, with most of the material written in 2015. This second edition updates the picture after nearly five years of innovation, consolidation, maturity and general churn in the area. In particular, supply chain finance (SCF) has become ‘main stream’ with well over half of the world’s major organizations adopting some form of an SCF solution. Moreover, new and exciting developments have appeared on the SCF horizon that deserve a deeper discussion. We would like to thank all those who have provided feedback on the first edition and those who have recently researched, presented or published in the area, which has helped us understand the evolution and occasional revolutions in SCF.

Why a book on supply chain finance? From our experience of and research into SCF many issues, questions and opportunities have been raised. Here is a sample: ●●

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Although elements of SCF are not new, eg factoring, innovative companies want to embrace an end-to-end supply chain approach, bringing new opportunities and new challenges. Organizations need to understand and align the end-to-end physical, information and financial flows. SCF is an increasingly important subject, not least because of ever extending global supply chains in an environment of restricted supply of credit in various geographies. SCF can build collaboration, improve relationships and enhance trust between supply chain partners, as well as improve financial performance. But it can have the opposite effect if approached or implemented in the wrong way.

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Introduction

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SCF needs a common definition, language and terminology. SCF impacts on the financial performance of supply chain partners – positively or negatively – and so the initiating organization’s reputation.

So the rationale for the book is to enable professionals, practitioners, academics and students to gain greater insights into, and to understand the opportunities and challenges of, adopting SCF approaches.

Inside a company We explore the relationships between the physical supply chain and the financial flows, linking them to the associated stakeholders within an organization, eg treasury, procurement, supply chain, systems, IT and other key stakeholders.

Across companies We look ‘up’ and ‘down’ the supply chain to see how innovative approaches to financing can build collaboration, improve relationships and enhance trust between supply chain partners, all with the goal of creating competitive and sustainable supply chains.

Industry-wide SCF is now an industry, with its solution providers, operators, advisers and academic researchers. Recognizing that SCF means different things in different countries, we also consider various initiatives to harmonize and develop cross-border financing. This discussion includes the situation and opportunities in geographies traditionally considered to have different finance systems, such as China and the Islamic countries.

Who should read this book? Since our first edition, there have been a number of publications in the area, but we believe this book provides a unique and comprehensive overview of SCF and is written for: ●●

professionals working in supply chain management, operations, logistics, procurement, information systems and finance functions such as management accounting, treasury and AR/AP in all business sectors;

Introduction

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the banking community, including the newly emerging alternative finance providers; government, regulatory bodies and professional communities; lecturers teaching modules on logistics and supply chain management, procurement, business management, banking and trade finance, supply chain finance; researchers at the intersection of operations management and finance; students studying logistics and supply chain management, procurement, finance, management accounting, business management, banking and financial services.

The authors Three of us have written this book: two are currently working in universities and one is an independent consultant. All of us have worked with and learned from many, many industry executives, fellow academics and literally hundreds of students and post-graduate researchers. We thank them all and apologise that there are too many to mention here.

Simon Templar Simon started his career in accounting with British Telecommunications (BT) and qualified as a management accountant in the 1990s. He worked for 14 years in a rapidly changing business in various management roles within BT. Taking a career break in 2001, he came to Cranfield University to study for his MSc in Logistics and Supply Chain Management and stayed in academia. In 2013 was awarded his PhD in the field of transfer pricing and internal markets. During his 14 years at Cranfield Simon has taught, researched and consulted in the area related to supply chain management and management accounting, and the emerging topic of supply chain finance. Simon has authored and collaborated on a number of journals and conference and practitioner papers associated with his research interests. His latest book, Supply Chain Management Accounting, was published by Kogan Page in March 2019. Simon is a Fellow of the Chartered Institute of Logistics and Transport and a founder member of the Supply Chain Finance Community.

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Introduction

Erik Hofmann Erik Hofmann (Dr rer pol, University of Technology, Darmstadt, Germany) is Director of the Institute of Supply Chain Management as well as Head of the Supply Chain Finance-Lab at the University of St Gallen, Switzerland. His primary research focuses on the intersections of logistics and SCM on the one side, and finance and performance as well as strategy issues, on the other. He has published in several operations management journals, for example Production Planning & Control, Journal of Business Logistics, International Journal of Physical Distribution & Logistics Management, International Journal of Operations & Productions Management and Supply Chain Manage­ ment: An International Journal. He is author/co-author of over 20 books and monographs, including Supply Chain Finance Solutions, The Supply Chain Differentiation Guide, Performance Measurement and Incentives Systems in Purchasing and Ways Out of the Working Capital Trap. He is a board member of the Supply Chain Finance Community.

Charles Findlay Charles graduated from the University of Oxford with a degree in Engineering Science and then spent five years with GEC as an industrial engineer working in various manufacturing industries in Europe and the United States. Following an MBA from London Business School, he joined Andersen Consulting, now Accenture, first in the Strategy practice, then running the UK Supply Chain practice and finally helping set up the Procurement outsourcing business. For the last few years he has worked as an independent consultant, an angel investor in early stage technology companies and is a founder member of the Supply Chain Finance Community. Publications include: Logistics Research Network (2012) ‘Current supply chain finance practices’; Buying Professional Services (2010) – case study contributor; Achieving Supply Chain Excellence through Technology, vol 5 (2003) ‘European Supply Chain Management Characteristics and Challenges’ and vol 2 (1999) ‘A Quick Start to eProcurement Savings’.

The Supply Chain Finance Community The SCF Community (SCFC) is for those interested in understanding, developing and promoting SCF – aligning and integrating the flows of finance and the flows of physical goods or services in extended, or end-to-end, supply chains.

Introduction

The SCFC aims to: ●●

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create linkages across existing organizations and associations to collate and consolidate common reference models, specifications, standards and best practices; refine and build cross-functional metrics, baselines, benchmarks and relative perspectives; contribute to research, conferences, consultations and publications.

The SCFC membership includes users, suppliers, advisers, consultants, analysts, academics, trade associations and professional bodies in the field. In particular, it is important to link across the finance, banking and supply chain (manufacturing, logistics and procurement) functions. The SCFC is a not-for-profit organization and is funded by its members and sponsorship of specific activities such as research, publications and conference forums.

Contents After this introduction, the book is divided into three parts: the past, the present and the future. There are nine chapters across these three parts. Below is a list of the chapter titles and then there is a short description of each. We recognize that few will read the whole book and we hope this points you to the most productive areas. In this vein, we have also tried to make each chapter self-contained so there is some overlap and repetition in content, although at different levels of detail. Part One: The background The nucleus – supply chains and financial performance The big issue – working capital management The flows – towards an integrated view of supply chain processes Part Two: The current practice The concept – a case for supply chain finance The ecosystem – who is involved in supply chain finance? The value proposition – solutions for supply chain finance The implementation – bringing supply chain finance programmes to life

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Introduction

Part Three: The future The global setting – supply chain finance in the context of cultural and geographical dispersion The look beyond – factors impacting the future of supply chain finance

Part One: The background Chapter 1: The nucleus – supply chains and financial performance This chapter supports the premise that there is a fundamental relationship between an organization’s management of its supply chain activities (external and intra) and the financial performance of the business. This impact forms the basis for the discussion in the next chapter, which focuses on one component of that financial performance – working capital. Subsequent chapters then describe supply chain finance’s potential impact on both working capital and overall supply chain competitiveness and, using the arguments in this chapter, on overall firm performance. This chapter has been reviewed, updated and the order has been revised to improve the flow. Additional material has been added to the chapter including an extra scenario for the FMCG Co case. Two new sections have been included, one on the weighted average cost of capital and another on the EBIT after asset charge.

Chapter 2: The big issue – working capital management This chapter explores why working capital management is a big issue in business. It builds on the first chapter by looking specifically at working capital within the overall financial situation of a company; the relationship between the financial statements (income statement and balance sheet) that were introduced in the previous chapter with the financial ratios used to measure liquidity and working capital management. The chapter also identifies initiatives corporates can introduce to improve their working capital and finally sets the scene for analysis of the impact, both benefits and costs, of supply chain finance in subsequent chapters. This chapter has been expanded to include an additional section on working capital and financial performance, the financial ratios have been updated and the text has been refreshed for changes in terminology.

Introduction

Chapter 3: The flows – towards an integrated view of supply chain processes This chapter explores the evolution of supply chain management from the perspective of the three flows that exist within a typical supply chain. The physical movement of goods from supplier to buyer, the bi-directional flow of information between the parties within the supply chain and finally the financial flow that moves money from buyer to supplier. The relationships between the three flows are introduced and their interdependencies are highlighted and discussed. The link to working capital is then explored, linking back to Chapters 1 and 2. Finally, we discuss the functional motivations and measures that impact decisions on these interconnected flows.

This chapter has been revised with the emphasis on the three supply chain flows (physical, information and financial), how they relate to each other and the importance of functional integration is also highlighted. The chapter includes a case ‘Dandelion Ltd’ that consolidates the learning from the three chapters in Part One.

Part Two: The current practice Chapter 4: The concept – a case for supply chain finance Supply chain finance has so far been acknowledged as an approach that can benefit the participants inside certain (dyadic) business relationships that lead to win–win situations for both the suppliers and the buyers. We now would like to examine if there really is a case for supply chain finance and, if so, what it looks like. The revision of this chapter has been to focus more on the different terms and foundations of supply chain finance. The latest findings have been incorporated into this section, such as the newest stage of supply chain finance development (transition stage) and the economics of supply chain finance.

Chapter 5: The ecosystem – who is involved in supply chain finance? The aim of this chapter is to identify the different types of organizations involved in supply chain finance and to describe their roles, capabilities and motivations. Given the multifunctional nature of supply chain finance, we

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8

Introduction

also explore the components within a typical ‘user’ organization that are required to agree, approve, implement and operate supply chain finance. The objective is to provide a framework or checklist so that readers can engage with appropriate organizations and the functions within them that fit with their situation and their requirements. Who are they? What do they do? Why? And how are they linked?

What’s new? As the industry matures with increasing adoption in all industries and geographies, knowledge and experience of supply chain finance is growing. The chapter has been updated, refined and enriched with more examples and descriptions of the active players in the space.

Chapter 6: The value proposition – solutions for supply chain finance This chapter outlines the different supply chain finance solutions available in practice. The overall case for supply chain finance is developed in Chapter 4 and a number of examples of the different options are described and justified. The aim of Chapter 6 is to identify and characterize the full range of supply chain finance approaches, in other words answering the question of ‘which one do we implement and why?’ We include example cost-benefit calculations for reverse factoring and dynamic discounting. Finally, there is a section on selecting a solution with some high level decision trees to help frame the discussion.

This chapter has been rewritten as supply chain finance approaches have become more common and as more formal characterizations and comparisons have become available. Some of the original material is now included in Chapter 4 as it fits better there. A new example calculation has been added for dynamic discounting. We have extended the decision trees to help the reader share and discuss selection within their organization.

Introduction

Chapter 7: The implementation – bringing supply chain finance programmes to life The aim of this chapter is to explore the enablers and inhibitors to implementing supply chain finance programmes and establish best practice guidelines for successful implementation. The objective is to prepare the reader to implement a supply chain finance programme by describing the challenges and providing checklists and guidelines taken from both the successful – and the less successful – initiatives. This chapter has been revised as a result of new research. Specifically, we have seen many more studies into what makes supply chain finance successful.

Part Three: The future Chapter 8: The global setting – supply chain finance in the context of cultural and geographical dispersion Since the early 2000s, companies have tried to optimize the flow of information and goods or services in more and more cross-border supply chains due to increasing competition driven by the megatrend of globalization. The world is becoming a smaller place, information is more easily accessible and, therefore, transparency is higher. Moreover, market barriers have been lowered resulting in a higher level of worldwide competition. Companies have started to focus on their core competencies, outsourcing more and more, working closer together. These developments are not without consequences. Hence, supply chains must work in an international setting, while setting global standards, on the one hand, and considering domestic specifications, on the other.

This chapter has been slightly revised and updated. New examples and illustrative examples have been introduced.

Chapter 9: The look beyond – factors impacting the future of supply chain finance The last chapter of our book addresses factors and developments that have the force to affect supply chain finance in a sustainable manner. These factors include tax issues, corporate social responsibility and, of course, new

9

10

Introduction

technologies. They not only impact supply chain finance, but their importance is also increasing considerably. Metaphorically speaking, tax issues can be described as the ‘uncertain side’, even the ‘dark side’, corporate social responsibility as the ‘bright side’ and new technologies as the ‘tech side’ of the future of supply chain finance. New technology, by definition, keeps changing so this whole subject has been updated. We have also added a formal framework for helping predict the impact on supply chain finance of global trends.

Glossary of terminology For a glossary of commonly agreed terms and definitions, we refer the reader to the Supply Chain Finance EBA European Market Guide. Version 2.0 (Euro Banking Association, June 2014) and Standard definitions for tech­ niques of supply chain finance from GSCFF (Global Supply Chain Finance Forum), 2015.

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PART ONE The background

12

THIS PAGE IS INTENTIONALLY LEFT BLANK

13

The nucleus

01

Supply chains and financial performance

O U TCO M E S The intended outcomes of this chapter are to: ●●

●●

●●

identify the impact that supply chain management (SCM) decisions have on the reported financial statements of the organization; explain the relationship between SCM decisions on other measures of financial performance (FP); introduce a set of financial frameworks that are used to illustrate the impact that SCM decisions have on the FP of a business.

By the end of this chapter you should be able to: ●● ●●

●●

describe the impact SCM decisions have on FP; identify how SCM decisions impact on creating earnings (profits), cash and economic value for a business; identify the financial impact of a SCM decision on the profitability, liquidity and asset utilization of a business.

Activities We recommend the following: ●●

●●

Calculate and compare the return on total asset-current liabilities (ROTACL) ratio for your business against one of your competitors, customers and suppliers using the data contained in their financial statements. Describe how your SCM decisions can impact on the financial ratios used to measure an organization’s FP.

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The background

●●

Compare one of your recent SCM initiatives using Christopher’s five drivers of shareholder value (SV). Did the initiative: ●●

increase profitability?

●●

reduce operating expenses?

●●

generate tax reductions?

●●

increase non-current asset (NCA) efficiencies?

●●

reduce working capital (WC)?

Introduction This chapter supports the premise that there is a fundamental relationship between an organization’s management of its SCM activities (external and internal) and the FP of the business. The connection between SCM and FP is not new. Borsodi (1929: Preface) recognizes the importance of understanding distribution and production costs and their impact on FP: In the fifty years between 1870 and 1920, the cost of distributing the necessities and luxuries which we consume has nearly trebled, while the cost of producing them has been reduced by more than one-fifth.

Borsodi also argues the need for decision makers to take a holistic perspective and that in business there are important trade-offs to be considered: It is evident that what we are saving through lower costs of modern methods of production, we are losing through the higher costs of modern methods of distribution.

Christopher (1998: 100) emphasizes the importance of understanding the special relationship that logistics has on the financial success of an organization: It is likely that in the future, decisions on logistics strategies will be made based upon a thorough understanding of the impact they have upon the financial performance of the business.

Notably, Christopher stresses that the decisions taken by logisticians will have an important impact on an organization’s income statement (IS) and balance sheet (BS), but also on the SV and economic value added (EVA) calculations.

The nucleus

The relationship between finance and supply chain (SC) leadership is an important one and will have a significant impact on an organization’s business performance. The Gartner Supply Chain Top 25 for 2019 (Griswold et al, 2019) looks at business performance and opinion: ‘The Supply Chain Top 25 ranking comprises two main components: business performance and opinion. Business performance in the form of public financial and CSR data provides a view into how companies have performed in the past, while the opinion component offers an eye to future potential and reflects leadership in the supply chain community. These two components are combined into a total composite score.’

The composite score: ‘similar to last year, we used a 50/50 overall weighting for this year’s ranking: 50% for the business performance component and 50% for the opinion component. The following three business data financial metrics and the CSR metric are used in the ranking: 1 ROA – Net income/total assets; 2 Inventory turns – Cost of goods sold/quarterly average inventory; 3 Revenue growth – Change in revenue from prior year; 4 CSR – Index of third-party CSR measures.’ SOURCE Gartner, ‘The Gartner Supply Chain Top 25 for 2019’ Mike Griswold et al, 15 May 2019

The Gartner Supply Chain Top 25 for 2019 companies are illustrated in Table 1.1 overleaf. However, Gartner then introduced a new category: ‘In 2015, we introduced a new category to highlight the accomplishments and capabilities of longterm leaders. We refer to these companies as Supply Chain “Masters” and define them as having attained top-five composite scores for at least seven out of the last 10 years. To be clear, this category is separate from the overall Supply Chain Top 25 list, but it is not a retirement from being evaluated as part of our annual research. To the contrary, if a “Master” company were to fall out of having a top-five composite score for long enough, it would lose this designation and be considered as part of the Supply Chain Top 25 ranking in the same way as any other company in our study.’

The Gartner Supply Chain Masters 2019 are illustrated in Table 1.2 overleaf.

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The background

Table 1.1  The Gartner Supply Chain Top 25 for 2019 Rank

Company

1

Colgate-Palmolive

2

Inditex

3

Nestlé

4

PepsiCo

5

Cisco Systems

6

Intel

7

HP Inc.

8

Johnson & Johnson

9

Starbucks

10

Nike

11

Schneider Electric

12

Diageo

13

Alibaba

14

Walmart

15

L’Oréal

16

H&M

17

3M

18

Novo Nordisk

19

Home Depot

20

Coca-Cola

21

Samsung Electronics

22

BASF

23

Adidas

24

AkzoNobel

25

BMW

Table 1.2  Gartner Supply Chain Masters 2019 Company

Years with Top Five composite score

Apple

2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017, 2018, 2019

P&G

2010, 2011, 2012, 2014, 2015, 2016, 2017, 2018, 2019

Amazon

2011, 2012, 2013, 2014, 2015, 2016, 2017, 2018, 2019

McDonald’s

2012, 2013, 2014, 2015, 2016, 2017, 2018, 2019

Unilever

2013, 2014, 2015, 2016, 2017, 2018, 2019

The nucleus

Supply chain disruption A 2013 study by PwC/MIT (2013: 1) analysed: The supply chain operations and risk management approaches of global footprint companies and looks at their operations and financial performance in the face of supply chain disruptions.

A key finding from this study (2013: 2) of 209 global operating companies was that: Supply chain disruptions have a significant impact on company business and financial performance.

So, as well as opportunities to improve performance, if SCs fail, they can have a negative impact on financial performance. The retailer Marks and Spencer plc, in their 2018 report and accounts (2018: 5), highlights the important link between their SC operation and FP: In order to be a faster and more commercial business we must improve our supply chain, which is slow, inefficient and expensive.

The importance of the relationship between SCM and business performance will be explored further in the next sections of this chapter.

The importance of supply chains To comprehend the relationship between SCM and FP, it is essential to first define SCM. Mentzer et al’s (2001: 18) definition of SCM is often cited within the academic literature (Johnson and Templar, 2011): The systemic, strategic coordination of the traditional business functions and the tactics across these business functions within a particular company and across businesses within the supply chain for the purposes of improving the long-term performance of the individual companies and the supply chain as a whole.

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The background

This definition confirms the connection between the management of an organization’s own SC operation and FP. The definition also highlights the importance of inter-organizational relationships between SC members. This provides individual organizations with an opportunity to capture additional financial benefits, such as reduced operating costs by implementing vendormanaged inventory (VMI), if they are able to coordinate initiatives across the business entities that make up the entire SC. SCs are designed to fulfil the demands of an end consumer for a product or service and therefore are derivative in nature, as they exist as a consequence of demand for another product or service further down the chain. Now let’s consider the importance of SCs to each of us and how we often take their efficient working for granted, until they go wrong. Here is an illustrative example based on one of the author’s use of numerous SCs on a weekend morning.

It is Saturday morning. I top up the water in my Italian espresso coffee machine, add the Colombian coffee and switch the machine on. It hisses and steams as the coffee drips and splutters into a cup. The sound of harp chord alerts me to a text message received on my Chinese manufactured mobile phone. I grab a South African orange, slice it into two and squeeze out its juice using my Italian designed juicer and peel my banana that has been grown in the Windward Islands. Two free-range eggs and a splash of milk are scrambled together in a saucepan that was also made in Italy and cooked using my gas cooker, added to hot toast from my electronic toaster, which has been spread with butter from France and sweet, hot black pepper is added (sourced from a variety of countries according to the description on the packaging). The letterbox rattles as my morning paper slaps onto the Spanish manufactured terracotta tiles; as I pick it up there is also a letter, with an Australian postmark.

This example would not have been possible without the many SCs that have come together at one point in time to facilitate the needs of a single customer experience: ●● ●●

●●

Water has to be collected, stored, purified and transported to my house. The coffee machine has been designed, manufactured, shipped to a retailer and then sold to me. The coffee has been grown, harvested, roasted, packaged and distributed to the coffee house where I purchased it.

The nucleus

●●

●●

●●

●●

●●

●●

●●

●●

●●

●●

The electricity supplied by the electric generator, available at the click of a switch, has been generated and transmitted across a network of copper cables. The mobile phone has been designed, manufactured and distributed; the mobile network that carried my text message has been constructed across the globe. The orange and the banana have been grown, harvested, packed and transported to enable them to be consumed thousands of miles from their source. The eggs and milk have been obtained locally, laid by free-range hens and produced by organic cows; the supply chain has been audited to ensure that both have been produced ethically. The gas has been obtained from beneath the earth, captured, stored, shipped, then piped and distributed to my house. Butter produced using milk from French cows and then transported across the English Channel has now been spread on my toast; the bread was baked locally using organic flour. Black peppercorns, grown in many countries, have been blended, stored, shipped and then sold in my local store. The morning paper, straight off the presses, has been transported overnight by express road freight and then delivered by hand. The Spanish tiles, which were handmade in Spain, have been transported by intermodal supply chains to the UK retailer. The letter posted from Australia a couple of days ago, which has been carried and delivered via a complex international SC operation, has travelled halfway around the world by different modes of transport to be delivered to my door.

This example illustrates the power of SCs and the impact that they have on our day-to-day lives. Wherever we live, extended SCs are now fundamental to our way of life and we are extremely dependent on their existence – something made apparent when they are impacted by industrial disputes or extreme weather conditions. SCs are often taken for granted and they are only noticed when, for instance, the newspaper does not hit the floor, the present we have ordered gets lost in transit, the lights fail to go on at home when the switch is flicked on, there is a lack of dial tone when the telephone is picked up or an absence of water when the tap is turned on.

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The background

Let’s pause for a moment and consider the financial investment behind how the following are delivered to us as consumers: a glass of water, a mobile phone call and the electricity used to power our appliances. To fulfil customer needs there is a considerable amount of money invested in the infrastructure of each of these SCs. Just think of the numerous warehouses, mobile phone masts, electricity pylons and the miles of water pipes that make up the physical infrastructure of each of these networks, and also the monies spent on operating expenses to deliver these products and services to us as consumers. Therefore, the prices we pay for the goods and services that we consume will include the associated costs of maintaining the SC infrastructure used to convey our purchases to us. Furthermore, investment in the future development of the network is also an associated cost included in the price: for instance, the hidden cost of an online retailer’s distribution network vs the traditional visible ‘bricks and mortar’ shops. Providers of capital (shareholders and lenders) who are prepared to take a risk to invest their funds into either buying shares or lending money to a venture require a return on their investment and hence a profit element will be included in the price charged to the customer. Shareholders will be looking for share price appreciation and income from dividends, while lenders will require interest on the monies they have lent. If the venture does not earn a sufficient return, they can always choose to invest elsewhere and get a higher return. It’s clear from the examples above that SCs are a significant cost and also a significant differentiator in business success; therefore, SC is a key consideration in evaluating an organization’s FP in meeting these investment objectives.

Supply chain management and financial performance The relationship between SCM and FP has been explored by numerous authors including: Oliver and Webber, 1982; Porter, 1985; Christopher, 1998, 2005; Christopher and Ryals, 1999; LaLonde, 2000; Lambert and ­Bur­duroglu, 2000; Lambert and Cooper, 2000; Timme and Williams-Timme, 2000; Ellram and Liu, 2002; Harrison and van Hoek, 2002; Stapleton et al, 2002; D’Avanzo et al, 2004; Hendricks and Singhal, 2003, 2005a, 2005b; Ketchen and Hult, 2007; Camerinelli, 2009; Johnson and Templar, 2011; Harrison et al, 2014; Braithwaite and Christopher, 2015; and Templar, 2019.

The nucleus

The premise is that any strategic, tactical and operational decision made by SC managers will have an impact on the FP of their organization, impacting on its profitability, liquidity and asset utilization, but will also have implications (positive or negative) for the other businesses that make up the end-to-end SC. Christopher (2011: 58) highlights three financial imperatives that supply chain managers need to be conscious of when making decisions: 1 The bottom line has become the driving force which, perhaps erroneously, determines the direction of the company. 2 Strong positive cash flow has become as much a desired goal of management as profit. 3 The pressure in most organizations is to improve the productivity of capital – to make the assets sweat.

Before any decision is taken, at whatever level, the decision maker should consider the potential impact of the SCM decision on the profitability, liquidity and asset utilization. Timme (2003: 230) states that the relationship between SCM and FP is an opportunity, which many companies are failing to exploit: Supply chain management has the potential to provide higher returns to shareholders. Yet few companies use it to manage overall financial performance.

In the following sections of this chapter you will be introduced to a number of frameworks that examine the relationship between SCM and FP. We begin with Porter’s value chain (VC). Why? Because Porter’s work in our opinion makes a direct link between the activities that make up a typical organization’s SC operation and its margin, and therefore the income statement (IS). As Porter (1985: 34) states: A firm gains competitive advantage by performing these strategically important activities more cheaply or better than its competitors.

Following discussion of Porter’s VC, the Du Pont model (DPM) is introduced which is used as a vehicle to illustrate the impact of SC decisions on an important financial ratio, return on capital employed (ROCE), aka return on total assets minus current liabilities (ROTA-CL). ROCE (ROTA-CL) is a significant financial ratio according to Brookson (2001: 43): ROCE reveals how much profit is being made on the money invested in the business and is a key measure of how well management is doing its job.

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The background

Importantly, the DPM uses information obtained from an organization’s IS and BS, from an SC perspective, and makes it possible to see the outcome of an SC decision on revenue, costs, assets and liabilities, which in turn will have an impact on the IS and BS, as well as the ROCE (ROTA-CL). After the DPM, and before moving on to exploring the concept of shareholder value (SV), we need to introduce and explain the concept of opportunity cost (OC), gearing and then the weighted average cost of capital (WACC). SV is introduced, then EBIT after asset charge (EAC), which also links together the concepts of OC and WACC. Finally, the supply chain ratio (SCR) is introduced, which focuses on the cash generated from operations in relation to the value of TA-CL employed in the business.

Porter’s value chain Porter (1985) highlighted the important relationship between FP and the management of the numerous activities that make up the company’s ‘end-toend’ operations, which includes both external and intra transactions between supply chain members. More than three decades since its original publication, Porter’s work still remains influential. In the value chain, Porter (1985: 33) argues that you have to look at the whole SC and not take too fragmented an approach, although he believes that each component has the opportunity to create value: Competitive advantage cannot be understood by looking at a firm as a whole. It stems from the many discrete activities a firm performs in designing, producing, marketing, delivering and supporting its production. Each of these activities can contribute to a firm’s relative cost position and create a basis for differentiation.

Thus, Porter’s work begins to emphasize the synergies between the components of the SC. The importance of Porter’s work is that it is about how value is created along the SC, and the focus of the model is on creating value for the final customer – who ultimately selects and pays for the product or service. Also, Porter considers value to the firm in terms of margin. Therefore, the famous arrow diagram is in fact a pictorial representation of an organization’s IS. The area of the arrow’s outer boundary represents the revenue generated, the smaller internal area is the expenditure, and subtracting expenditure from income derives margin. If an organization’s IS were presented in this way (Figure 1.1), then the value (no pun intended) of the SC to FP would be made explicit.

The nucleus

Figure 1.1  Value chain income statement £ Sales revenue

£ XXX

Less primary costs ●●

Inbound logistics

XX

●●

Operations or manufacturing

XX

●●

Outbound logistics

XX

●●

Marketing and sales

XX

●●

Service

XX

Earnings before support costs

XXX

Less support costs ●●

Procurement

XX

●●

Technology development

XX

●●

Human resource management

XX

●●

Firm infrastructure

XX

Earnings before interest and tax

XXX

Corporates need to focus on each of Porter’s activities to see if they are able to improve the effectiveness and/or reduce the costs of them, as they will have a bearing on the business’s overall FP. The following extracts from Nestlé’s Annual Report (2017: 52) emphasizes the importance of margin growth: Nestlé is committed to margin expansion. We have set an underlying trading operating profit margin target of 17.5% to 18.5% by 2020, up from 16% in 2016. Our primary driver is to reduce structural costs in non-consumer facing areas.

Nestlé has identified a number of opportunities: Well-identified projects in manufacturing, procurement and general administration are expected to deliver total savings of CHF 2.0 to 2.5 billion by 2020.

These savings will be delivered by: optimising our manufacturing footprint and increasing efficiency throughout our operations. This will both increase our capacity utilisation and reduce our

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The background conversion costs. Through global procurement, we leverage Nestlé’s purchasing power worldwide.

Importantly, if the activity currently delivered in-house can be delivered by a third party at a lower cost because of their expertise or size (economies of scale) without eroding value, then this introduces the ‘make or buy decision’. This has led to organizations opting to outsource their non-core activities to third-party providers, including support activities such as HRM, finance and IT services; and primary activities in Porter’s model, including inbound and outbound logistics, manufacturing and after sales service are also now being supplied by third parties. However, Porter’s value chain focuses on the single firm (firm level). The inter-organizational network perspective (including customers, suppliers and service providers) is missing.

Supply chain management and financial statements This section illustrates the impact that typical SC decisions can have on the elements that make up the IS and BS, as well as the key financial ratios that are used by stakeholders to appraise the FP of a corporate and its ­management. SC decisions will have an impact on the organization’s revenue and its operating expenses (OPEX) and, therefore, its profitability (in the IS). A typical SC comprises non-current assets such as property, plant and equipment (PPE), and net WC (current assets minus current liabilities). Examples of current assets (CA) include inventories (raw materials, work-in-progress and finished goods), accounts receivables (AR) and cash, while current liabilities (CL) are short-term debts, such as accounts payable (AP) to suppliers, proposed dividends to shareholders and taxes owed to the government. Before we can explore the impact of our SC decisions on the FP of a business it is essential that we examine the IS and BS in more depth. It is also important to review their relationship with the financial ratios used to measure business performance. A fictional company FMCG Co has been used in this case to illustrate the impact of SC decisions on the FP of a business. The assumptions and costs used in the scenarios are indicative and are used for training purposes as they illustrate the cause and effect relationship between SC decisions and FP.

The nucleus

Income statement Figure 1.2 illustrates the IS for FMCG Co for the year ending 31 March 20XX. The IS (profit and loss account) in its simplest form is an equation, as it derives the organization’s earnings (profit) by subtracting expenses (costs) from its revenue (income, sales, turnover) as introduced in the previous section. If revenue is greater than its expenses, then the business is earning a profit; if not then the organization will make a loss in the accounting period. FMCG Co’s IS illustrates that the company has revenue of £2.4 billion and when all expenses for the financial year are included, the company has retained earnings of £177 million. Retained earnings for each year are added to the previous year’s earnings and are included in the capital employed (CE) part of the BS. Financial ratios are used to illustrate FP. Profitability ratios are frequently used to analyse profit at different points in the IS, and the ratios chart the erosion of income from revenue to retained earnings. Table 1.3 overleaf illustrates a sample of profitability ratios. SC managers take decisions that typically impact on an organization’s revenue, cost of goods sold and OPEX in the income statement. Hence, SC managers can have a positive impact on revenue generation by designing distribution channels that enhance customer service, and they can reduce

Figure 1.2  FMCG Co income statement FMCG Co Income Statement for the year ending 31 March 20XX

£m

Revenue

2,400

Less cost of goods sold

1,200

Gross profit

1,200

Operating expenses Interest paid Earnings before tax Corporation tax Earnings after tax Dividends Retained earnings for the year

900 3 297 60 237 60 177

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The background

Table 1.3  FMCG Co profitability ratios Ratio

Calculation

FMCG Co

Gross profit margin %

(Gross profit/ Revenue) * 100

(£1,200m/£2,400m) * 100 = 50%

Earnings before interest and tax %

(EBIT/Revenue) * 100

(£300m/£2,400m) * 100 = 12.5%

Earnings after tax % (EAT/Revenue) * 100

(£237m/£2,400m) * 100 = 9.9%

Retained earnings

(£177m/£2,400m) * 100 = 7.4%

(Retained earnings/ Revenue) * 100

the cost of goods sold by negotiating the cost of inputs down and optimizing transportation, thus reducing operating costs.

Balance sheet The BS illustrates: ●●

where the organization has raised the money to fund its operations;

●●

where the organization has spent these funds.

In essence the BS is also an equation that has two equal halves. One half illustrates the CE (capital employed, ie equity and non-current liabilities) in the business (where the money has come from) and the other half illustrates the TA minus CL (TA-CL) of the organization (where the money has been spent). If we now take a look at FMCG Co’s BS in Figure 1.3 we can see that the company’s CE is £1.2 billion and its TA-CL are also £1.2 billion, and therefore the BS is in equilibrium. Let’s now explore each half of the BS in greater detail as it is important for us, as SC managers, to identify which elements our decisions have a direct impact on. CE includes all the shareholder funds such as share capital, reserves and retained profits plus any long-term liabilities (NCL) such as bank loans. NCA are the organization’s fixed assets, which include tangible (property, plant and equipment) and intangible (goodwill) assets, while WC is calculated by taking the organization’s CA (inventory, accounts receivables and cash) and deducting its CL (accounts payables, proposed dividends and any tax outstanding) from them. The decisions that SC managers take will generally be concerned with the components of NCA, CA and CL rather than where the organization sources its capital.

The nucleus

Figure 1.3  FMCG balance sheet FMCG Co Balance Sheet as at 31 March 20XX Non-current assets (NCA)

£m 1,000

Current assets (CA)

400

Current liabilities (CL)

200

Total assets minus current liabilities

1,200

Equity Ordinary shares

600

Retained earnings

300

Total equity (E)

900

Non-current liabilities (NCL) Borrowings Total equity and liabilities

300 1,200

Return on total assets minus current liabilities aka Return on capital employed Return on capital employed (ROCE) is a financial ratio used by analysts to measure the return (earnings) as a percentage of CE in the business and is a signification measure of FP. Siemens (2017: 9) in their 2017 annual report and accounts state that ROCE is their primary ratio: Within the framework of One Siemens, we seek to work profitably and as efficiently as possible with the capital provided by our shareholders and lenders. For purposes of managing and controlling our capital efficiency, we use return on capital employed, or ROCE, as our primary measure. We aim to achieve ROCE within a range of 15% to 20%.

The DPM explores the linkages between the IS (EBIT percentage) and BS (TA-CL). The model was developed at the beginning of the twentieth century and uses information from both statements and generates the ROCE formula, as illustrated in Figure 1.4. When the two sub-ratios are multiplied together, they derive the ROCE ratio.

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The background

Figure 1.4  Return on capital employed formula Earnings before interest and tax Capital employed

Turnover

Earnings before interest and tax

Capital employed

Turnover

Total Asset – Current Liabilities Turnover

EBIT Percentage

ROCE is calculated by dividing earnings before interest and tax (EBIT) by CE and multiplying by 100 to give a percentage. An important point to recognize is that CE is equal to TA-CL and therefore TA-CL can be substituted for CE in the ratio. Therefore, in this case study we refer to return on total assets minus current liabilities (ROTA-CL) rather than ROCE as decisions taken by SC managers will more often impact on these variables (NCA, CA and CL). SC managers can have a positive impact on ROTA-CL, or ROCE, by making decisions that improve the numerator EBIT (revenue minus cost of goods sold minus OPEX) or decrease the value of the denominator TA-CL by reducing NCA and CA and increasing CL. Often an SC initiative such as improving inventory management can have an impact on both the numerator and denominator. FMCG Co currently has a ROTA-CL of 25 per cent, calculated by dividing EBIT/TA-CL and multiplying by 100 to give a percentage, which means that for every £1 invested in TA-CL the company is making a return of £0.25. The organization’s stakeholders can use the output of this ratio as a benchmark to compare alternative investments or returns from other companies operating in the same industrial sector. Alternatively, ROTA-CL can also be derived by multiplying together two other ratios: the EBIT percentage and the TA-CL turnover multiplier. FMCG Co has an EBIT percentage of 12.5 per cent (EBIT divided by sales revenue expressed as a percentage), which means that for every £1 of sales, the company earns £0.125 earnings before interest and tax. The company has a TA-CL turnover multiplier of 2 (sales revenue divided by TA-CL), which means that for every £1 invested in TA-CL, it produces £2 in sales revenue. Therefore, SC managers need to recognize the importance of the relationship between these two financial ratios when making SC decisions. This relationship between EBIT and TA-CL turnover and their input to ROCE is illustrated in Figure 1.5. The figure also highlights the elements from the IS and BS (that influence ROTA-CL, EBIT and TA-CL) and this diagram is typically referred to as the DPM.

The nucleus

Figure 1.5  FMCG Co ROTA-CL or ROCE Return on Total Assets – Current Liabilities Percentage 2 * 12.5% = 25%

Total Assets – Current Liabilities Turnover £2,400m/£1,200m = 2

Total Assets – Current Liabilities £1,200m

Non-current Assets £1,000m

Earnings Before Tax and Interest Percentage (£300m/£2,400m) * 100 = 12.5%

Revenue £2,400m

Working Capital £200m

–

Total Cost £2,100m

Cost of Sales £1,200m

Current Assets £400m

EBIT £300m

=

Operating Expenses £900m

Current Liabilities £200m

Inventories £150m

Account Receivables £220m

Cash £30m

Account Payables £170m

Other £30m

NOTE  CA - CL = WC

The traditional DPM has been adapted to illustrate the impact of SC decisions on ROTA-CL rather than ROCE. The following equations using the numbers taken from FMCG Co’s BS illustrate the different combination of asset calculations that are often used to balance with CE. (NCA + WC) = (NCA + CA − CL) = (TA − CL) = (E + NCL) = £1,200 million (£1,000m + £200m) = (£1,000m + £400m − £200m) = (£1,400m − £200m) = (£900m + £300m) In Figure 1.5 the ROTA-CL percentage is used instead of the ROCE percentage, as SC practitioners take decisions that impact on the total assets and current liabilities rather than capital employed. We shall now look at four SC management scenarios and explore the impact of each scenario separately on FMCG Co’s financial statements (FS) and ratios as depicted in the adapted DPM. The four scenarios are: 1 reducing inventories; 2 extending account payables;

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3 shortening accounts receivables; 4 outsourcing non-current assets.

Reducing inventories The financial impact of reducing inventory will reduce CA, improve cash flow and reduce OPEX (Lambert and Lalonde, 1976; Waters, 1992) and therefore have a positive impact on the organization’s earnings while also reducing total assets on the balance sheet. Reducing inventory will have a direct effect on the organization’s cash-to-cash cycle (C2C) as the number of days’ inventory held by the business is lower, which is a key component of the C2C calculation. FMCG Co has decided to review its procurement strategy. As a result of improving its demand forecast accuracy, it is now able to reduce its safety stock, thus reducing inventory levels. The reduction in inventory levels will also reduce the cost of holding inventory, typically 25 per cent of the inventory’s cost or net realizable value (whichever is lower) as assumed by FMCG Co (space, handling, insurance, cost of capital, damages, shrinkage and obsolescence). The reduction in inventory will not impact on customer service due to better forecasting accuracy. The company anticipates that a 30 per cent reduction in inventory levels can be achieved, which equates to £45 million for the year. This additional cash will now be used to repay part of the organization’s long-term debt (non-current liability). The company’s cost of holding inventory is 25 per cent; therefore, there will be a saving of £11.25 million in OPEX and an increase in earnings. Improving inventory management has increased the organization’s EBIT percentage to 13 per cent and its TA-CL turnover multiplier to 2.08, resulting in an increase in ROTA-CL from 25 per cent to 27 per cent. Figure 1.6 illustrates the impact of the inventory reduction using the DPM on ROTA-CL. It is now possible to see how the inventory reduction impacts on the components of both the IS and BS. A reduction in inventories reduces total of TA-CL; if sales are unchanged then the TA-CL multiplier is improved. The costs associated with holding inventory have reduced therefore reducing OPEX; if revenues do not change then the company’s earnings will increase, improving the EBIT percentage. An improvement in the TA-CL multiplier and EBIT percentage causes the ROTA-CL percentage to increase, thereby illustrating the relationship between SCM decisions and an improvement in the FP of the business.

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Figure 1.6  FMCG Co inventory reductions and ROTA-CL, or ROCE Return on Total Assets – Current Liabilities Percentage 2.08 * 13% = 27%

Total Assets – Current Liabilities Turnover £2,400m/£1,155m = 2.08

Total Assets – Current Liabilities £1,155m

Non-current Assets £1,000m

Earnings Before Tax and Interest Percentage (£311.25m/£2,400m) * 100 = 13%

Revenue £2,400m

Working Capital £155m

Total Cost £2,088.75m

Cost of Sales £1,200m

Current Assets £355m

Inventories £105m

–

=

EBIT £311.25m

Operating Expenses £888.75m

Current Liabilities £200m

Account Receivables £220m

Cash £30m

Account Payables £170m

Other £30m

Extending accounts payable The treasury and procurement functions of FMCG Co are considering extending the time it takes to pay its suppliers and, at the same time, on-board their suppliers onto a supply chain finance (SCF) programme provided by the company’s financial service provider (FSP). It is assumed that the SCF programme will not incur any additional net costs to FMCG Co. (Chapter 4 describes the economic situation for FMCG Co, the FSP and the ­suppliers.) The impact of this decision will potentially increase FMCG’s AP at the end of the financial year from £170 million to £340 million. The decision will have a negative impact on its liquidity ratios (current and acid test ratios). The current ratio (CR) measures the proportion of CA to CL. Before the decision to extend payment terms the ratio was 2:1 (£400m:£200m); however, after, the ratio has reduced to 1.08:1 (£400m:£370m). The acid test (AT) ratio is a stricter measure of liquidity and removes the value of inventory from the equation. Hence, before, the AT ratio was 1.25:1 (£250m:£200m); it is now 0.68:1 (£250m:£370m). The potential risk for FMCG Co is that if their short-term liabilities demand payment then the business could have insufficient CA to meet their obligations. However, the company’s cash conversion cycle (CCC)

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Figure 1.7  FMCG Co accounts payable increased from £170m to £340m Return on Total Assets – Current Liabilities Percentage 2.33 * 12.5% = 29.13%

Total Assets – Current Liabilities Turnover £2,400m/£1,030m = 2.33

Total Assets – Current Liabilities £1,030m

Non-current Assets £1,000m

Earnings Before Tax and Interest Percentage (£300m/£2,400m) * 100 = 12.5%

Revenue £2,400m

Working Capital £30m

Total Cost £2,100m

Cost of Sales £1,200m

Current Assets £400m

Inventories £150m

–

=

EBIT £300m

Operating Expenses £900m

Current Liabilities £370m

Account Receivables £220m

Cash £30m

Account Payables £340m

Other £30m

will be improved as its C2C cycle time (inventory days plus AR days minus AP days) will be reduced as a result of extending its suppliers’ payment period. The impact of extending accounts payables on ROTA-CL has increased the ratio from 25 per cent to 29.13 per cent, as illustrated in Figure 1.7. Increasing accounts payable by £170 million has also increased current liabilities to £370 million, which has reduced the company’s working capital and also the value of the TA-CL, improving the company’s TA-CL turnover multiplier and the ROTA-CL percentage. With the additional cash the business has decided to reduce its long-term debt.

Shortening accounts receivables FMCG Co AR account for 55 per cent of their CA and nearly 16 per cent of TA. The business is keen to improve its cash position to exploit a future investment opportunity. To achieve this aim they are having discussions with their FSP to factor £120m of their AR (Figure 1.8). The cost to the business will be 5 per cent of their value, which is £6m and will be an expense in the IS. FMCG Co will receive an injection of cash of £114m, which has now increased its cash on hand to £144m. The impact of this decision has marginally decreased its ROTA-CL and EBIT percentages but has also slightly enhanced the TA-CL multiplier. If the business decides not to go ahead with the

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Figure 1.8  FMCG Co accounts receivables reduced from £220m to £100m Return on Total Assets – Current Liabilities Percentage 2.01 * 12.25% = 24.62%

Earnings Before Tax and Interest Percentage (£294m/£2,400m) * 100 = 12.25%

Total Assets – Current Liabilities Turnover £2,400m/£1,194m = 2.01

Total Asset – Current Liabilities £1,194m

Non-current Assets £1,000m

Revenue £2,400m

Working Capital £194m

Total Cost £2,106m

Cost of Sales £1,200m

Current Assets £394m

Inventories £150m

–

=

EBIT £294m

Operating Expenses £906m

Current Liabilities £200m

Account Receivables £100m

Cash £144m

Account Payables £170m

Other £30m

investment opportunity and decides to reduce its long-term loan, the ROTA-CL would be 27.22 per cent (£294m/£1,080m).

Outsourcing non-current assets FMCG Co is considering outsourcing its fleet of distribution vehicles to a third-party logistics service provider (LSP). The vehicle fleet will be sold to the LSP resulting in a reduction of NCA on the BS and an injection of cash (current asset). The cash from the disposal of the vehicles could be used to invest in other assets, reduce debt or return cash to shareholders as dividends. FCMG Co has decided to repay some of its long-term debt. With the sale of their vehicle fleet, FMCG Co no longer has standing (fixed costs) and running costs (variable costs). However, it will have the charge from the LSP for delivering its goods to FMCG Co’s customers. As distribution is the core business of an LSP, FMCG Co should also be able to benefit from lower distribution charges from the LSP, as the LSP can leverage cost savings due to economies of scale, increased vehicle utilization and standardization of vehicle type. FMCG Co now has the opportunity to utilize the LSP network coverage, enabling it to potentially reach more customers than it was able to do with its own fleet of vehicles.

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Additional cash flow benefits include no longer having to buy new vehicles and the potential opportunity to reduce C2C times, as the LSP payment terms may be longer than previous expenses such as driver salaries, which were paid in the month in which they were incurred. Figure 1.9 illustrates the potential impact of the outsourcing opportunity on the company’s ROTA-CL using the DPM. Figure 1.9  FMCG Co outsourcing and ROTA-CL, or ROCE Return on Total Assets – Current Liabilities Percentage 2.18 * 14.6% = 31.8%

Total Assets – Current Liabilities Turnover £2,400m/£1,100m = 2.18

Total Assets – Current Liabilities £1,100m

Non-current Assets £900m

Earnings Before Tax and Interest Percentage (£350m/£2,400m) * 100 = 14.6%

Revenue £2,400m

Working Capital £200m

Total Cost £2,050m

Cost of Sales £1,200m

=

EBIT £350m

Operating Expenses £850m

Current Liabilities £200m

Current Assets £400m

Inventories £150m

–

Account Receivables £220m

Cash £30m

Account Payables £170m

Other £30m

NCA are reduced by £100 million and the cash received has been used to repay some of the company’s long-term debt, reducing it to £200 million. As TA-CL have been reduced to £1.1 billion, the TA-CL multiplier has improved from 2 to 2.18. OPEX have been reduced by £50 million, as the LSP is able to provide transportation savings through economies of scale. Sales revenue has remained the same; however, a reduction in OPEX has increased earnings and therefore the EBIT percentage has increased from 12.5 per cent to 14.6 per cent. The outsourcing opportunity has resulted in an improvement in both financial ratios and therefore ROTA-CL has increased from 25 per cent to 31.8 per cent. A fictional company and indicative financial figures have been used to illustrate the impact of four SC scenarios: reducing inventory, outsourcing NCA, extending accounts payables and shortening accounts receivables. The impact of each scenario was compared with the base case using an adaptive

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DPM and the impact on the three key financial ratios EBIT percentage, TA-CL multiplier and ROTA-CL percentage was illustrated. A summary of the results from the different scenarios is illustrated in Table 1.4. Table 1.4  Summary of results by scenario Financial ratios

Base Inventory Account Account Outsourcing case management payables receivables opportunity

ROTA-CL % 25.00

27.00

29.13

24.62

31.83

EBIT %

12.50

13.00

12.50

12.25

14.60

2.00

2.08

2.33

2.01

2.18

TA-CL multiplier

The aim of this case study was to confirm that SCM decisions have a direct bearing on the financial performance of a business. Although the figures used in the case are indicative, they illustrate the cause and effect relationship between SC decisions and FP. Therefore SC managers need to be aware of the important role that their decisions have on an organization’s FP and need to be able to recognize and articulate the impact their decisions have on the IS, the BS and also the financial ratios that are used to measure FP, such as the examples used in this case (ROTA-CL, ROCE, EBIT, TA-CL turnover, CR and AT). It is important to stress that the types of SC decisions illustrated in this section are fundamental in nature and are also relevant to the subsequent models that will be introduced.

Infinite Return on total assets – current liabilities Mathematically, ROTA-CL is EBIT divided by average TA-CL. This leads to two options to increase the ROTA-CL, as discussed in the previous section: 1 by increasing EBIT; 2 by decreasing the intensity of asset utilization, ie reducing the average total assets − current liabilities. The first option is very straightforward. The earnings of the firm can be increased by increasing sales and reducing costs and expenses. The second option is to reduce the value of TA-CL, as discussed in the previous section. Interestingly, if the average value of TA-CL is around zero, ROTA-CL will be near infinite.

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An infinite ROTA-CL... or the positives of negative WC (CA − CL) How is it possible to get such a spectacular result of a near infinite ROTA-CL/ROCE in practice? The best way to answer this question is to deconstruct average TA-CL into its components: Average TA-CL = NCA + (CA − CL) The average TA-CL consist of two parts: the TA (NCA + CA) and CL (shortterm debt). The NCA are fixed in the short run and consist of PPE, while CA and CL are liquid. In order to achieve a near infinite ROTA-CL the formula for the average TA-CL has to approach zero. This holds true if the CL are equal to the value of the TA. The term negative net WC occurs when CL exceed CA. But what does a negative net WC really mean and is it, despite its name, a positive attribute for a company? In short, a company with a negative net WC finances part of its business on the money of its trading partners (short-term financing), rather than investors or banks etc. (long-term financing). Whether this is a positive attribute depends on the specific firm, its business model and the sector. A successful company with negative net WC collects as much money as possible from its customers in advance and at the same time stalls paying its creditors. Examples of negative net WC can be found in retailing (supermarkets), communication and broadcasting sectors. The communication and broadcasting traditionally has low fixed costs (FC) with low or zero inventory and a frequent use of subscriptions services, which make it possible to collect money from customers even before the delivery of a service. In this sector a negative net WC can be a positive attribute. The company effectively uses money from its vendors to grow its business without losing its momentum by paying for inventories and payables. But even in this sector a negative net WC has its dangers. What are the dangers of negative working capital? First, not all sectors and firms could and should try to have a negative WC. We see low or negative WC where there are high NCA, such as retail shops, or where there are commitments to long-term customer income, as in telecommunications where there may also be a high fixed network asset.

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Inherent in a negative WC is the danger of bankruptcy because if this results in delaying payment to creditors and they, for whatever reason, want their money earlier than expected, the company has no means of paying them back. This is because a negative WC may mean that the company is financing CA and part of their NCA using creditors’ money. The difficulty in paying its creditors also influences the rating results of the company, which in turn results in higher interest rates from FSPs. This was illustrated earlier, when FMCG Co decided to extend their payment terms and we saw the impact on their liquidity ratios. In addition, due to the negative WC, the firm is hindered in seizing new market opportunities to grow, because it lacks the financial possibilities. But even if the firm were in a sector that has all the right conditions and has the right business model for negative WC, there is still one obstacle to overcome – namely the danger of shrinking revenues. If the revenues shrink, the positive effects of a negative WC are reversed, and the company needs continued outgoing payments to settle historic purchases at a time when it has lower revenue generation.

Opportunity cost, cost of capital, gearing and weighted average cost of capital This section introduces you to a number of economic and financial concepts that have an impact on business decisions: opportunity cost (OC), cost of capital, gearing and the weighted average cost of capital (WACC).

Opportunity cost OC is an economic concept and it is an important one with regard to investment decisions as it underpins investment appraisal, WACC, shareholder value and EAC. CIMA (2005: 14–15) defines OC as: The value of the benefit sacrificed when one course of action is chosen in preference to an alternative. The opportunity cost is represented by the forgone potential benefit from the best rejected course of action.

Earlier we saw that FMCG Co decided to factor £120 million of its AR, receiving cash of £114 million to fund a potential investment opportunity;

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however, this cash can only be spent once, therefore the OC of the i­ nvest­­ment opportunity is any alternative decision including repaying their longterm loan.

Cost of capital and gearing The cost of capital according to CIMA (2005: 87) is the: Minimum acceptable return on investment, generally computed as a discount rate for the use in investment appraisal exercises.

For example, if I had £100,000 to invest and I could invest the money in a bank paying 5 per cent interest per annum or invest in a friend’s new business venture, I would want a greater return than 5 per cent because of the potential risk. Therefore, I might expect to receive 10 per cent per annum, because there is a risk that I may lose all of my investment. In this simple example the company’s cost of capital is 10 per cent. However, a business can be funded by selling shares and borrowing. These different sources will have an impact on its cost of capital, and the ratio between these two sources of funding is referred to as gearing. Gearing in its simplest form is the percentage of an organization’s CE that is funded by NCL; for example, FMCG Co’s CE is £1,200m of which £300m is borrowings. FMCG Co’s gearing percentage is 25 per cent (£300m/£1,200m). A question that is often asked is ‘what should the gearing percentage be?’ The age-old accountant’s response ‘it depends’ applies as it is the business context (start-up, funding an acquisition, investing in NCA) that will determine the level of gearing that makes sense and also whether FSPs are prepared to lend, which will be based on risk and the organization’s ability to service the debt (interest payments) and repay the outstanding capital. This composite cost of capital rate based on the different sources of funding can be derived in different ways, and one method is the weighted average cost of capital (WACC).

Weighted average cost of capital The WACC is a weighted average and represents a composite figure of the company’s cost of capital based on the composition of its sources of longterm funding. It is thus a proxy measure of expected returns required by the providers of capital and is used to evaluate future capital decisions.

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Table 1.5  WACC calculation for FMCG Co 20XX Capital

Market Expected Payment value return

Equity

£1,800m

9%

£162m

NCL

£300m

5%

£15m

Total

£2,100m

£177m

Calculation

(£177m/£2,100m)*100 = 8.43%

CIMA (2005: 98) defines WACC as: The average cost of the company’s finance (including equity, debentures and bank loans) weighted according to the proportion each element bears to the total pool of capital.

Typical market values are used to calculate the WACC. Let’s assume that FMCG Co’s current share price is £2 and the company has issued share capital of 900,000 and that the shareholders expect to earn a return of 9 per cent. Their FSP will be receive 5 per cent interest on their loan. The WACC equals £177m/£2,100m, which equates to 8.43 per cent. Hence FMCG Co will need earnings in excess of £177m to reward their investors (dividends) and meet their interest payments, as illustrated in Table 1.5 In this example FMCG Co’s cost of capital is 8.43 per cent. Hence investment decisions need to earn more than this figure. If they do, they will create value for their shareholders and service their debt from their lenders. However, in practice, the calculation is more complex. For instance, interest expenses on debt are tax deductible in most countries. The resulting reduction in the cost of debt reflects the tax advantage of financing with debt, which is also called the tax shield. A typical WACC calculation used by investment analysts is as follows (Brealey et al, 2012): E D WACC = rE * + rD *(1 − t )* E+D E+D With rE = rf + b *(rm − rf )  D bL = bU * 1 + (1 − t )*   E 

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β=

Cov (Ri , Rm ) s 2 (Rm )

rD = rf + RP

WACC = Weighted average cost of capital E = Equity D = Debt re = Expected return on equity rd = Expected return on debt or interest rate t = Corporate tax rate rf = Risk-free interest rate rm = Expected return on the market portfolio β = Beta coefficient βl = Leveraged beta βu = Unleveraged beta RP = Risk premium Typically it can be more expensive to borrow short term rather than long term (overdraft interest, for example), therefore an organization may decide to convert short-term debt to long-term debt to improve its cash flow in the short term (reduce interest payment). If the expected return on debt is less than the expected return on equity, then the organization’s WACC will be reduced.

Shareholder value and supply chain management Maximizing the returns to shareholders is the fundamental objective of the organization’s board of directors and its managers (Rappaport, 1998; Christopher and Ryals, 1999; Harrison and van Hoek, 2002; Lukas et al, 2005). Rappaport (1998: 32) defined SV in terms of cash flow: The shareholder value approach estimates the economic value of an investment by discounting forecasted cash flows by the cost of capital. These cash flows, in turn, serve as the foundation for shareholder returns and share-price appreciation.

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SV, according to CIMA (2005: 96) is: Total return to the shareholders in terms of both dividends and share price growth, calculated as the present value of future free cash flows of the business discounted at the weighted average cost of the capital of the business less the market value of its debt.

Both of these definitions highlight that value will be created for the shareholder when the returns generated by an investment cover the costs of financing the CE. Harrison and van Hoek (2002: 52) provide a definition of SV that illustrates the impact that its creation has on the investment behaviour of shareholders and therefore the access to capital of the firm: Creating shareholder value is widely used today to describe the main objective of a business. In its simplest form, shareholder value is created when the shareholder gets a better return by investing in your business than from a comparable investment.

Shareholders will invest in an organization, looking to make a return on their original investment based on the combination of dividends received (income) and share price appreciation (capital growth). The generation of future cash flows is essential to the fulfilment of future shareholder returns. Therefore, the board and the managers of the organization will endeavour to take business decisions that create future shareholder returns. According to Lukas et al (2005: 414): There is growing acceptance by today’s executives that unless they demonstrate their ability to enhance shareholder value, they will be replaced, new capital will be difficult to obtain, and their business will be put at risk.

Typically, organizations will publish their objective of maximizing returns to their shareholders in their report and accounts and will disclose the total shareholder returns (TSR) in the annual report and accounts, comparing their TSR performance with their peer group and the average for the stock exchange their shares are listed on. Let’s now explore the relationship between the management of the organization’s SC operation and SV. There is a growing body of literature that stresses the importance of SCM and its impact in creating/destroying SV (Christopher and Ryals, 1999; Harrison and van Hoek, 2002; Singhal and Hendricks, 2002; Hendricks and Singhal, 2003; Christopher 2005; Ibrahim and Kennedy, 2007). This relationship can also be seen in the marketing literature, where Srivastava et al (1999) discuss SCM as one of three metaprocesses that affected SV.

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How an organization deploys its assets in its SC has an impact on profitability, liquidity and the asset utilization of the organization, which in turn affects cash flows (Srivastava et al, 1999; Christopher, 2011). As highlighted by Rappaport (1998), future cash flow generation is a powerful driver of SV. SC decisions that liberate cash or increase the velocity of cash flow will hence improve SV. Christopher (2005: 90) identified five areas where SCM can have a positive impact on an organization’s SV: 1 profitable growth; 2 cost minimization; 3 tax minimization; 4 fixed capital efficiency; 5 WC efficiency. Examples where SC practitioners are making decisions that will increase SV include: improving quality/performance/brand value of the product or service to sustain price and drive growth; deployment of NCA (to own or lease); use of distribution assets (make or buy decisions); choice of manufacturing location (tax-efficiency considerations); and relocation (off-shoring or on-shoring) or rebalancing between factories in different geographies; reducing WC cycle time by reducing the number of inventory days by adopting postponement initiatives or implementing VMI, just in time (JIT) and the use of electronic data interchange (EDI); improving AR and AP by applying a raft of SCF initiatives; reducing operating costs by focusing on the cost of serving different customers; introduction of contemporary costing approaches such as target costing (new product development); total cost of ownership (procurement); and activity-based costing (ABC) to control the cost of SC processes. Note also that there may be human resource (HR) implications that must be considered before the SC decision can be implemented, such as switching a production plant from one country to another or changing the apportionment between fixed versus variable costs in terms of the use of employed versus agency workers. These examples illustrate the kinds of SC decisions that can have an impact on SV. Therefore, SCM is an important consideration in SV delivery.

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EBIT after asset charge In this section we consider EAC, which is derived from economic value added (EVA™). According to CIMA (2005: 88), EVA™ is defined as: Profit less a charge for capital employed in the period.

Therefore, value is only added by a business when the cost of capital is deducted from the organization’s earnings for the year; if the resulting figure is positive then value has been added, if negative then value has been eroded. One organization that has embraced the use of EAC is Deutsche Post (2007: 8): We are introducing EBIT after asset charge as a new primary performance metric to focus all divisions on sustained value growth. From 1st January 2008, management incentives will also be tied to this metric. In this way, we aim to improve cash generation.

A further justification for the adoption of EAC as an enabler of goal congruence at Deutsche Post DHL (2013: 50) is cited as: Making the asset charge a part of business decisions encourages all divisions to use resources efficiently and ensures that the operating business is geared towards increasing value sustainably whilst generating cash flow.

In 2018 Deutsche Post had an EBIT of 3.162m euros and the company’s WACC was 8.5 per cent, which resulted in an asset charge of 2.446m euros. The company’s EAC was 716m euros, therefore creating value for its stakeholders (Deutsche Post, 2018: 42).

The supply chain ratio The approach taken by Johnson and Templar (2011: 94) brings cash generation into an SC model (Figure 1.10). This model was developed based on the DPM approach and aligns it with the value chain model of Porter (1985) and some of the ideas suggested by Christopher (1998, 2005). This model is useful in that it illustrates how decisions made in the supply chain impact on the relationship between cash generation and the TA-CL deployed by an organization. Although the ratio does not explicitly discuss SV, focusing on cash generated from operations is the key, which in turn will impact on future SV. Thus, the focus of the supply chain ratio (SCR) is the relationship between

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Figure 1.10  The supply chain ratio

Cash generation

Sales

Net cash inflow from operations Sales

Asset efficiency

Total assets less current liabilities

Net cash inflow from operations Total assets less current liabilities

Strategic imperative

Operating profit

∆ Working Capital

Potential tactical decisions

Net cash inflow from operations

Increased customer intimacy

Reduce cashto-cash time

Supply Chain Ratio

Total assets less current liabilities

Other adjustments

Outsource

Fixed Assets

Current Assets

Reduce stock and WIP

Current Liabilities

Supplier rationalization

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SC decisions and the organization’s enterprise value (EV); hence the ratio becomes a proxy measure for SC performance. Reducing inventory within the supply chain is a potential tactical decision that will reduce the value of the CA on the BS. By reducing the ratio’s denominator, this will improve the ratio when combined with an initiative to improve the C2C cycle time. By reducing AR this will increase cash flow as customers are now paying the business faster, which will have a positive impact on the numerator and therefore EV.

Inter-organizational financial performance The premise is that any strategic, tactical and operational decision made by SC managers will have an impact on the FP of their organization, impacting on its profitability, liquidity and asset utilization, but will also have implications (positive or negative) for the other businesses that make up the end-toend SC. Using the SC network illustrated in Figure 1.11, let us explore potential inter-organizational SC decisions that improve financial performance for the whole SC, using ROTA-CL as an indicator of financial performance for each individual organization and for the whole SC network. Figure 1.11  The inter-organizational supply chain network C3

S3 S3

C2

S2 S2

S4

S3

S1 Supplier

S3 S2 S3

S2

S4

Focal Company

S1 Supplier

S3 S3

C1 Customer

S1 Supplier

S2

S3

C2 C3 C2

C1 Customer

C3 C2

C2

C3

C1 Customer

S2

C3 C2

S2 S3

C3

C2

C3

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To increase the ROTA-CL for individual companies and the overall network, then decisions that reduce the value of assets employed and increase EBIT will need to be taken. Two scenarios are presented. The first scenario is that the whole network agrees to collaborate and share their customer demand data between each buyer and supplier node in real time. The end result is that the demand data is improved compared to the forecasts and the negative results of the demand amplification (the Forester Effect) are dramatically reduced. The positive impact on every organization is that the risk of a stock out is reduced, and they now need to hold fewer inventories. Financial performance as measured by ROTA-CL will increase across the network as CA (less inventory) reduce and operating costs reduce (reduction in the costs of holding inventory), thereby improving both the numerator and the denominator of the individual organization’s ROTA-CL calculation. Their cash flow will also be improved as they have less cash tied up in inventories, freeing up cash for other business ­initiatives. In the second scenario, the network members decide collectively to adopt an SCF initiative, which results in a reduction in the supplier’s funding costs, therefore reducing their cost base; if the cost savings result in lower prices for the products they sell, then the cost of goods sold is reduced for the buyers so improving the EBIT and ROTA- CL across the network.

Summary This chapter highlighted the impact that SCM decisions have on the financial statements of the organization, explained the relationship between SCM decisions on measures of financial performance and introduced a set of financial frameworks that are used in business to illustrate the impact that supply decisions have on the FP of a business. However, it is important to stress that ultimate performance comes from delivering a product or service that the user values and this reflects on the earnings generated. The SC can impact this by making the product or service better, cheaper, more environmentally sustainable and in many other ways. However, an SC decision can also have both positive and negative implications for a business depending on the different functional perspectives within the organization, and therefore a holistic understanding of the ­financial impacts on the business is essential. An initiative to rationalize

The nucleus

the number of stock-keeping units would be welcomed by SC managers and a­ ccountants in terms of operating cost savings and cash flow improvements; however, sales and marketing may feel that the decision will restrict customer choice and thus have a negative impact on future revenue generation. The importance of purchasing and SCM in terms of FP is highlighted by Ellram and Liu (2002: 30), who argue that it extends beyond the realm of ‘just’ cost reduction: It extends to such critical performance areas as business growth, profitability, cash flow and asset utilisation. Supply chain managers need to be able to quantify that broader impact. And then convey that message upward so that top management better understands how purchasing and supply management can contribute to company success.

The quotation also stresses that SC practitioners need to be able to communicate to their organizations the importance of their SC operation in delivering a competitive advantage for the business.

References Borsodi, R (1929) The Distribution Age: A study of the economy of modern distribution, D Appleton and Company, New York Braithwaite, A and Christopher, M (2015) Business Operations Models, Kogan Page, London Brealey, RA, Myers, SC, Allen, F and Mohanty, P (2012) Principles of Corporate Finance, Tata McGraw-Hill Education, New York Brookson, S (2001) Understanding Accounts, Dorling Kindersley, London Camerinelli, E (2009) Measuring the Value of the Supply Chain: Linking financial performance and supply chain decisions, Gower, Aldershot Christopher, M (1998) Logistics and Supply Chain Management: Strategies for reducing cost and improving service, 2nd edn, Pearson Education, Harlow Christopher, M (2005) Logistics and Supply Chain Management: Creating value-adding networks, 3rd edn, Pearson Education, Harlow Christopher, M (2011) Logistics and Supply Chain Management: Creating value-adding networks, 4th edn, Pearson Education, Harlow Christopher, M and Ryals, L (1999) Supply chain strategy: Its impact on shareholder value, The International Journal of Logistics Management, 10 (1), pp 1–10

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The background CIMA (2005) CIMA Official Terminology, CIMA Publishing, Oxford D’Avanzo, RL, Starr, CE and von Lewinski, H (2004) Supply chain and the bottom line: A critical link, Outlook: Accenture, 1, pp 28–35 Deutsche Post DHL Group (2007) [accessed 22 January 2020] Annual Report 2007 [Online] www.dpdhl.com/content/dam/dpdhl/en/media-center/investors/ documents/annual-reports/dpwn_annual_report_2007_en.pdf (archived at https://perma.cc/R9T7-KJQC) Deutsche Post DHL Group (2013) [accessed 22 January 2020] Annual Report 2013 [Online] https://annualreport2013.dpdhl.com/dpdhl_gb2013/static/export/docs/ DPDHL_2013_Annual_Report.pdf (archived at https://perma.cc/9E2R-ETGF) Deutsche Post DHL Group (2018) [accessed 22 January 2020] Annual Report 2018 [Online] www.dpdhl.com/content/dam/dpdhl/en/investors/agm/2018/ DPDHL_2017_Annual_Report.pdf (archived at https://perma.cc/A5Z9-CFFZ) Ellram, LM and Liu, B (2002) The financial impact of supply chain management, Supply Chain Management Review, 6 (6), pp 30–37 Griswold, M, Ennis, K, Aronow, S and Romano, J (2019) [accessed 22 January 2020] The Gartner Supply Chain Top 25 for 2019 [Online] www.gartner.com/ en/documents/3913625 (archived at https://perma.cc/42VR-FXN8) Harrison, A and van Hoek, R (2002) Logistics Management and Strategy, Pearson Education, Harlow Harrison, A, van Hoek, R and Skipworth, H (2014) Logistics Management and Strategy: Competing through the supply, Pearson Education, Harlow Hendricks, KB and Singhal, VR (2003) The effect of supply chain glitches on shareholder wealth, Journal of Operations Management, 21 (5), pp 501–22 Hendricks, KB and Singhal, VR (2005a) An empirical analysis of the effect of supply chain disruptions on long-run stock price performance and equity risk of the firm, Production and Operations Management, 14 (1), pp 35–52 Hendricks, KB and Singhal, VR (2005b) Association between supply chain glitches and operating performance, Management Science, 51 (5), pp 695–711 Ibrahim, R and Kennedy, D (2007) Supply chain management program first- and second-order effects model: A new strategic tool, The International Journal of Advanced Manufacturing Technology, 34 (1), pp 201–10 Johnson, M and Templar, S (2011) The relationships between supply chain and firm performance: The development and testing of a unified proxy, International Journal of Physical Distribution and Logistics Management, 41 (2), pp 88–103 Ketchen, DJ and Hult, GTM (2007) Bridging organization theory and supply chain management: The case of best value supply chains, Journal of Operations Management, 25 (2), pp 573–80 LaLonde, BJ (2000) Making Finance take notice, Supply Chain Management Review, 4 (5), pp 11–12 Lambert, DM and Burduroglu, R (2000) Measuring and selling the value of logistics, The International Journal of Logistics Management, 11 (1), pp 1–18

The nucleus Lambert, DM and Cooper, MC (2000) Issues in supply chain management, Industrial Marketing Management, 29 (1), pp 65–83 Lambert, DM and LaLonde, BJ (1976) Inventory carrying costs, Management Accounting, 58 (2), p 31 Lukas, BA, Whitwell, GJ and Doyle, P (2005) How can a shareholder value approach improve marketing’s strategic influence? Journal of Business Research, 58 (4), pp 414–22 Marks and Spencer PLC (2018) [accessed 22 January 2020] Annual Report 2018 https://corporate.marksandspencer.com/documents/reports-results-andpublications/annual-report-2017.pdf (archived at https://perma.cc/EAA5-LGS8) Mentzer, JT, Dewit, W, Keebler, JS, Min, S, Nix, NW, Smith, CD and Zacharia, ZG (2001) Defining supply chain management, Journal of Business Logistics, 22 (2), pp 1–25 Oliver, RK and Webber, MD (1982) Supply-chain management: Logistics catches up with strategy, in Logistics: The Strategic Issues, ed M Christopher (1992), Chapman and Hall, London, pp 63–75 Nestlé (2017) [accessed 22 January 2020] Annual Report 2017 [Online] www. nestle.com/media/mediaeventscalendar/allevents/2017-annual-report (archived at https://perma.cc/6DYM-MJHT) Porter, M (1985) Competitive Advantage: Creating and sustaining superior performance, Free Press, New York PwC/MIT (2013) [accessed 22 January 2020] Making the right risk decisions to strengthen operations performance. PwC and the MIT forum for supply chain Innovation [Online] www.pwc.com/gx/en/operations-consulting-services/pdf/ pwc-and-the-mit-forum-for-supply-chain-innovation_making-the-right-riskdecisions-to-strengthen-operations-performance_st-13-0060.pdf (archived at https://perma.cc/DWA6-WMUD) Rappaport, A (1998) Creating Shareholder Value: A guide for managers and investors, The Free Press, New York Siemens (2017) [accessed 22 January 2020] Annual Report 2017 [Online] www. siemens.com/investor/pool/en/investor_relations/Siemens_AR2017.pdf (archived at https://perma.cc/E5YW-MW5D) Singhal, V and Hendricks, KB (2002) Supply chain glitches torpedo shareholder value, Supply Chain Management Review, 6 (1), pp 18–24 Srivastava, RK, Shervani, TA and Fahey, L (1999) Marketing, business processes and shareholder value: An organizationally embedded view of marketing activities and the discipline of marketing, The Journal of Marketing, 63, pp 168–79 Stapleton, D, Hanna, JB, Yagla, S, Johnson, J and Markussen, D (2002) Measuring logistics performance using the strategic profit model, International Journal of Logistics Management, 13 (1), pp 89–107

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The background Templar, S (2019) Supply Chain Management Accounting: Managing profitability, working capital and asset utilization, Kogan Page, London Timme, SG (2003) [accessed 22 January 2020] The financial supply chain, mThink Knowledge [Online] http://mthink.com/article/financial-supply-chain (archived at https://perma.cc/V9ZM-7HR3) Timme, SG and Williams-Timme, C (2000) The financial–SCM connection, Supply Chain Management Review, 4 (4), pp 32–40 Waters, D (1992) Inventory Control and Management, 2nd edn, Wiley, Oxford

Study question The financial impact of purchasing and supply management goes well beyond cost reduction. It extends to such critical performance areas as business growth, profitability, cash flow and asset utilisation. (Ellram and Liu, 2002: 30)

How can supply chain managers make a positive contribution to the five areas identified by Ellram and Liu?

Study solution Supply chain managers can make a positive contribution to the five areas identified by Ellram and Liu, as shown in Table 1.6.

Table 1.6  Five areas identified by Ellram and Liu (2002: 30) Performance area

Supply chain initiatives

Cost reduction

Reducing costs by applying business process re-engineering and target costing

Business growth

Supporting new product introductions and improving customer service levels

Profitability

Reducing operating expenses, reducing the cost to serve customers and reducing the cost to supply

Cash flow

Improving cash-to-cash cycle times

Asset utilization

Network optimization and improving routing and scheduling Inventory reductions

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The big issue

02

Working capital management (WCM)

O U TCO M E S The intended outcomes of this chapter are to: ●●

identify the demand for liquidity and net WC;

●●

calculate the financial ratios used to manage liquidity and net WC;

●●

describe the components of a cash to cash cycle (C2C);

●●

identify the initiatives organizations use to manage net WC components;

●●

explain the limitations of WCM performance measures;

●●

recognize the need to develop financially sustainable supply chains.

By the end of this chapter you should be able to: ●●

explain the importance of WCM for an organization;

●●

identify the needs for liquidity and net WC in business;

●●

be able to calculate liquidity and net WC financial ratios;

●●

identify the components of a typical C2C cycle;

●●

describe the relationship between an organization’s liquidity and its management of net WC;

●●

identify SC initiatives organizations use to manage WC components;

●●

explain the benefits and limitations of WCM performance measures;

●●

explain the need to develop an inter-organizational perspective to WCM.

52

The background

Activities We recommend the following: Apply the components of the C2C cycle to identify initiatives that could be introduced to improve WCM in your organization. List the opportunities and the challenges associated with each initiative.

Introduction In the previous chapter we introduced the premise that SC decisions will have a direct impact on the FP of an organization. This chapter narrows down the argument and explores why the use of cash, as commonly defined as working capital management (WCM), is a big issue in business. Building on the first chapter we look specifically at net WC within the overall financial situation of a company, and the relationship between the financial statements (IS and BS) that were introduced in the previous chapter and the financial ratios used to measure liquidity and net WC. The chapter also identifies initiatives corporates can introduce to improve their WCM and finally sets the scene for analysis of the impact, both benefits and costs, of SCF in subsequent chapters.

The demand for liquidity and net working capital The amount of cash in a business has often been compared to the level of oil in a car’s internal combustion engine. Too little oil in an engine will result in its moving parts seizing up, as there is insufficient lubrication, causing serious damage to components within the engine and ultimately its destruction. Now let’s consider any business with insufficient cash and no alternative funding available. In this instance, the venture will have to cease trading as it is likely that there would be insufficient funds to pay wages, buy raw materials, pay creditors and overheads, or invest in new property, plant and equipment when the need arises. If we compare the engine that has been starved of lubrication with a business that has insufficient cash and a liquidity problem, we will find that both have ceased to work.

The big issue

Conversely, too much oil in an engine can impact its efficiency and can lead to serious damage. Likewise, too much cash in a business is usually costly and can also lead to inefficiencies and decisions that can have negative impacts on shareholder value. Therefore, it is essential to monitor the level of oil within an engine by checking the engine’s dipstick or acting on the feedback from the oil pressure light or gauge, before it is too late. Similarly, monitoring a business’s liquidity using financial ratios is crucial, not only from a day-to-day ­perspective but also, importantly, the future cash flow requirements of the business need to be identified to enable sufficient funds to be made available, either internally or from the financial markets. Context is incredibly important as different driving conditions can impact on the engine’s lubrication requirements and, similarly, an understanding of the narrative behind the numbers is essential as every business will require variable amounts of cash during its business cycle; for instance, during its initial start-up, acceleration, expansion and growth, maturity and beyond. Consequently, cash management within a business is as essential as the engine management system in a car. Christopher (2011: 58) ranks the management of cash on a par with profit generation: Strong positive cash flow has become as much a desired goal of management as profit.

Why is cash flow incredibly important to business and such a big issue in business today? It is all to do with the timing of business transactions and the availability and access to credit finance. In addition, financial analysts/ stock markets monitor cash generation and cash flow as an important metric that is less susceptible to adjustments which can be applied to reported profits. Let us now consider the legendary summer holiday lemonade business, an initiative where many an entrepreneur has cut their teeth over the years. The premise is that you find a location, build a stand, promote your product, buy the ingredients and plastic glasses and then make the lemonade – not forgetting to factor in the opportunity cost of your time into the pricing of the product. However, even before you sell your first glass of lemonade you have had to find sufficient cash to make or buy the stand and purchase the lemons and other ingredients in the product’s recipe (bill of materials). If you have no access to credit then you will need to find sufficient cash to finance the venture and then recoup the cash from selling the lemonade at a later date: the so-called liquidity gap. If all your customers pay in cash then

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The background

your C2C cycle will be fairly short; however, if they were to pay on credit, then this will extend the liquidity gap and will have consequences for refreshing your lemonade inventories and customer service levels. The importance of cash flow to the success of any business is therefore vital, whatever the size: whether the business is seasonal, as is the case with agricultural companies that have a single annual harvest; or poultry, which must be raised from the egg to the mature bird; or the cheese and whisky businesses whose products need to mature over many years before they can be sold; or the manufacturers of complex aircraft and aero-engines that require extensive capital investment beforehand; or a self-employed person who supplies services to multinational organizations who has to eat. The UK government has recognized the importance of liquidity as an enabler of growth in the economy, but also highlights that insufficient liquidity can have serious implications for the financial sustainability of a business and also for its trading partners with its wider SC, both upstream (suppliers) and downstream (customers). On 23 October 2012 the UK Prime Minister announced an SCF scheme to improve cash flow: In the current climate, viable businesses can struggle to get the finance they need to grow – this scheme will not only help them secure finance and support cash flow but will help secure supply chains for some of our biggest companies and protect thousands of jobs. (Prime Minister’s Office, 2012)

The variety of SCF initiatives is examined in depth in subsequent chapters.

Net working capital Accountants, managers and the financial media often use the phrase net WC in business, but what does it actually mean? The Chartered Institute of Management Accountants (UK) terminology defines net WC (CIMA 2005: 82) as: Capital available for conducting the day-to-day operations of an entity, normally the excess of current assets over current liabilities.

The criteria for current assets (CA) and current liabilities (CL) are illustrated in Table 2.1, which has been extracted from CIMA’s official terminology guide. A business’s net WC is calculated by subtracting its CL from its CA and both of these figures can be obtained from the organization’s BS. If the ­resulting figure is positive then the organization will have net CA, as its s­ hort-term assets are greater than its short-term liabilities. Conversely, if the CL are greater than

The big issue

Table 2.1  CIMA criteria for current assets and current liabilities Current assets

Current liabilities

Asset that satisfies any of the following criteria:

Liability that satisfies any of the following criteria:

●●

●●

●●

●●

is expected to be realized in, or is intended for sale or consumption in, the entity’s normal operating cycle; is held primarily for the purpose of being traded; is expected to be realized within 12 months of the balance sheet date;

●●

●●

●●

is cash or cash equivalent.

is expected to be settled in the entity’s normal operating cycle; is held primarily for the purpose of being traded; is due to be settled within 12 months of the balance sheet date.

SOURCE  CIMA, 2005: 65

the CA, then the company’s net WC is referred to as net CL. Table 2.2 illustrates the net WC calculation for two companies that operate in two different industrial sectors: one has net CA and the other has net CL. Table 2.2  Net current assets and net current liabilities Engineering Co £m

Retailer Co £m

Current assets

50.0

60.0

Current liabilities

36.0

69.0

Net working capital

14.0

−9.0

Net current assets

Net current liabilities

Typical components that make up CA and CL are illustrated in Table 2.3. Table 2.3  Components of CA and CL Current assets

Current liabilities

Inventories Trade and other accounts receivables Other current assets Cash and cash equivalents

Trade and other payables Short-term borrowings Current portion of long-term borrowings Current tax payable Short-term provisions

SOURCE  CIMA, 2005: 61

Let’s now explore further a number of the specific five elements that make up the C2C calculation: three are CAs and two are CLs.

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The background

Current assets Inventories CIMA’s (2005: 73) official terminology defines inventories as: Assets held for sale in the ordinary course of business in the process of production for such a sale or in the form of materials or suppliers to be consumed in the production process or in the rendering of services.

Typically, inventory is sub-divided into three types: ●●

raw materials (RM);

●●

work in progress (WIP);

●●

finished goods (FG).

The automotive industry provides us with an excellent case study, where we can find numerous examples of all these types of inventories within a car manufacturing plant. RM include blank steel and aluminium sheets for pressing into car body panels and consumables such as packaging and components; sub-assembly parts that are awaiting installation on the assembly line. WIP inventory refers to the partially assembled vehicles that are moving along the line; and, finally, FG are the completed cars that are now rolling off the line and awaiting onward delivery to the dealers and the final customers. The levels of inventory owned by an organization in its SC operation will have implications for the FP of the business. As mentioned previously, inventory in its many guises is a CA on the BS, therefore too much inventory will have implications for the business in terms of asset utilization. Asset utilization is a key measure of SC performance. Asset turnover ratios are typically calculated by dividing sales revenue by the value of the different classifications of assets (TA, NCA, TA − CA, WC and inventory). Since the value of inventory is included in the TA figure, therefore reducing inventories will improve the ratio. Inventories will also have a financial impact on the organization’s IS, as their cost inputs into the COGS (cost of sales) calculation that determines the gross profit of the business. The costs associated with holding inventory, according to the literature, typically average 25 per cent of the inventory’s cost. This percentage includes the OC of capital tied up, handling and storage costs, insurance, damages, obsolescence and shrinkage. Hence the costs of holding excessive inventory levels will consequently have a negative impact on the bottom line. Finally, the amount of cash tied up in excess inventories will have negative implications for the business’s cash flow, liquidity and C2C cycle.

The big issue

Trade and other accounts receivables (AR) CIMA (2005: 76) defines trade and other AR as: Monetary amount owed by a person or organisation to the entity as a consequence of the sale of goods or services, known as trade receivables in International Accounting Standards (IASs).

Cash and cash equivalents Cash equivalents (official CIMA terminology 2005: 62) are described as: Short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to insignificant risk of changes in value (IAS 7).

Current liabilities Two important elements of an organization’s CL are now examined further.

Trade and other accounts payable (AP) Trade and other account payables are defined by CIMA (2005: 75) as: Person, or an entity, to whom money is owed as a consequence of the receipt of goods or services in advance of payments, known as trade payables in IASs.

Short-term borrowing A bank overdraft is classified as an example of a short-term borrowing by an organization.

Liquidity The relationship between CAs and CLs is an important one and accountants typically use two key financial ratios to measure liquidity, which you were introduced to in the previous chapter. The current ratio (CR) and the acid test (AT) (sometimes referred to as the quick ratio) are used to measure an organization’s liquidity. CIMA (2005: 92) defines liquidity as the: Availability of sufficient funds to meet financial commitments as they fall due.

The CR compares a business’s CAs with its CLs and expresses the outcome as a ratio. In the case of Engineering Co, the ratio is 1.39:1.00, which means that

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The background

they have £1.39 in CAs for every £1.00 of CLs. Therefore, in theory, there are sufficient CAs that can be converted back into cash to pay off the organization’s creditors if payment is required. In the case of Retailer Co, the ratio is 0.87:1.00 as they have less CAs compared to their CL, which means that the company has insufficient CAs to cover its CLs if all its creditors demand payment. Interestingly most accountancy textbooks argue that a typical manufacturing company’s CR should be 2:1; so what does this mean for Engineering Co? We will tackle this important question later on. The acid test (AT) ratio is a stricter measure of an organization’s l­ iquidity, as it does not take into consideration the value of the company’s inventory in deriving the ratio. The decision not to include inventory is based on the assumption by accountants that the subsequent value of the inventory may not be achieved on disposal. Therefore, the value of CAs minus inventory is compared against the value of CLs. The ratio is: current assets – inventory : current liabilities Let’s now look at the AT ratio for Engineering Co, using figures taken from their report and accounts: £50.0m − £16.0m = £34.0m Engineering Co’s AT ratio is 0.94:1.00 (£34.0m:£36.0m). Typically accounting textbooks suggest that this ratio should be 1:1, which means that the company has only 94 pence in CAs to cover every £1 of CLs. The AT ratio for Retailer Co is 0.24:1 (£16.6.m:£69.0m). The question that now needs to be answered is: as with inventory, is it possible to convert the full value of their ARs to cash? This question will be explored further in subsequent chapters of the book, when looking at SCF tools. You are now probably thinking to yourself, what is the point of having benchmarks of 2:1 and 1:1 for these ratios? This is a good question to ask as it goes straight to the heart of the problem with ratio analysis. With ratio analysis ‘context is everything’ and you need to understand the story behind the figures. These ratios will be influenced by numerous contextual factors, including the size of the business, its financial standing and ability to access credit, the industrial sector and geographic location that the business operates in and, finally, the current economic climate. As stated previously, all organizations are different and they can also have different liquidity ratios, which are sometimes less than these benchmarks and are able to operate with net CLs. This is because they have ­excellent C2C times and consequently do not require high liquidity ratios. This highlights the importance of not just relying on one set of financial

The big issue

r­atios alone, but also understanding the story behind the financial figures that are published in a company’s report and accounts. However, ratios do provide you with a useful starting point for your analysis as they can highlight areas that need exploring further, raise questions that you need answering, identify trends and can be used to compare similar businesses.

The cash-to-cash cycle Before exploring the components of the C2C calculation it is essential to recognize that the language of accounting is evolving and changing, but also that different terminology is used to describe the same thing, which can also be very confusing. For example, stock and inventory are used interchangeably. Table 2.4 illustrates this point with regard to the components of the C2C where different wording is used, yet they mean the same thing. Table 2.4  Working capital terminology Debtors collection period

=

Days sales outstanding (DSO)

=

Accounts receivable days

Creditors payment period

=

Days payments outstanding (DPO)

=

Accounts payable days

But should we not use all the terminology all the time rather than settle on one that may make the book less readable to all audiences? The C2C cycle (CIMA official terminology 2005: 98) is defined as: The period of time which elapses between the point at which cash begins to be expended on the production of a product and the collection of cash from the purchaser.

The C2C cycle is typically measured in days and is calculated using three financial ratios: ●●

inventory days (DIH);

●●

receivable days (DSO);

●●

payment days (DPO).

The C2C is the sum of the number of inventory days plus the number of receivable days minus the number of payment days. C2C days = Inventory days + receivable days − payable days.

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The background

The C2C is also referred to as the working capital cycle or alternatively cash conversion cycle (Richards and Laughlin 1980: 34), which is the: Time interval between actual cash expenditures on a firm’s purchase of productive resources and the ultimate recovery of cash receipts from product sales, [and] establishes the period of time required to convert a dollar of cash disbursements back into a dollar of cash inflow from a firm’s regular course of operation.

The C2C provides the average number of days needed to convert tied up working capital into cash by measuring (Gentry, Vaidyanathan and Lee, 1990: 90): The days funds are committed to inventories and receivables, less the number of days that payment to suppliers is deferred.

DPO, as part of current liabilities, provide interest-free external financing and are subtracted because they represent an interest-free loan. The financing needs of a company are reduced accordingly. Figure 2.1 depicts graphically how the C2C period is determined by the inventory period plus the AR period minus the AP period. Figure 2.1  C2C cycle and its components

Supplier interface

Inventory period

A/R period

A/R period

Customer interface

CCC

Inventory Cash purchased paid to from supplier supplier

Goods sold to customer

Payment received from customer

Time

Operating cash

Inventory days (DIH) This ratio measures the average number of days of inventory held by the organization’s inventory. The average number of inventory days is calculated by using the following formula (CIMA official terminology 2005: 23): Inventory days = Average inventory/Average daily cost of sales in period

The big issue

Accounts receivable days (DSO) The CIMA official terminology (2005: 24) states that the receivable days ratio: Indicates the average time taken, in calendar days, to receive payment from credit customers.

The average number of receivable days is calculated by using the following formula: Receivable days = Average trade receivables/Average daily revenue on credit terms.

Accounts payable days (DPO) The CIMA official terminology (2005: 24) states that the payable days ratio: Indicates the average time taken, in calendar days, to pay for supplies received on credit.

The average number of payable days is calculated by using the following formula: Payable days = Average trade payables/Average daily purchases on credit terms. The following data for two hypothetical companies is illustrated in Table 2.5 and will be used to calculate net WC and liquidity ratios.

Table 2.5  Financial data from Alpha and Delta reports Company

Alpha

Delta

Average inventory £m

 15

 6

Cost of sales £m

 80

 45

Average accounts payable £m

 15

 20

Average accounts receivables £m

 22

 12

Sales (credit) £m

125

120

Purchases (credit) £m

 90

 60

61

62

The background

Alpha’s WC ratios have been calculated using the following formulas, which were introduced to you previously and are now shown below: Inventory days (DIH)

Average inventory/Average daily cost of sales in period £15m/£0.219m = 68 days

Receivable days (DSO)

Average trade receivables/Average daily revenue on credit terms £22m/£0.342m = 64 days

Payable days (DPO)

Average trade payables/Average daily purchases on credit terms £15m/£0.246m = 61 days

Working capital days (C2C)

Inventory days + receivable days − payable days 68 days + 64 days − 61 days = 71 days

The liquidity and WC ratios for both companies have been calculated and are illustrated in Table 2.6. Here is the paradox. Alpha has current and acid test ratios that are above the typical benchmarks of 2:1 and 1:1 respectively; the company therefore has a positive net WC. However, the company has a liquidity gap, as its C2C cycle is 71 days and hence has to find additional sources of funds to finance its day-to-day net WC requirements. Conversely, in the case of Delta, both liquidity ratios are below their respective benchmarks, meaning the company has net current liabilities, but the business has a negative net C2C cycle of −36 days, which means that the company is able to invest surplus cash as it has sufficient finances to fund its net WC needs. Table 2.6  Liquidity and working capital ratios Ratio

Alpha

Delta

Inventory days

68

 49

Receivable days

64

 37

Payment days

61

122

Cash-to-cash cycle days

71

−36

Current ratio*

2.5:1

0.9:1

Acid test ratio*

1.5:1

0.6:1

22

 −2

Working capital £m

* Assumption that both companies have nil cash balances

The big issue

The question is, which company has the better performance? The answer to the question, which will frustrate you, is that it depends on the perspective taken! Paradoxically, Alpha has better liquidity than Delta, but has a worse C2C cycle. This indicative example stresses the point that it is important to take a holistic perspective when using ratio analysis to compare company performance and, as stated previously, understanding the narrative behind the numbers is crucial. C2C cycle times can typically vary by geography, by industrial sector and by the size of the organization.

Working capital management and firm performance When looking at the existing literature on the relationship between WC levels and profitability of a firm, extant evidence allows for multiple explanations of the nature of this relationship. Overall, there is evidence that supports three apparently contradictory linkages (Wetzel and Hofmann, 2019): ●●

●●

●●

a negative relationship between levels of working capital and firm profita­ bility (ie lower levels of working capital will maximize firm performance); a positive relationship between levels of working capital and firm profita­ bility (ie higher levels of working capital will maximize firm performance); a non-linear relationship between levels of working capital and firm profita­ bility (ie optimal levels of working capital will maximize firm performance).

A first group (the traditional WCM school of thought) of studies carried out supported the notion of a negative relationship between levels of working capital and firm performance (Wetzel and Hofmann, 2019). Shin and Soenen (1998) found strong evidence that supports such a relationship using a sample of 58,985 firms and investigating a time span from 1975 to 1994. Using correlation analysis and regression, they demonstrated a significant negative relationship between CCC cycle length and firm profitability. This notion gained further support from studies by Deloof (2003), Wang (2002) and Lazaridis and Tryfonidis (2006) for firms operating in the Belgian, Taiwanese, Japanese and Greek markets, respectively, which confirmed the findings of Shin and Soenen. Regarding possible explanations for the negative nature of the relationship between levels of WC and profitability, authors often cite root causes related to costs and perception of WC investments by shareholders. Lower

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The background

levels of WC imply lower interest payments and thus an improved shareholder value (Kieschnick et al, 2013). Lower levels of inventory, which are also associated with lower levels of WC, may also influence profitability: as inventory levels lower, so do the associated costs of holding inventory (storage, handling, opportunity COC and insurance costs), which are typically 25 per cent of inventory’s book value (Christopher, 2011), which in turn increases shareholder value. Furthermore, reducing WC is an effective means of internal financing and to generate liquidity. Insisting on a short AR period will foster cash flows towards the firm, whereas a high amount of AP, will delay cash flows away from the firm (Falope and Ajilore, 2009; Autukaite and Molay, 2011). Moreover, when WC is regarded as an investment to keep a business running (Rafuse, 1996), high levels of WC imply opportunity costs that arise due to the investment in WC instead of other projects that could provide higher returns (Deloof, 2003). Thus, shareholders value an additional investment in net WC at less than the cash equivalent of the investment (Autukaite and Molay, 2011). A second group of researchers (the alternative WCM school of thought) have found a positive association of levels of WC and firm performance through their research (Wetzel and Hofmann, 2019). Tauringana and Afrifa (2013) found a positive relationship in their study of 133 SMEs from 2005 to 2009 between return on assets (ROA) and levels of WCM, measured using the C2C. The same results were obtained by Gill et al (2010) in a study with 88 firms listed on the New York Stock Exchange from 2005 to 2007, or by Padachi (2006), who found a positive association between WC levels and profitability in a study of 58 small manufacturing firms between 1998 and 2003. The reasons cited for a positive relationship between levels of WC and firm profitability are rooted in considerations of the impact of higher WC levels on business operations. By extending payment periods (ie accepting higher DSO), firms may differentiate themselves from competitors by offering better value to customers that then translates into better profitability measures (Shipley and Davies, 1991; Deloof and Jegers, 1996; George and Kirk, 2003). Such extensions of payment periods may be perceived as a price cut (Petersen and Rajan, 1997; Emery, 1984) and reduce the risk for buyers as they may use the extended payment period to inspect the quality of the purchase (Biais and Gollier, 1997). In the long run, the practice of granting high DSO can further contribute to improved profitability as it may serve as an instrument to strengthen ties to customers and increase their loyalty (Long et al, 1993; Deloof and Jegers, 1996; Shah, 2009). Regarding a firm’s suppliers, accepting low levels of AR, which increases net WC, may also lead to improved financial performance, as early payments to suppliers are often

The big issue

associated with discounts on purchases, which in turn lead to reduced costs and thus to improved profitability (Ng et al, 1999; Wilner, 2000). Also, higher levels of inventory may help to smooth operations and reduce the risk of potential losses from forgone business due to stockouts and disruptions in the production process, as well as from fluctuations in input prices (Blinder and Maccini, 1991; Wang, 2002). Finally, higher levels of WC may also provide firms with a cost-effective means of short-term financing. According to Fazzari et al (1993), conversion costs from CA into cash are substantially lower than conversion costs for NCA, making WC a more efficient source of internal financing in case of liquidity squeezes. Last, a third group of researchers (the progressive WCM school of thought) has postulated a relationship between levels of WC and profitability that attempts to reconcile the opposing theories of a negative or positive relationship between WC and performance (Wetzel and Hofmann, 2019). According to subsequent recent studies, the relationship between levels of WC and firm performance is non-linear, which implies that an optimal level of WC exists at which the costs and benefits of WC are in balance. Baños-Caballero et al (2014) found a concave relationship with a value-maximizing level of WC for a sample of non-finance firms in the UK, which changes depending on the degree of financial constraint a firm is subject to. These results were confirmed in a study on the restaurant industry, where Mun and Jang (2015) also found a concave relationship between WC and firm performance present in a study of 298 firms. Afrifa and Padachi (2016) found that the same is true for SMEs using a sample of 160 firms listed on the Alternative Investment Market from 2005 to 2010. These results were confirmed by studies on different markets and ­industries, such as Portuguese SMEs (Pais and Gama, 2015), non-financial Indian companies (Altaf and Shah, 2017) and Croatian software providers (Korent and Orsag, 2018). A theoretical explanation for such a relationship arises from the notion of WC as an investment. According to this perception of WC, the costs of the investment (opportunity cost, interest, delayed cashflows, etc.) must be balanced against the benefits (protection from stockouts, liquidity buffer, value proposition to customers) (Rafuse, 1996). It becomes apparent from the review of extant studies that there is as yet no consensus on the relationship between WC and firm profitability. While earlier studies provide evidence of a positive or negative relationship, more recent studies from 2014 to 2018 attempt to resolve this conflict by providing evidence for a non-linear, either convex or concave, relationship between WC and firm performance (Wetzel and Hofmann, 2019).

65

The background

Working capital management and the cost of capital WCM policies can be differentiated in two extremes (Schmid, 2010): relaxed and restricted. A relaxed WCM policy provides large amounts of cash and inventories. Customer credit terms are liberal and the firm does not take advantage of AP. A restricted WCM policy does exactly the opposite: cash, inventories and AR are minimized, whereas AP are maximized. Without any other factors the relaxed policy represents WC that is not optimized to exploit the maximum profitability, while the restricted one is completely optimized. When we consider profit maximization, there is no real justification for a relaxed policy, because it merely adds additional costs and avoids profit. But there is one vital additional factor: uncertainty in expected payments, sales and lead order times. This forces companies to prepare for any unfavourable or unexpected events in terms of extra cash and inventory reserves. In addition, if there are not enough RM, the manufacturing process has to be interrupted immediately. Furthermore, stringent payment conditions could deter potential customers and lower sales. On the AP side, the discount terms must be taken into account, eg a 2 per cent discount for payment within 10 days, so that it is rational to pay within a predetermined period if a firm does not have high opportunity costs (OCs) of around 20 per cent. So, decision makers have to determine the ‘adequate’ WC policy to maximize the firm’s profit (Garcia-Teruel and Martínez-Solano, 2007; Brigham and Ehrhardt, 2008). An efficient, lean and mean policy is good until it reaches the point where it becomes too risky and generates more costs than it saves. Hence, it is a challenge to estimate the optimized WC policy and calculate the expected risks. Figure 2.2 is a qualitative illustration of how the optimal policy for a firm could look. Figure 2.2  Illustration of costs with differing working capital policies 1

Working capital optimization

Additional Costs

66

Costs Risk Real costs 0

Relaxed

Moderate Policy

SOURCE  Brigham and Ehrhardt (2008: 207–210).

Restricted

The big issue

With a restricted policy, there are no additional costs caused by non-optimized WC. There is a trade-off between the linear cost savings through a restricted policy and the costs that arise from the exponential risks due to low inventories and illiquidity (Garcia-Teruel and Martínez-Solano, 2007: 165). The question is then: how can we determine the optimum point of WC? We suggest that a firm should optimize their AR and AP and minimize their inventories to a reasonable minimum. So dependent on the firm’s risk profile, the WC structure could look completely different. There is, however, always an optimum between the two extremes that has to be investigated. The intrafirm WC optimization is a prerequisite for inter-organizational optimization of WC in the SC. The first step, according to the profit-­maximization assumption, has to be the intra-firm-optimization, before dipping into highly collaborative SC synergies. Between WCM and the cost of capital (COC) – measured by the WACC – there are several interconnections. On the one side, a shorter C2C lowers the net operating assets and WCM has a direct impact on the financing needs of a company and therefore its capital structure. The capital structure, through the effects of the leverage ratio on the weights of equity and debt, has a direct impact on WACC. As the beta coefficient and the risk premium as further components of WACC are also influenced by leverage, this is another link between capital structure and COC. There clearly exists a connection between WCM and COC. In addition, it is generally agreed that efficient WCM indirectly leads to an increase in profit as revenues rise and costs fall. The falling costs have an impact on operating leverage, measuring fixed costs in relation to variable costs. Operating leverage, as part of the business risk of a firm – the risk of a firm without financial leverage – is another factor influencing beta. WCM therefore is a source of operational and financial efficiency (Smid, 2007: 128). Looking at the picture from the other side, COC influences WCM according to Groth and Anderson (1997: 476): The cost of capital is the minimum rate of return, given the risk, for investing and flowing capital through the business cycle.

As COC is the indifference point between investing in the C2C cycle or investing the money elsewhere, this determines the size of the total cash cycle, ie the WC. In other words (Groth and Anderson, 1997: 476): Investments in this business cycle are only rational if they generate economic returns greater than the cost of capital (COC) and higher than that available in alternative opportunities of equal risk.

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The background

Working capital management What decisions can managers take to improve working capital? In the lecture room it is incredibly easy to improve the C2C cycle of an organization, simply by playing with the components of the C2C cycle: by extending the time you pay your suppliers, or cutting the time given to your customers to pay you and, finally, reducing the amount of inventory on the BS. Each decision on its own will improve the C2C time and collectively they will generate an even greater improvement. However, no organization has the luxury of the freedom given to the lecturer in the classroom. In business there are often consequences that have to be taken into consideration and trade-offs that need to be made when managers decide to change one or more of the WC components. Such changes may have positive or negative implications for the FP of the business and may also impact the suppliers and customers that they trade with. Reducing the time given for a customer to pay may mean that the customer places their next order with your competitor, instead of with you. Extending the time your organization takes to pay a supplier may cause that business to fail. Reducing inventory levels without taking into consideration your production processes could reduce the efficiency of the process, incurring additional costs and may also have implications for product availability, something that can consequently impact negatively on customer service levels.

Managing inventory days The DIH calculation has two elements: the numerator, which is the average inventory, and the denominator, which is the average daily cost of sales. The composition of the COGS calculation will vary according to the type of business. For example, for a retailer who sells model cars its cost of sales calculation will be different from that of an automotive manufacturer. The retailer purchases model cars from a toy manufacturer and then sells them on to its customers. The COGS calculation will include the opening inventory of model cars at the start of the financial year plus the total value of models purchased during the year minus the closing inventory of models on the last day of the retailer’s accounting period, as illustrated in the indicative example on the following page.

The big issue

Sales

£160,000

Less cost of goods sold Opening inventory

£15,000

plus purchases

£75,000

minus closing inventory

£12,000

Gross profit

£78,000 £82,000

In this example the retailer’s average inventory will be £13,500 (£27,000/2). Therefore, the inventory days will be 63 days. The average inventory days is derived by taking the average inventory of £13,500, dividing by COGS £78,000, then multiplying by 365 to arrive at 63 days. In the case of an automotive manufacturer the composition of their COGS calculation will be different. The value of WIP – partially completed cars on the assembly line – will contain proportions of direct materials and direct wages costs as well as indirect costs including depreciation for the use of NCA. There are numerous SCM initiatives that organizations could introduce to reduce their inventory levels and therefore improve their C2C time. Table 2.7 highlights for each initiative a brief description and examples of the industrial sectors that have adopted it in their SC operation. The benefits of reducing inventory levels are not just confined to the C2C cycle but also can be seen in the organization’s IS and BS: Income Statement

Balance Sheet

Impact on the COGS calculation Reduce OPEX Reduced shrinkage Reduced product availability could impact on sales revenue

Reduce CA Reduce net WC Reduce tangible NCA if warehousing capacity is no longer required Reduce TA Reduce the current ratio

Reducing the value of inventory will impact on numerous financial ratios that measure profitability, liquidity, asset utilization and WC efficiency. This list of financial ratios is not exhaustive but does highlight the complexity that a single decision can have on the organization’s FP and, importantly, the

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Table 2.7  Inventory reduction initiatives Initiative

Description

Postponement

Delaying the conversion of raw materials or WIP into finished goods until the last possible moment to DIY, fashion, avoid holding excessive finished goods inventories and therefore enhancing ability to react to changes electronics and in consumer demand. An everyday example is the way DIY stores are able to mix a specific colour of computers paint for a customer without the need to hold inventory of that colour, only the raw materials components that can also be configured into a variety of different colours.

Electronic data The use of information technology to communicate customer demand data throughout the supply chain interchange (EDI) will provide opportunities to improve inventory management and therefore reduce inventory levels, costs and risk. Often the axiom ‘replacing inventory with information’ is recited when referring to the use of EDI.

Sector

Retailing

Centralize By holding inventory centrally, an organization can benefit from economies of scale, optimizing inventory Fashion, parts inventory holding and distribution costs, but also enhancing product availability and improving customer service levels. Just-in-time

The delivery of a specified SKU by a supplier to a customer at the agreed time and location that will synchronize with the business process of the customer and therefore reduce the likelihood of holding inventory at the location.

Automotive

Cross-docking

Avoid holding inventory at transhipment centres and the associated inventory storage cost, as goods are typically cross-docked from larger inbound deliveries for onward delivery in smaller shipments. A UK retailer is currently using an intermodal rail service to move containers of groceries from its rail connected central distribution centre to a rail terminal over 100 miles away, where the containers are then delivered by road to their various stores.

Retailing

Vendor-managed Typically, inventory is managed often electronically and may be owned by the supplier at the Food inventory customer’s premises and then replenished when required. A typical example is flour and sugar in silos manufacturers at bakeries and food manufacturers. Standardized components

The use of standardized components within more than one finished product, for example cars and computers. The aim is to reduce the variety and complexity of inventory management and therefore reduce costs and improve financial performance.

Automotive and electronics

The big issue

need to communicate and consult with other functions within the organization before executing a decision: ●●

inventory turnover;

●●

ROCE per cent;

●●

inventory days;

●●

working capital turnover;

●●

cash-to-cash cycle;

●●

gross profit per cent;

●●

TA-CL turnover;

●●

EBIT per cent;

●●

acid test ratio;

●●

current ratio.

Managing receivable days As stated previously, receivable days (DSO) measures the time it takes for an organization’s customers to pay for the goods and services it has purchased. Therefore, if a business is able to reduce the value of its AR as a proportion of its sales on credit, then the ratio will improve and the numbers of AR days will decrease. However, the ability of a business to reduce its AR days is dependent on the relationship between the buyer (customer) and the supplier (seller) and particularly the one with the greater power over the other in the relationship. Two hypothetical scenarios are presented with regard to the power relationship between buyer and supplier. An SME is selling to a large multinational organization in a very competitive business environment; this would be an important deal for the SME to win. However, during the negotiation period, the customer states that its standard terms and conditions are that suppliers will be paid in 60 days from receipt of the supplier’s invoice. The power in this buyer–supplier relationship is with the buyer in this instance and not with the supplier; if the supplier wants the business then it will have to accept the customer’s terms and conditions. Conversely, if a new start-up company (buyer) wants to purchase components from a large supplier, the value of the transaction is relatively small in sales value to the supplier. In this scenario, however, the supplier asks to be paid in full, with no credit period offered to the buyer as they do not yet have a proven credit history; thus the power in this relationship rests with the supplier. These two scenarios, although hypothetical, are indicative of real-life situations between buyers and sellers. Suppliers have two options that can improve their receivable days and cash flow. The first is the direct option. Where a supplier deals directly with its customer, depending on the power relationship, it may decide to:

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The background

●●

trade on a cash only basis with their customers;

●●

reduce the credit time period offered to its customers;

●●

offer its customers a discount on the value of their invoice if they settle earlier.

Alternatively, the supplier could use the indirect option where a third party is introduced to liberate the cash for the customer and therefore improve its C2C cycle. There are numerous initiatives that can be implemented under the banner of SCF and they are explored later in the book.

Managing payable days In recent years it has been fashionable for buyers to gain net WC efficiencies by extending their payment terms to their suppliers; for instance, increases from 60 to 90 days are commonplace. This strategy will improve the C2C cycle of the buyer and enhance their cash flow. The end result is that the value of the AP on the BS will increase. The amount of payments outstanding has now increased as a proportion of credit purchases, resulting in an increase in the payment days ratio. The impact of this decision will also have implications for the organization’s liquidity ratios as the increase in AP will have a negative impact on the CR and AT. The downside of this decision is the negative impact on the supplier’s net WC and liquidity. This can result when its customer increases the payment period; again, the power in the buyer–supplier relationship will have a considerable influence on which supplier’s terms are increased. The decision to increase the payment terms can have unforeseen implications for the buyer in terms of its reputation and there have been numerous examples in the media with regard to buyers imposing extended terms on their smaller suppliers. The Forum of Private Business (2020), a support group for small businesses, has established the ‘Hall of Shame’, which for over 20 years has highlighted UK companies who have introduced payment initiatives that have had negative implications for their suppliers: In that time, we have shared some of the UK’s biggest names for poor payment practices, resulting in government intervention, extensive media coverage and some businesses reconsidering changing the way they do business.

The buyer can mitigate the impact of extending payment terms on its suppliers by introducing SCF programmes directly or indirectly by a third-party intermediate. However, even the introduction of certain SCF initiatives by UK companies has led to their names being included on the ‘Hall of Shame’ list. These different SCF initiatives will be discussed later in the book.

The big issue

Managing the cash-to-cash cycle With the C2C we have an instrument in our hands to manage working capital efficiently. Hager (1976:19) points out that: From a strictly detached point of view, the aim of effective cash management with respect to the cash cycle would be to shorten the cycle as much as possible and thus speed the flow of cash in and out of operations.

But lowering the C2C as much as possible is not the goal of efficient WCM, since WCM is an ‘optimization problem’ that arises in the tension of the classical financial objectives, liquidity and profitability. WCM is expected to support the overall corporate goal of profitability while at all times meeting the company’s liquidity requirements. Jose et al (1996: 33) emphasize the importance of promoting a company’s well-being in terms of liquidity as well as profitability, since: Firms with glowing long-term prospects and healthy bottom lines do not remain solvent without good liquidity management.

On the one hand, a long C2C is an indicator of conservative liquidity management or even excess liquidity and has a negative effect on profitability because of different costs. As Skomorowsky (1988: 84) states: It is commonly accepted that tying up cash in excess inventory has a depressing effect on net income.

On the other, it is generally agreed in theory that a low C2C, indicating an effective WCM, has a positive effect on profitability. Skomorowsky (1988: 84) argues that a short C2C: Influences the maximum attainable profitability of a business because every dollar of cash available for operations has a multiplier effect determined by how frequently that business can turn over cash.

It follows that a lower C2C indicates higher profitability, because this company makes more revenue per invested unit in the production process (Hutchison et al, 2007: 42). A lower C2C cycle therefore leads to a higher present value of the net cash flows produced by the company’s assets, resulting in a higher company value (Jose et al, 1996: 35). In addition, excess funds invested in inventory do not generate additional value and cannot be used for other purposes or new investments that could bring the company additional return – potential profits are lost. According to Finnerty (2006: 394), this: Can lead to slower company growth because the funds have not been efficiently used for expansion.

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The background

In addition, a targeted WCM reduces the capital tied up and often considerable financial resources are released. For each day by which the C2C is lowered, less funds committed have to be financed and the need for costly external financing is reduced. The reduction of redundant working capital to a minimum leads to a reduction in assets and capital tied up. In addition to the reduction of financing costs such as interest payments, general costs related to the asset base are reduced as well. Rafuse (1996: 62) aptly summarizes: Reducing stock produces major financial benefits by simultaneously improving cash flow, reducing operating cost levels, lowering the asset base and reducing capital (capacity) spending. No other single management action can generate such a high degree of financial leverage.

The trade-off between an opportunity-cost-minimizing maintenance of enough liquidity and achieving sufficient profitability has to be kept in mind while managing net WC.

Who owns working capital management? If a business wants to improve its C2C, it will require a holistic perspective to be taken by a number of functions within its organizational structure. The following questions relating to the management of net WC need to be considered: ●●

Which functions have an impact on inventory policy within the organi­ zation?

●●

Who owns the cost of sales calculation?

●●

Which function is responsible for establishing supplier payment terms?

●●

Who manages the supplier relationship?

●●

Who is responsible for establishing customer payment terms?

●●

Who manages the relationship with the customer?

●●

Which function owns cash management within the organization?

A research study (Cosse, 2011) undertaken by the Cranfield Centre for Logistics and Supply Chain Management focused on WCM initiatives in four multinational organizations. The study highlighted the functions that were involved with SCF initiatives.

Table 2.8  Ownership of working capital management

Initiation Ownership Working team

Tel Co

PharmaCo

ChemCo

AutoCo

Finance and Treasury

Sourcing Group

Finance and Treasury

Purchasing

Finance (Procurement Group)

Corporate Finance WC team

Procurement Operations

Procurement

Treasury/Cash management









Procurement









Accounting (AP)









Legal/Auditors









IT









Finance









Sponsorship

CFO

Treasury and Finance

Treasury

CFO

SOURCE  Cosse (2011: 139)

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The background

However, WCM is an incredibly complex area, as illustrated in Table 2.8, and functions within an organization can also have opposing perspectives with regard to the elements that are involved in the C2C, adding another layer of difficulty. The level of inventory is a key example as marketers, accountants and logisticians all have different perspectives on what is the ‘right’ level. A debate about inventory levels must address customer service, risk, inventory holding and liquidity, among others. This can lead to conflict between functions and may necessitate trade-offs between departments before an agreement is reached. There will also be potential areas of conflict between functions with regard to receivables (trade-off between sales and credit management policy) and payables (procurement policy and payment terms) decisions. The goals of individual functions can clash with those of other departments. For example, the financial function is set the objective to reduce the C2C cycle: it could do this by implementing policies that reduce inventory days and AR days. However, this could have a negative impact on customer relationships due to product availability issues and customers switching to competitors that offer better payment terms, thus conflicting with the goals of the marketing function, which is targeted with creating and retaining revenue. To minimize the conflict between the parties involved in the management of WC, and to identify trade-offs between functions, the application of the RACI (Responsible, Accountable, Consulted, Informed) method to develop a responsibility assignment matrix is recommended. Figure 2.3 illustrates its application within the context of the WCM process. Figure 2.3  The application of the RACI method to the WCM process Define who is in charge of what (lead, support).

Discuss the current status of inventory, receivables, payments and (liquidity) risk management. Sub-process (KPI)

WCM Process

Who is the recipient?

Supply Chain Management Plan

Source

Make

Accounting liver

Marketing/ sales

P1 P2 P3

P Determine the relevant sub-processes within a workshop session. Establish adequate KPIs for each sub-process.

Document and communicate your WCM organization across all functions.

Bring this (secondary) WCM organization to 'life' by establishing weekly/ monthly meetings.

The big issue

The limitations of working capital ratios The problem with financial ratios is that they are typically based on averages. An average is an artificial construct; it is the central measure of a data set that may not even occur in a real-life situation. For an extreme example that highlights the weakness of the average, let’s consider a shoe retailer. The retailer is asked to measure the average shoe size sold in the last hour of trading. The retailer sells 10 pairs of shoes and the indicative data is displayed in Table 2.9. Table 2.9  Shoe sizes Shoe size sold

2

4

7

9

14

8

6.5

8.5

12

7

The average shoe size is calculated to be 7.8, which does not even exist as a shoe size and so this measure is of little value to the retailer. However, importantly, the mode of 7 and the range 12 (the difference between the highest and lowest value) may be of extra value to the retailer in this illustration, because the mode indicates the most popular size sold and the range the different shoe sizes that need to be held. The season of the year, a particular month, the day of the week and the hour of the day will all have an impact on the average shoe size sold on a particular day; therefore, is the average important? We now consider the average inventory figure used in the inventory days calculation. The ratio takes the opening inventory figure at the beginning of the accounting period plus the closing inventory value on the last day of the financial year end and divides this total by two to give an average period for the financial year. This average is used in the inventory day ratio as its numerator. The denominator is the average daily cost of sales for the period, again an average. Therefore, the end result is a figure that has been derived by a combination of two averages that may or may not have occurred during the accounting period. The same averaging methodology is applied to the AR and AP days’ ratios. The end result is a C2C figure that is derived from three ratios that are all averages. The C2C figure is used to compare an organization’s performance with other organizations in the same industrial sector and even analysts’ reports will compare the company’s ratios with industry and sector benchmarks (that are also averages).

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The background

Ratios do have a value as measures of comparison, but it is important to recognize the limitations involved in the way they are derived. Ratio analysis over a number of years can identify trends; for example, an improvement in the organization’s C2C cycle can be explained by a concerted effort to reduce the levels of inventory or extent days payable. This can be triangulated with reference to other sources of information such as company press releases and investor relations briefings, or to third-party reports produced by financial analysts. Table 2.10 illustrates a set of working capital and liquidity ratios for UK retailer Marks and Spencer Group plc for the period 2006 to 2019. It illustrates an increase in inventory days over the 14-year period from 17.52 days to 24.63 days in 2019. Receivable days have increased by 212 per cent over the period from 1.97 to 4.17; this has been offset by a 284 per cent increase in payment days from 11.3 in 2006 to 32.05 in 2019, resulting in a C2C cycle improvement of 11.38 days over the time period. Both current and acid test ratios are below the typical benchmarks quoted in accounting textbooks, but they should be compared with the norm for the retailing sector, as context is crucial. Importantly, it should now become clear to you that the ratios do not give us the full story behind the numbers and that additional research is required to understand the narrative. However, the ratios provide us with the prologue to the storyline. Note, though, that there are other factors that need to be taken into consideration when comparing financial ratios. The ratios are derived from data contained in the organization’s financial reports and, typically, companies will aim to present the company’s figures in the best possible light – the term ‘window dressing’ is often used to explain this phenomenon. Accounting policies (depreciation and inventory valuation methods) and economic conditions (boom versus recession) will also vary across geographical regions of the world and they will have an impact on the data used to calculate the ratios – the old adage ‘comparing like with like’ is an important saying to remember. It is also an advantage that the ratios are calculated in a consistent way and a single source of data is advisable. Table 2.11 illustrates inventory days for retail multiples operating in the UK, with data supplied from a single source. However, even if we compare like with like data, the ratios do not explain the narrative behind the numbers. For instance, in Table 2.11, why is Marks and Spencer Group plc’s ratio for inventory days in 2019 168 per cent of WM Morrison Supermarkets plc’s? Ratios are the starting point of the investigation not the end point; in this instance the difference could be due to the varying characteristics of goods held by each company.

Table 2.10  Financial ratios for Marks and Spencer plc Ratio

2019

2018 2017

Inventory days (DIH)

24.63

26.64

4.17

3.89

Payable days (DPO)

32.05

29.78

Cash to cash days (C2C)

−3.25

Receivables days (DSO)

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007 2006

26.07 27.65

28.25

29.95 27.92

25.05

25.68

23.47

21.59

19.78

17.69

17.52

3.94

4.21

3.68

3.39

3.36

3.42

2.89

1.97

34.45

3.76

4.00

4.38

35.34 34.25

34.25

40.50 35.41

36.32

30.32

14.38

9.18

11.04

11.36

−6.06 −3.55

−7.06 −5.09 −3.46

10.57

14.02

9.54

8.13

0.75 −3.42

3.69

−1.62

4.49

Current ratio

0.67

0.72

0.73

0.69

0.69

0.58

0.57

0.73

0.74

0.80

0.60

0.59

0.53

0.57

Acid test ratio

0.35

0.29

0.41

0.31

0.31

0.22

0.22

0.39

0.43

0.48

0.37

0.35

0.27

0.38

SOURCE  Fame, published by Bureau van Dijk (2020)

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The background

Table 2.11  Inventory days ratios UK retail multiples UK Retailer

2019

WM Morrison Supermarkets plc

14.68

J Sainsbury plc

22.26

Tesco plc

14.94

Marks and Spencer Group plc

24.63

SOURCE  Fame, published by Bureau van Dijk (2020)

Importantly, it is information that is not typically disclosed in a company’s financial reports and is available only internally, which is the most useful when trying to understand an organization’s C2C cycle. Such internal information includes: ●●

inventory days by stock-keeping unit (SKU);

●●

classification of inventory by speed of turnover;

●●

segmentation of accounts payable by supplier;

●●

percentage of procurement spend by supplier;

●●

payment terms by supplier;

●●

segmentation of accounts receivables by customer.

Ratios only inform; they are an output of a calculation; they do not specify the appropriate level of net WC an organization should adopt. As discussed earlier, optimizing net WC is complex. However, too little net WC can have grave financial consequences for an organization (stockouts, production problems and liquidity issues) just as with a lack of oil in an internal combustion engine. Conversely, excessive net WC can also have financial consequences that can have a negative impact on FP. Too much inventory traps cash that could be used to invest in alternative investment opportunities that could generate higher returns; excessive inventory levels generate additional holding costs and cash tied up in unproductive assets will have an impact on profitability ratios such as ROCE and asset utilization ratios.

Financially sustainable supply chains If we were to extend the principle of optimizing net WC from the individual organization to the SC, then this establishes the premise of developing financially sustainable SCs that optimize net WC. Table 2.12 illustrates the C2C cycle for three different companies that operate in a confectionery SC.

The big issue

Table 2.12  Working capital ratios: confectionery supply chain Working capital ratio

Retail multiple Food processor Raw material

Inventory days (DIH)

16

34

35

+ Receivable days (DSO)

 2

29

30

– Payable days (DPO)

26

34

23

= Working capital cycle (C2C)

−8

29

42

However, when comparing their respective C2C times, traditionally the analysis would be focused on their peers within their industrial sector, not on their extended SC. SCF should enable organizations to take a holistic perspective to develop an inter-organizational evaluation of net WC throughout the SC. This raises a number of interesting points regarding optimization, should an individual organization adopt a sub-optimized net WC that allows the SC to achieve an optimized position. The inter-organizational perspective with regard to net WC is developed further in Chapter 4. The analysis of the three companies’ working capital cycles reveals the following: ●●

●●

●●

●●

●●

●●

●●

The retail multiple has the shortest working capital cycle, which is negative eight days. The retailer’s receivable days are two, as their customers typically will pay for their purchases by cash, debit or credit cards compared to its payable days to their suppliers, which are 26. Inventory is held for 16 days by the retailer, which equates to an inventory turnover of around 23 times per annum (365 days/16 days = 23). The food processor and raw material supplier both have similar inventory days of 34 and 35, which equates to an inventory turnover of 10.5 times a year. The food processor and raw material supplier also have similar receivable days of 29 and 30. The payment days vary with the food processor on average paying their suppliers in 34 days, compared to 23 days for the raw materials supplier. This is the key difference between the companies’ working capital cycles, resulting in the food processor having a cycle time of 29 days compared to the raw material supplier, which has 42 days. The range between the shortest and longest working capital cycle in this supply chain is 50 days.

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It is important for all the organizations that operate in a supply chain to recognize that their working capital cycles are different and that they will have implications for cash flow management, liquidity and the financial sustainability of the whole supply chain. As the old saying goes, a ‘supply chain will be only as strong as its weakest link’.

The liquidity domino effect in supply chains The importance of developing financially sustainable SCs is illustrated in the following hypothetical example, which introduces the liquidity domino effect. A focal firm that is at the centre of a complex SC network has decided that it will extend its AP days to its tier 1 suppliers (S1) to improve its net WC position. Say this policy is then cascaded up the entire SC at every tier: from S1 to S2, then from S2 to S3 and finally from S3 to S4. As a result of this decision by the focal firm, however, an S4 supplier who supplies a unique component to the network is now unable to finance the increase in its C2C days and, consequently, ceases to trade due to insufficient liquidity. The unique component is no longer available to the S3 company that incorporates it into its product, which is then combined with a number of other components by the S2 supplier, which then sells the completed subassembly to the S1 supplier, which integrates the sub-assembly into the final product, which is sold on to the focal firm. The end result is that in the short term the lack of availability of the unique component will have a domino effect throughout the network, impacting on the supplier base and the focal firm’s customers, its customers and its customer’s customers, as highlighted in Figure 2.4. The financial impact of the initial decision by the focal firm to extend its suppliers’ payment terms will have implications for all the organizations that have incorporated the unique component into their product and will have negative implications for all their top lines and bottom lines. This may be a hypothetical example, but in practice there are a number of real-life examples where a shortage of key components has had a serious impact on the financial performance of supply networks due to supply being interrupted by natural disasters. For instance, the 2011 Japanese earthquake and resulting tsunami was a terrible human tragedy in terms of loss of life, but it was also an economic tragedy, impacting the Japanese economy and industrial sectors such as those involved in the production of electronic components.

The big issue

Figure 2.4  The liquidity domino effect in the supply chain network C3

S3 S3

C2

S2 S2

S4 S3

S2

S3

S1 Supplier

S3 S2 S3

S2

S4

Focal Company

S1 Supplier

S3 S3

C1 Customer

S1 Supplier

C2 C3 C2

C3

C1 Customer

C2 C2

C1 Customer

S2

C3 C3

C2

S2 S3

C3

C2

C3

Summary This chapter has highlighted the reasons why WCM is a big issue for business. The demand for liquidity and net WC has been explored and the financial ratios used to manage liquidity (CR and AT) and WC (inventory days, receivable days and payable days) introduced. The components of C2C have been defined and described and the relationship with liquidity and WCM has been discussed. The initiatives organizations use to manage WC components have been introduced and examples of their adoptions have been presented. The limitations of WCM performance measures have been identified and discussed and the argument for financially sustainable SCs introduced.

References Afrifa, GA and Padachi, K (2016) Working capital level influence on SME ­profitability, Journal of Small Business and Enterprise Development, 23 (1), pp 44–63 Altaf, N and Shah, F (2017) Working capital management, firm performance and financial constraints, Asia-Pacific Journal of Business Administration, 9 (3), pp 206–19

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The background Autukaite, R and Molay, E (2011) Cash holdings, working capital and firm value: Evidence from France. International Conference of the French Finance Association (AFFI), May 11–13 Baños-Caballero, S, García-Teruel, PJ and Martínez-Solano, P (2014) Working capital management, corporate performance, and financial constraints, Journal of Business Research, 67 (3), pp 332–38 Biais, B and Gollier, C (1997) Trade credit and credit rationing, The Review of Financial Studies, 10 (4), pp 903–37 Blinder, AS and Maccini, LJ (1991) The resurgence of inventory research: What have we learned? Journal of Economic Surveys, 5 (4), pp 291–328 Brigham, EF and Ehrhardt, MC (2008) Financial Management: Theory and practice, South-Western, Mason, OH Bureau van Dijk [accessed 22 January 2020] Fame Database [Online] www. bvdinfo.com/en-gb/our-products/data/national/fame?gclid=EAIaIQobChMI6H3psSZ5wIVR7TtCh0e4ANSEAAYASACEgKUHvD_BwE (archived at https:// perma.cc/SL7J-7NKE) Christopher, M (2011) Logistics and Supply Chain Management: Creating value-adding networks, 4th edn, Pearson Education, Harlow CIMA (2005) CIMA Official Terminology, CIMA Publishing, Oxford Cosse, M (2011) An investigation into the current supply chain finance practices in business: A case study approach, unpublished MSc Thesis, Cranfield School of Management, September Deloof, M (2003) Does working capital management affect profitability of Belgian firms? Journal of Business Finance and Accounting, 30 (3–4), pp 573–88 Deloof, M and Jegers, M (1996) Trade credit, product quality, and intragroup trade: Some European evidence, Financial Management, 25 (3), pp 33–43 Emery, GW (1984) A pure financial explanation for trade credit, Journal of Financial and Quantitative Analysis, 19 (3), pp 271–85 Falope, OI and Ajilore, OT (2009) Working capital management and corporate profitability: Evidence from panel data analysis of selected quoted companies in Nigeria, Research Journal of Business Management, 3 (3), pp 73–84 Fazzari, S and Petersen, B (1993) Working capital and fixed investment: New evidence on financing constraints, The RAND Journal of Economics, 24 (3), pp 328–42 Finnerty, JE (2006) Working capital and cash flow, in Encyclopedia of Finance (1st edn), ed C-F Lee, AC Lee and J Lee, pp 393–404, Springer, New York Forum of Private Business [accessed 22 January 2020] Hall of Fame [Online] www. fpb.org/getbritaintrading/hall-of-shame (archived at https://perma.cc/EB6P-595N) García-Teruel, PJ and Martínez-Solano, P (2007) Effects of working capital management on SME profitability, International Journal of Managerial Finance, 3 (2), pp 164–77 Gentry, JA, Vaidyanathan, R and Lee, HW (1990) A weighted cash conversion cycle, Financial Management, 19 (1), pp 90–99 George, WB and Kirk, V (2003) The product differentiation hypothesis for ­corporate trade credit, Managerial and Decision Economics, 24 (6/7), pp 457–69

The big issue Gill, A, Biger, N and Mathur, N (2010) The relationship between working capital management and profitability: Evidence from the United States, Business and Economics Journal, 10 (1), pp 1–9 Groth, JC and Anderson, RC (1997) The cost of capital: Perspectives for managers, Management Decision, 35 (6), pp 474–82 Hager, HC (1976) Cash management and the cash cycle, Management Accounting, 57 (9), pp 19–21 Hutchison, PD, Farris II, MD and Anders, SB (2007) Cash-to-cash analysis and management, The CPA Journal, 77 (8), pp 42–47 Jose, ML, Lancaster, C and Stevens, JL (1996) Corporate returns and cash ­conversion cycles, Journal of Economics and Finance, 20 (1), pp 33–46 Kieschnick, R, Laplante, M and Moussawi, R (2013) Working capital management and shareholders’ wealth, Review of Finance, 17 (5), pp 1827–52 Korent, D and Orsag, S (2018) The impact of working capital management on profitability of Croatian software companies, Zagreb International Review of Economics and Business, 21 (1), pp 47–65 Lazaridis, I and Tryfonidis, D (2006) Relationship between working capital management and profitability of listed companies in the Athens stock exchange, Journal of Financial Management and Analysis, 19 (1), pp 26–35 Long, MS, Malitz, IB and Ravid, SA (1993) Trade credit, quality guarantees, and product marketability, Financial Management, 22 (4), pp 117–27 Mun, SG and Jang, SS (2015) Working capital, cash holding, and profitability of restaurant firms, International Journal of Hospitality Management, 48, pp 1–11 Ng, CK, Smith, JK and Smith, RL (1999) Evidence on the determinants of credit terms used in interfirm trade, The Journal of Finance, 54 (3), pp 1109–29 Padachi, K (2006) Trends in working capital management and its impact on firms’ performance: An analysis of Mauritian small manufacturing firms, International Review of Business Research Papers, 2 (2), pp 45–58 Pais, MA and Gama, PM (2015) Working capital management and SMEs ­profitability: Portuguese evidence, International Journal of Managerial Finance, 11 (3), pp 341–58 Petersen, MA and Rajan, RG (1997) Trade credit: Theories and evidence, The Review of Financial Studies, 10 (3), pp 661–91 Prime Minister’s Office (2012) [accessed 22 January 2020] Prime Minister announces supply chain finance scheme [Online] www.gov.uk/government/news/prime-minister-­ announces-supply-chain-finance-scheme (archived at https://perma.cc/WS3R-5QZV) Rafuse, ME (1996) Working capital management: An urgent need to refocus, Management Decision, 34 (2), pp 59–63 Richards, V and Laughlin, E (1980) A cash conversion cycle approach to liquidity analysis, Financial Management, 9 (1), pp 32–38 Shah, NH (2009) Optimisation of pricing and ordering under the two-stage credit policy for deteriorating items when the end demand is price and credit period sensitive, International Journal of Business Performance and Supply Chain Modelling, 1 (2/3), pp 229–39

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The background Shin, HH and Soenen, L (1998) Efficiency of working capital management and corporate profitability, Financial Practice and Education, 8, pp 37–45 Shipley, D and Davies, L (1991) The role and burden-allocation of credit in distribution channels, Journal of Marketing Channels, 1 (1), pp 3–22 Skomorowsky, P (1988) The cash to cash cycle and net income, The CPA Journal, 58 (12), pp 84–85 Smid, R (2007) Unlocking value from your sheet through working capital ­management, Journal of Payment Strategy and Systems, 2 (2), pp 127–37 Schmid, D (2010) Comparative advantages in supply chains: Investigation of WACC and working capital. Unpublished BA thesis, University of St Gallen, November Tauringana, V and Afrifa, GA (2013) The relative importance of working capital management and its components to SMEs’ profitability, Journal of Small Business and Enterprise Development, 20 (3), pp 453–69 Wang, YJ (2002) Liquidity management, operating performance, and corporate value: Evidence from Japan and Taiwan, Journal of Multinational Financial Management, 12 (2), pp 159–69 Wetzel, P and Hofmann, E (2019) Supply chain finance, financial constraints and corporate performance: An explorative network analysis and future research agenda, International Journal of Production Economics, 216, pp 364–83 Wilner, BS (2000) The exploitation of relationships in financial distress: The case of trade credit, The Journal of Finance, 55 (1), pp 153–78

Study questions Question 1 Data for three companies in the same business sector has been supplied in Table 2.13.

Table 2.13  Working capital data Company

Alpha

Beta

Gamma

Average inventory £

13,500,000

12,000,000

7,500,000

Cost of sales £

60,000,000

45,000,000

30,000,000

Accounts payable £

15,000,000

10,500,000

10,500,000

Accounts receivable £

37,500,000

60,000,000

45,000,000

150,000,000

150,000,000

150,000,000

30,000,000

24,000,000

22,500,000

Sales (credit) £ Purchases (credit) £

The big issue

Complete Table 2.14 by calculating the working capital ratios for each c­ ompany. Table 2.14  Working capital ratios Company

Alpha Beta Gamma

Inventory days Receivable days Payable days Working capital cycle days

Question 2 Data for three companies in the same business sector has been supplied in Table 2.15.

Table 2.15  Working capital data Company

Red

Amber

Green

Inventories €

2,000,000

5,000,000

2,000,000

Accounts receivables €

6,900,000

11,000,000

3,800,000

100,000

2,000,000

200,000

4,500,000

6,000,000

8,000,000

Cash € Current liabilities €

Complete Table 2.16. Table 2.16  Liquidity ratios Company Current ratio Acid test ratio Net working capital

Red Amber Green

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The background

Study solutions Question 1 Per Table 2.17, Alpha has the shortest working capital cycle with negative 10 days as it has the best set of working capital ratios of the three companies. Beta has the longest cycle of 83 days compared to Gamma’s 31 days. Table 2.17  Working capital ratios Company

Alpha

Beta

Gamma

Inventory days

 82

 97

 91

Receivable days

 91

146

 110

Payable days

183

160

170

Working capital cycle days

−10

 83

 31

Question 2 Per Table 2.18, Amber has the highest current ratio, acid test ratio and the largest net working capital, compared to Green that has the lowest liquidity ratios of all three companies and has net current liabilities of €2 million. Table 2.18  Liquidity ratios Company

Red

Amber

Green

Current ratio

2.00:1.00

3.00:1.00 0.75:1.00

Acid test ratio

1.56:1.00

2.17:1.00 0.5:1.00

Net working capital €m

4.5

12.0

−2.0

89

The flows

03

Towards an integrated view of supply chain processes

O U TCO M E S The intended outcomes of this chapter are to: ●● ●●

describe the evolution of SCM; explain the need to manage the physical, information and financial flows associated with the SC;

●●

identify the interdependences between the three flows;

●●

explain the need for functional integration when making WCM decisions.

By the end of this chapter you should be able to: ●●

●●

●●

describe the transition of SCM from discrete activities to networked, integrated and collaborative ecosystems; identify how the three SC flows can impact on the financial performance of a business; identify WCM initiatives and their impact on an organization’s cash flow.

Activities We recommend the following: ●●

●● ●●

follow your purchase to payment system from the issue of the purchase order to the payment of the supplier’s invoice; identify the interfaces between the three flows; identify the reason why payments to suppliers are delayed, for example a route cause analysis of why an invoice is disputed.

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The background

Introduction This chapter explores the evolution of SCM from the perspective of the three flows that exist within a typical supply chain (SC). The physical movement of goods from supplier to buyer, the bi-directional flow of information between the parties within the SC and finally the financial flow that moves money from buyer to supplier. The relationships between the three flows are introduced and their interdependencies are highlighted and discussed. The link to working capital is then explored, linking back to Chapters 1 and 2. Finally, we discuss the functional motivations and measures that impact decisions on these interconnected flows.

The evolution of supply chain management To understand the relationship between SCM and firm performance it is essential first to define SCM and then to trace the evolution and development of the phenomenon of SCM. Early research into SCM focused on operating performance and associated cost reduction in the SC, particularly in the form of reducing inventory within an organization. Christopher (2011) argues that it is efficient to share information along the SC and take a more integrative perspective in order to facilitate inventory reductions throughout the end-to-end SC. In this section, the move from more fragmented to more integrated SC models will be discussed. A change in the approach to SCM – from functional to holistic – has accompanied this move, as well as an alignment from cost-based to shareholder value-based models. These changes have implications for SC decision making and design. Oliver and Webber, who are credited with introducing the term SCM in 1982, highlight the poor performance of discrete SC functions and the negative impact on firm performance and call for an integrated approach to SCM. Mentzer et al’s (2001: 18) definition of the SCM, which is often cited within the literature (Johnson and Templar, 2011), highlights the role of the SC as one of the enablers of firm performance enhancement. This evolution of SCM is illustrated by the following quotation taken from an Oliver and Webber (1992: 64) article that was reproduced in an anthology of SCM papers edited by Martin Christopher in 1992. They believe that the move from fragmented to holistic requires a different kind of approach: We found that the traditional approach of seeking trade-offs among the various conflicting objectives of key functions – purchasing, production, distribution

The flows and sales – along the supply chain no longer worked very well. We need a new perspective and, following from it, a new approach: supply chain management.

Numerous authors including Stevens (1989), Hesse and Rodrigue (2004) and Jain et al (2010) have documented the development of SCM over the years. They all take a slightly different perspective to the development of SC thinking, research and practice but a common theme of consolidation and integration flows through the timeline. Stevens’ perspective takes a holistic view of the organization and its SC partners based on flows, which illustrates the evolution of SC thinking in terms of a linkage or integration of processes or flows from receipt of materials to delivering customer service. Stevens’ four-stage model charts the ­development of SCs from Stage 1, the baseline, which is made up of a set of discrete activities with each activity buffered by inventory, through to Stage 4, which is an integrated flow between external and internal SC stakeholders. There are two intermediate stages between the baseline and external integration stages: they are functional and internal integration. Hesse and Rodrigue (2004) illustrate this evolution in SC thinking from 1960 to 2000, showing the transition from fragmented, functional approaches through various stages of consolidation and finally into integration. In the 1960s there are numerous discrete activities that make up the conversion of raw materials into finished goods that are then sold to customers. Hesse and Rodrigue (2004: 175) argue that these individual activities have consolidated between the 1960s and 1980s. An example of consolidation they present is materials management, which is an amalgamation of demand forecasting, purchasing, requirement planning, production planning and manufacturing inventory. The trend for integration continues on into the 1990s as material management and physical distribution converge together to form logistics. In the 2000s Hesse and Rodrigue consolidate logistics with other functions including information technology, marketing and strategic planning to form SCM. Jain et al (2010: 12) take a different perspective to the evolution of SCs. They argue that the evolution of SCM can be plotted against six time ­periods or eras. The evolution begins with the definition of SCM by Oliver and Webber (1982), which is referred to as the creation era. The next era ­identified by Jain et al, which is common to Stevens’ flow perspective and Hesse and Rodrigue’s consolidation perspective, is the integration era, and they see integration of systems between SC stakeholders that enable flow and ­exchange of data as an exemplar of this era. Globalization is their third era, where organizations adopt global SC solutions to open new opportunities to create value. Eras 4 and 5 are referred to as the specialization eras.

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In era 4 organizations focus on their core business areas and non-core activities are outsourced. Jain et al argue that this era is also associated with the decline of the traditional vertically integrated organization, where once a manufacturer had their own distribution function, they were now prepared to outsource this activity to a specialist logistics operator. In the fifth era, specialization continues within the organization at a higher level and SCM is seen as a service. The final era is dominated by the digital revolution, emergent technologies, increased customer data capture and the importance of sharing information, both financial and non-financial, throughout the members of an SC. Further, the traditional SC relationships are metamorphosing buyers and suppliers are collaborating together, but also examples of horizontal collaboration between former competitors are emerging. Alongside the changes in external integration, the relationships between internal functions within an organization are evolving. Manufacturing and marketing divisions are converging, and we are now moving from SCM to Demand Chain Management (DCM) in the future (Heikkilä, 2002; Frohlich and Westbrook, 2001; Jüttner et al, 2007; Christopher and Ryals, 2014). Alicke et al (2016: 3) stated that the supply chain of the future will include: The application of the internet of things (IoT), the use of advanced robotics, and the application of advanced analytics of big data in supply chain management: place sensors in everything, create networks everywhere, automate anything, and everything to significantly improve performance and customer satisfaction.

Supply chain management levels Having looked at how SCM has evolved to an integrated, cross-functional and cross-organizational view, we now give a framework to help evaluate and classify the level of development that an SC has reached. We then explore the flows of product, information and funds associated with the different levels of development. Harland (1996: S64) classified the management of SCs into four discrete levels: 1 an internal SC that integrates business functions; 2 the management of dyadic or two-party relationships with immediate suppliers; 3 the management of a chain of businesses: including a supplier, a supplier’s suppliers; 4 the management of a network of interconnected businesses.

The flows

Whichever SC level you manage – from the internal SC within an organization to a complex multinational network made up different business entities, for example the aerospace sector – it is recognized that all SC levels can play an important role in contributing to an organization’s shareholder value. Timme (2003: 1) argues that: Supply chain management has the potential to provide higher returns to shareholders. Yet few companies use it to manage overall financial performance.

Porter’s (1985) argument was that business managers, not just those responsible for SC, should focus on value optimization; putting all of this together, decision makers need to understand which of the SC components create and which destroy value. To do this, an organization needs to be aware of the three flows that are present in every SC operation and flow across company borders. They are: 1 the physical flow of goods; 2 the flow of information (paper-based or electronic); 3 the financial flow moving from buyer to supplier. In the following Figures, the physical flow of goods are represented by a solid arrow, the information flow by a dash bi-direction and the financial flow by a single directional dotted arrow. Figure 3.1 illustrates a simple linear SC operation where the focal firm supplies a customer who then sells the product on to its consumer. The focal firm has a tier 1 supplier who supplies them with a range of sub-­assembles and a tier 2 supplier who in turn supplies raw materials to the tier 1 supplier. Between each node in the SC there exists a physical, an ­information and a financial flow. Each of the entities within this SC are independent organizations in their own right, hence it is an inter-­ organizational SC. Figure 3.2 illustrates another linear SC operation, but in this example there is an intra-relationship between an internal buyer and internal seller as they exist within the same business entity, for example a factory and marketing operation, possibly in a different country. The factory buys from an external supplier and then sells a finished product internally to its marketing division, a transfer price is charged between the internal buyer and seller, which is a cost to the buyer and revenue to the supplier (providing the ­opportunity for an organization to have internal profit centres within its SC). The three flows still exist between the SC nodes; however, the SC is now made up of both intra- and inter-transactions.

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Figure 3.1  Linear SC operation with three flows Physical flow

Tier 2 Supplier

Information flow

Tier 1 Supplier

Focal Firm

Customer

Consumer

Financial flow

Figure 3.2  Linear SC operation with an intra-firm and inter-organizational flow Physical flow

External Supplier

Information flow

Internal Supplier

Internal Customer

External Customer

Consumer

Intra-firm Supply Chain Financial flow

In Figure 3.3 the internal customer has discovered that an alternative external supplier exists that is able to supply an identical component that meets the same quality standards as their internal supplier, but at a lower price than the internally supplied component. The internal customer is now faced with an interesting dilemma: to stay with their internal supplier or to purchase externally – the make or buy decision. In Chapter 2 you were introduced to Porter’s value chain (1985: 33–34), which identified the primary and secondary activities that comprise a typical value chain. Porter argues: Each of these activities can contribute to a firm’s relative cost position and create a basis for differentiation. A firm gains competitive advantage by performing these strategically important activities more cheaply or better than its competitors.

The flows

Figure 3.3  Linear SC operation with make or buy option Physical flow Information flow

Intra-firm Supply Chain External T2 Supplier

Internal Supplier

Internal Customer

External Customer

Consumer

Make or buy decision External T1 Supplier Financial flow

Therefore, if the internal customer in Figure 3.3 decides to outsource the component, they have the opportunity to gain a potential competitive advantage over their competitors, or do they? Before making this strategically important decision it is essential that the buyer understands the total cost of ownership of purchasing the external component, but also the relevant costs and benefits of the internally produced component. Ellram and Siferd (1993: 164) state that: All costs associated with the acquisition, use and maintenance of an item must be considered in evaluating that item and not just the purchase price.

Failure to identify both the relevant costs and benefits could result in a suboptimal decision that could destroy value rather than create value. As Ryals and McDonald (2008: 266) highlighted: There are many examples of transactions where the cheapest product or service turns out to be of poorer value than buying a more expensive product which lasts longer and requires less maintenance.

Figure 3.4 illustrates an SC network where the focal firm is at the centre of the network and has multiple tier 1 suppliers who in turn have their own upstream SC operations to manage. The focal firm also has multiple customer relationships to manage and its customers have their own ­

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Figure 3.4  SC network with three flows Information Flow C3

S3 S3

C2

S2 S2

S4 S3 S3

S1 Supplier

S3 S2 S3

S2

S4

Focal Company

S1 Supplier

S3 S3

C1 Customer

S1 Supplier

S2

C2 C3 C2

C3

C1 Customer

C2 C2

C1 Customer

S2

C3 C3

C2

S2 C2

S3

C3

C3

Financial Flow

­ ownstream relationships to manage. As highlighted in the previous Figures, d each of the nodes in the network will have a physical flow, a bi-directional information flow and a financial flow. Now have a go at the Activity and then we will look at each of the flows in detail.

Activity In your organization identify examples of the three flows. First map the physical flows within your organization’s SC operation, then identify the different types of information flows that exist between nodes (they can be paper based and electronic) and finally trace the financial flows that occur in your business between the SC nodes. Alternatively, if you don’t want to do your organization, then choose an SC operation that you are interested in to discover more about it.

The flows

Physical flow The physical flows involve the movement of the product along its SC, typically from raw materials through the conversion process into finished goods and then on to the final consumer. The flows are usually in one direction, although sometimes goods are returned from the customer (recalls and returns) and will then need to move back up the SC (reverse logistics). The following illustration highlights the physical flows in the chocolate SC. It is Saturday morning; the doorbell rings and you are greeted by your local supermarket’s smiling delivery driver who has your weekly grocery order. The order is unloaded, is correct and you sign for it. You start unpacking and putting your groceries away, when you discover a large bar of milk chocolate that you ordered yesterday online, which you put aside to devour with a cup of coffee after you have finished replenishing your kitchen cupboards and fridge-freezer. Your coffee maker hisses and fizzes as you unwrap the bar of chocolate and suddenly you notice a logo of a green frog on the wrapper, with the words Rainforest Alliance Certified. Thinking to yourself, you imagine the long journey that the cocoa has travelled from its origin, its conversion into chocolate and then on to you. There is a snap as you break a chunk of chocolate off the bar and enjoy its fantastic flavour. Let’s briefly look at the physical flow of a chocolate SC using this fictitious example. The majority of the world’s cocoa (FAO, 2020) is grown in the Ivory Coast (32 per cent), Ghana (18 per cent), Indonesia (17 per cent), Nigeria (8 per cent) and other countries (25 per cent). Traditionally by very small family farmers/growers who account for 90 per cent of global production (Make Chocolate Fair, 2020) and are typically members of a local co-operative or association (Fair Labor Association, 2016). The cocoa supply chain (Cargill, 2020a) begins with the ripe cocoa pods being harvested by hand, collected and stored. The pods are broken open and the beans are collected; they are then left to ferment for a number of days (five to six), then sun dried (7–10 days) and finally bagged. The beans are consolidated from the different growers typically using road haulage and transportation to the port, where they are graded and stored prior to shipping. The cocoa beans are transported by sea from the port of origin to the destination port such as Amsterdam (the largest cocoa bean port in Europe) and Antwerp, typically in jute bags, but also in ventilated containers or shipped loose in containers. Offloaded from the ship, the beans are stored either in bags or loose, where the cocoa beans are sampled, analysed and the necessary documentation is processed, prior to shipping to chocolate manufacturers by road transport.

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The background

The cocoa beans arrive at the chocolate manufacturer’s factory, where the cocoa beans are converted into chocolate, which is combined in the production process with other ingredients to produce a variety of different confectionery products that are also differentiated typically by size and flavour. The finished chocolate bar is wrapped automatically and consolidated into a case; cases are packed into boxes, again automatically, which travel on a conveyer where they are placed onto pallets. The pallet contains a single SKU; the pallet is loaded onto a truck and then a full truck is dispatched to the manufacturer’s finished goods distribution centre (DC), which on this occasion is managed by an LSP. On arrival at the DC the goods are unloaded, checked and receipted into inventory. The pallets are put away into bulk store, awaiting replenishment of the picking face for case picking, or a full pallet of a single SKU is picked for a customer’s order. The DC adopts the FIFO inventory process. A customer’s order is picked and marshalled at the dispatch area, where the order is loaded onto a truck for delivery to the retailer’s DC by road haulage typically operated by a third-party haulier. The finished chocolate products arrive at the retailer’s own DC and are unloaded, checked, put away into bulk storage; picking faces are typically replenished prior to picking a store order. The chocolate SKUs are then picked and cases consolidated with other SKUs into roll cages that are marshalled at the dispatch area, checked to avoid a roll cage being delivered to the wrong store and loaded onto a trailer for delivery to the store using the retailer’s own transport fleet. Once at the store the roll cages are unloaded, checked, and then either placed in the store’s stock room prior to replenishing the product on the shelf or taken immediately to refill the product instore. Items are unpacked from their case and replenish the shelf in store. Customers can buy the chocolate bar directly instore or can order their grocery order online, where the customer’s order is picked, consolidated and packed at the store, then loaded onto a delivery vehicle and delivered to the customer by road and unloaded at the customer’s delivery address.

Information flow The flow of information is bi-directional and flows up and down the SC between the buyer and the seller; the information system can be paper-based or electronic. The following four examples illustrate the flow of information between parties in the SC.

The flows

Three-way match Your accounts payable department has received an invoice from a confectionery supplier, which details the full description of the goods delivered to your distribution centre, including the date, the quantity and price. The invoice includes your purchase order (PO) number for reference. Before the invoice is approved for payment a three-way match is undertaken, where the invoice is checked with the PO to agree that the correct confectionery goods were supplied at the agreed price and quantity. The next stage is to confirm that they were received at the distribution centre by checking a copy of the goods received note. If everything is in order then the invoice will be approved for payment, but if there is a discrepancy the invoice will be disputed, delaying payment authorization until the dispute is resolved. Once the invoice has been authorized the payment will be made to the confectionery supplier based on the timings that are in the terms and conditions agreed by both parties when the order was placed by the buyer with the supplier.

Electronic data interchange The next time you are waiting to pay for your groceries at the supermarket checkout, as you listen to the bleep bleep as each item’s bar code is scanned electronically by the checkout operator, the electronic display shows the item’s description and price as well as the continuous update of the cumulative cost of your purchases. You look up and down at the number of checkouts processing other customers’ purchases and now think to yourself how many customers are served in a day at this store? Not only is that a considerable number of bleeps (and revenue), but also a vast amount of data captured. Then multiply this by the number of stores owned by the company. The data captured is extremely important and valuable to the retailer, primarily from a financial perspective in terms of sales revenue and cash collection, and from a sales and marketing aspect as to which products are selling and which aren’t. From an inventory management perspective, the data at SKU level is critical as it is used to manage inventory levels in stores, at the distribution centres and when exchanged with suppliers at their distribution centres, but also at their manufacturing facilities and for their raw material (farmers and growers) and packaging suppliers. EDI enables customer actual demand data to be shared electronically between nodes in the SC, thus providing increased visibility of customer demand, which will enable the separate SC parties to improve their ­inventory management, reducing SC risk in terms of stockouts, reducing inventory

99

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The background

levels and holding costs, reducing waste and improving on-shelf availability at store level. SKU that are not selling in one geographical location can be repositioned (there are cost implications) where they are selling. EDI from a business perspective can have a positive impact on sales revenue, reduce operating expenditure, improve cash flow and asset utilization, with an associated improvement on the organization’s bottom line (earnings). However, there is a cost associated with investing in the ­technology. One thought, when you look at your grocery receipt next time after you have been shopping, what other data are we giving to the retailer, especially if you have their loyalty card?

Vendor-managed inventory Vendor-managed inventory (VMI) is where inventory is managed remotely by the supplier at the buyer’s location. An example is in bulk silos where levels of inventory are monitored by sensors in the silos and the data is sent electronically to the supplier. When the levels of inventory reach the reorder point a shipment is sent to the buyer. The process works similarly to the monitoring of the ink levels in your printer at home. The data can be accessed electronically over the wi-fi by your computer and the ink can be replenished or purchased when the levels are low. VMI is often used to monitor flour and sugar in the food sector, fuel levels at filling stations and cement at a buyer’s construction site. The buyer is also able to use the data to monitor and manage their consumption of the inventory, and the seller can use the data to invoice the customer electronically for the amount consumed.

Track and trace An order was recently placed with a US supplier. The order was placed electronically from the seller’s website, payment was taken by credit card and authorized. The order was confirmed by email immediately and a receipt attached as a pdf file. A later email confirmed that the order had been picked and was waiting to be collected by the seller’s LSP. A reference number was included allowing the order to be tracked via the LSP’s website. The following events were posted electronically giving the time and date that they ­occurred:

The flows

●●

collected by the LSP;

●●

received at the LSP’s local distribution hub;

●●

dispatched to the LSP’s air hub:

●●

received at the LSP’s US air hub;

●●

dispatched by air;

●●

received at the LSP’s UK air hub;

●●

cleared by UK customs;

●●

dispatched to the LSP’s UK region distribution hub;

●●

arrival at the LSP’s UK region distribution hub;

●●

dispatched to the LSP’s local distribution centre;

●●

arrival at the LSP’s local distribution centre;

●●

dispatched to customer’s delivery address;

●●

delivery at customer’s address.

These four examples highlight the importance of information flows within the supply chain with regard to areas such as inventory management, accounts payables, demand management and customer service.

Financial flow The financial flow typically in a B2C transaction begins with the customer either paying the retailer instantaneously in cash, cashless (for transactions under £30 in the UK), debit or credit card, or by bank transfer for the goods purchased or services consumed in a store, restaurant, garage, etc. Alternatively, the buyer in B2C and B2B transactions will receive an invoice requesting payment for the goods or service purchased by a due date as part of the terms and conditions of sale, for example 30, 60 or 90 days. We may be stating the obvious here, but one organization’s accounts payables are another organization’s accounts receivables, and therefore their cash flows and liquidity are interconnected. The importance of improving an organization’s financial flow is illustrated by two cases from the cocoa industry. The first case illustrates how information can be used to improve SC traceability and cash flow for cocoa growers in Ghana by exploiting the benefits of mobile banking. The second case illustrates the importance of providing funding for businesses in the Ivory Coast to replace their non-current assets.

101

102

The background

Cargill in 2017 established a traceability system for cocoa using mobile banking in Ghana: Farmers deliver their cocoa to community warehouses where beans are digitally weighed and assigned a fully traceable bar code. This means we can trace each individual bag of Ghanaian cocoa beans to the originating individual farm. 

(Cargill, 2020b)

The benefits for the growers are: The use of a mobile banking application means our employees and farmers carry no cash, which contributes to improved safety and security. Farmers receive payment immediately, accessing funds quicker and reducing time spent traveling to and from a bank.

In 2017 Cargill jointly established an initiative in the Ivory Coast to finance trucks in the cocoa SC: Our innovative, award-winning initiative, launched in partnership with the International Finance Corporation and Société Ivoirienne de Banque (SIB), provides a credit facility which allows cooperatives in Côte d’Ivoire to lease cocoa collection trucks. 

(Cargill, 2020c)

The benefits for hauliers according to Sawadogo Moussa, Chairperson of Cooperative CINPA are: The costs that we have saved by not having to repair old trucks will help us pay for the new trucks. We won’t even be aware that we’re spending money for those trucks… We will be repaying the trucks step by step through the sales of our cocoa beans. 

(Cargill, 2020c)

Both examples highlight the importance of the financial flow and initiatives that can improve cash flow and enable organizations to improve their financial performance.

Orchestrating the three flows The hypothetical case, Assemble Co, will be used to show the three flows (physical, information and financial) alongside each other within a typical SC operation.

The flows

C A S E S TU DY  Assemble Co Assemble Co was established by three friends who met at university a decade ago and who identified a unique opportunity in the wearable technology sector. They realized they could buy existing components and then assemble them into a finished product, enabling the consumer to have bespoke wearable technology considerably cheaper than the competition. The friends struggled to secure the finances they needed to get their business off the ground, however, until a chance encounter at an alumni event with a venture capitalist. The venture capitalist believed in their innovative concept, decided to take a risk and supported the development of the business in the early years. This enabled the three friends to take the idea from the flip chart, prove the concept and take it to the market in exchange for a considerable equity stake. The business has recently been floated on the stock exchange. The company has a limited core range of products but is able to provide the consumer with a considerable variety with regard to choice of colour, functionality and shape of the finished product. It can also specialize the finished product by incorporating a customer’s monogram and peripherals. The churn in products was fast and, consequently, limited production runs were produced by colour and shape. Some products have now become collectable; for instance, a triangular shaped midnight blue step counter achieved an innovative design award and is now extremely sought after by collectors. The company’s SC concept has not changed since its conception on a lecture room white board. The key concept of an agile supply based on collaborative buyer–supplier relationships was key to the success of the venture and, as the owners had limited finances, they only wanted to invest minimally in non-current assets. The SC had to support the delivery of innovative new products and at the same time deliver excellent customer service. The SC was built on two strategic collaborative long-term relationships: the first with an online international retailer and the second with a number of key component suppliers. The company required its products to be distributed quickly and widely, so the product was sold through a single online retailer that had an extensive national and international distribution capability. The downside of this was that the retailer’s payment terms were 90 days. The sourcing and availability of high-quality components was also key to the success of the business and the three friends decided that they would work with a number of component suppliers to give them dual sourcing. Dual

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The background

sourcing was essential to give the company continuity of supply and therefore reducing SC risk. Initially volumes were not high so the power in the relationship was originally with its suppliers. However, great product design with standardized components meant that it could negotiate discounts and payment terms with its suppliers. The company currently has 60-day payment terms with its suppliers. Assemble Co physical flows Assemble Co purchases components from numerous suppliers and then ­assembles them into final products that are then sold through a single distribution chain by an online retailer (On-Line Co) who adds a mark-up and distributes the products to the final consumer. The components are delivered to Assemble Co by its suppliers on the same day the order is placed and are then assembled to the customer’s order, also on the same day. The suppliers typically hold 45 days of inventory and usually pay their suppliers in 120 days. Assemble Co has a pick to zero policy and holds zero inventory of components and finished products. The final products are picked up by its distributor at the end of the day and taken to its National Distribution Centre (NDC) where they are consolidated with other shipments and distributed to customers. No inventory is held by On-Line Co and customer returns are handled by a specialist company, which is paid by the distributor. The returns are consolidated by On-Line Co, which refunds the customer and then returns them back to Assemble Co, charging a fee for the returns service and a refund on the original purchase price of the products. Assemble Co refunds the distributor and employs a specialist recycling firm to dispose of products that are returned. Assemble Co information flows In this case, orders are placed with On-Line Co electronically by the customer on a daily basis and the customer’s delivery date is confirmed also electronically by the retailer. The order is then electronically transferred to Assemble Co and the retailer’s orders are confirmed electronically by the supplier. The orders are then consolidated into product type by Assemble Co. The components are ordered with suppliers based on the SKU’s bill of materials at 8.00 am the day after the customer has placed the order with the distributor; again, the order is confirmed automatically by the supplier. The supplier picks, packs and dispatches the order for a midday delivery to Assemble Co. The components are assembled into finished

The flows

goods during the afternoon and the distributor is sent, electronically, a notification of the order to be picked up at 7.00 pm for onward distribution to the consumer. Assemble Co financial flows In cases where the consumer places an order online and uses a credit or debit card to pay the retailer, goods are then shipped to the consumer within 48 hours and the consumer’s account is then charged on confirmation of delivery. Assemble Co receives payment from On-Line Co in 90 days and currently pays its suppliers in 60 days. Component Co finally pays its suppliers in 120 days.

Linkages and dependences Camerinelli (2014) stresses the importance of the interdependences of the three flows and identifies three processes (source to pay, order to cash and fulfil to service) and their activities that link the SC flows together, consolidating Camerinelli’s flows into a single one, end-to-end process, as illustrated in Figure 3.5. The process begins with a customer placing an order with a supplier and ends when the supplier is paid. Let’s look at Assemble Co’s end-to-end process. The terms and conditions between Component Co and Assemble Co are typically payment on 60 days after the receipt of an invoice. The flow of documentation starts with a purchase order (PO) from Assemble Co detailing the exact components required, where and when they are to be delivered, and also including the buyer’s terms and conditions. On receipt of the PO by the supplier, the PO is authorized by finance and then forwarded to the distribution centre to be picked. A picking list is produced, the order is picked and a goods received note (GRN) is then generated. This will accompany the dispatched order to the customer. Once it has arrived at Assemble Co the delivery is unloaded and the components are physically checked on arrival against the GRN. The GRN is ­authorized and a copy is returned to the supplier and the GRN itself is forwarded to accounts payable pending payment. Component Co then invoices Assemble Co and includes on the invoice the customer’s PO number as well as the supplier’s GRN number and payment details. On receipt of the invoice a three-way match is carried out by Assemble Co to make sure that all the documentation agrees. To do this the customer checks the PO with the GRN

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106

Figure 3.5  Integrated end-to-end SC process

Start

Source suppliers

Purchase order approval

PO#. PO date. Item#. Quantity. Price. Delivery date. Currency Send purchase order

Date PO approved . . Quantity approved Delivery date accepted

Purchase order request

Date of shipment. Item# shipped. Quantity shipped. Inspection documents Receive order

Production process quality check. Product tracking

Receive invoice

Receive payment advice

Generate and send payment

Payment date. Payment channel

Process payment advice

Return

Produce goods

Turn into sales order and confim

Manage inventory

Ship goods

Negotiate sales terms

Reliability. Responsiveness. Quality of goods. Price Select supplier and goods

Send invoice

Date of shipment. Shipping documents. Customs inspection results. Tracking goods

Transport

Date of invoice. Price charged. Payment terms

Prepare to load shipment

Accept?

Reason for rejection

Offload / inspect / store goods

Yes

Collect payment

Date invoice received. Origin of disputes Reconcile and account

Condition of goods

No

Date of shipment. Shipping documents. Customs inspection results. Tracking goods

Receive goods

Date received

Quality of reconciliation data

Date of collection

SOURCE  Adapted from Camerinelli (2014)

SOURCE-TO-PAY ORDER-TO-CASH FULFIL-TO-SERVICE SOURCE-TO-PAY ORDERTO-CASH

The flows

and the supplier’s invoice and, if they all concur, then the invoice is approved for payment. If they do not match, then the invoice will be disputed with the supplier, which will delay the payment until the query is resolved. A similar process will exist between Assemble Co and On-Line Co; however, the payment terms will be different. Table 3.1 illustrates the C2C cycle times for the three businesses. The C2C cycle is calculated by adding together the number of inventory days and accounts receivable days then subtracting accounts payable days. In this hypothetical example On-Line Co has minus 88 days as the business typically receives payment from its customers in two days and pays Assemble Co in 90 days. Assemble Co does not hold any inventory as the company receives its components just in time (JIT) and has a zero inventory policy. However, as the company pays its suppliers in 60 days but only receives payment from On-Line in 90 days, this means it has a liquidity gap of 30 days. Assemble Co will need to find additional finances to fund its working capital shortfall or must negotiate improved terms with both buyer and supplier. Component Co has a C2C time of minus 15 days, which is due to the difference of 60 days between their accounts payable days and accounts receivable days. If they were able to reduce the number of inventory days, they hold this would improve their C2C cycle time further. However, reducing their inventory may have a negative impact on availability and therefore damage revenue if this results in shortages and a negative impact on reputation. EY (2018) highlight the importance of three processes (Figure 3.6) in creating value, their impact on value drivers such as cost, cash service and risk, and their relationship with the IS and BS and the implication for financial performance in terms of an organization’s ROCE (which was explored in the previous chapter). They are procure to pay, forecast to fulfil and order to cash.

Table 3.1  Cash-2-cash cycle times Component Co

Assemble Co

On-Line Co

Inventory days (DIO)

 45

 0

 0

Accounts receivable days (DSO)

 60

90

 2

Accounts payable days (DPO)

120

60

 90

Cash-2-cash cycle days

–15

30

–88

107

108

Figure 3.6  Procure to pay, forecast to fulfil and order to cash process GOALS

PROCESSES

VALUE DRIVERS

SUPPLIERS

COST P&L

EFFICIENCY

Procure to pay

Procurement strategy

Supplier & Requisitioning & order contract control management

Goods & invoice receipt

Invoice processing

Discrepancy reduction

Payment insurance

CASH BS

Forecast to fulfil

Product range management

Demand planning

Material Sales order Finished Manufacturing Inventory processing & planning, goods scheduling & purchasing & management Customer Warehousing execution replenishment service logistics

ROCE

EFFECTIVENESS

SERVICE P&L

COMPLIANCE

Order to cash

Sales & Credit & quote risk management management

Order processing

Invoicing

Collections Dispute Cash management management application

RISK

CUSTOMERS

SOURCE  E&Y 2018

P&L

V A L U E

The flows

Figure 3.6 also identities the interfaces between the three processes and also the functions that are involved in the supplier/customer relationship. The figure also relates the processes to three organizational goals of efficiency, effectiveness and compliance, which are essential attributes for every SC operation and form the basis for SC performance measurement and appraisal. In the next section of the chapter we will explore the importance of managing cash flow.

The importance of managing cash flow To illustrate the importance of cash flow and the implications for firm performance and financial sustainability, we will use a hypothetical case study, Dandelion Ltd. This case reinforces the learning from the previous chapters.

C A S E S TU DY  Dandelion Ltd You have been asked by some friends to help them prepare a cash flow forecast for their new venture, Dandelion Ltd. The bank manager has asked them to produce a cash flow forecast for their first six months of trading. The company will start trading on 1 April 20XX. You have been given the following information: ●●

●●

●●

●●

●●

The company will start on 1 April 20XX with £250,000 of share capital. Non-current assets will be purchased in the following months: £160,000 in April, £90,000 in June and £60,000 in August. Sales are to be £200,000 per month for the first three months and £360,000 per month for the next three months. Customers are given two months’ credit, so, for example, sales in April will be paid in June. Components are 25 per cent of sales value and paid in the same month they are purchased.

●●

Fixed production overheads are £30,000 per month.

●●

Variable production overheads are 15 per cent of sales value per month.

●●

Wages are £30,000 per month.

●●

Depreciation is charged on a straight-line basis and assets have a 10-year life with no scrap value.

109

110

The background

Using the information in the case we are going to produce a cash flow forecast for the new venture for the six months ending September 20XX, to understand the business’s cash position. A forecast IS and BS will also be produced to see if the business is profitable and making a positive return for its shareholders. A cash flow forecast (Table 3.2) has been produced for Dandelion Ltd, which illustrates the cash received and the payments made. The cash flow forecast reveals three important figures: the cash balance at the end of each month, the cumulative cash position of the business and the cash balance at the end of the trading period. It can be seen from the cash flow forecast that Dandelion Ltd has five successive months where payments exceed cash receipts and only one month (September) when receipts are greater than payments. This results in a cash deficit of £132,000 at the end of the trading period. However, note that the cumulative cash position at the Table 3.2  Dandelion Ltd cash flow forecast Dandelion Ltd Cash flow forecast for the 6 months ending 30 September 20XX Receipts £K

APR

MAY

JUN

JUL

AUG

Share capital

SEPT

250

  0

  0

  0

  0

  0

Sales cash

  0

  0

200

200

200

360

Total receipts

250

  0

200

200

200

360

Payments £K

APR

MAY

JUN

JUL

AUG

SEPT

Non-current assets

160

   0

  90

   0

  60

   0

Fixed production overheads

 30

  30

  30

  30

  30

  30

Components

 50

  50

  50

  90

  90

  90

Wages

 30

  30

  30

  30

  30

  30

Variable production overheads

 30

  30

  30

    54

  54

  54

Total payments

300

 140

 230

 204

 264

 204

Net cash flow £k

–50

–140

 –30

  –4

 –64

 156

Balance brought forward

  0

 –50

–190

–220

–224

–288

Balance carried forward

–50

–190

–220

–224

–288

–132

The flows

end of August is minus £288,000; therefore an overdraft facility would be required to fund the cash shortfall, if the bank was prepared to offer one. The crucial question that now needs to be answered is this: is the company profitable? Table 3.3 illustrates a simplified forecast IS for the business. The company has sales revenue of £1.68 million for the six months’ trading and makes an EBIT of £636,000, which equates to nearly 38 per cent. The company is making a profit but has poor cash flow and a forecast overdraft of £132,000. The final question to ask is, what is the return that the business is delivering on the capital employed? In Chapter 1 you were introduced to a key financial ratio, ROCE, and we can now calculate ROCE for Dandelion Ltd. We have the EBIT figure from the IS, but we also need the value of the total net assets, which we can get from the BS. Table 3.4 illustrates the company’s BS for the period. Taking the total assets of the business and subtracting the value of its current liabilities derives the organization's capital employed. Dandelion Ltd has total assets minus current liabilities of £886,000 and these assets have delivered earnings before interest and tax of £636,000, resulting in a ROCE percentage of 72 per cent, which can now be compared to alternative investment opportunities. Figure 3.7 illustrates the significant flows in the organization’s SC operation. As in previous figures a solid line represents the physical flows, a dashed line an information flow and a dotted line a financial flow. The figure also highlights the various functions within the business that are involved in the SC:

Table 3.3  Dandelion Ltd forecast income statement Dandelion Ltd Forecast income statement for the 6 months ending 30 September 20XX £K Sales revenue

£K 1,680

Less expenses Fixed production overheads

180

Components

420

Wages

180

Variable production overheads

252

Depreciation Earnings before interest and tax

12

1,044 636

111

112

The background

Table 3.4  Dandelion Ltd forecast balance sheet Dandelion Ltd Forecast balance sheet as at 30 September 20XX £K Non-current assets Property, plant and equipment

298

Current assets Accounts receivables Cash

720 0

Current liabilities Bank overdraft

132

Total assets minus current liabilities

886

Equity Ordinary share capital

250

Retained earnings

636

Capital employed

886

●●

●●

●●

sales and marketing (sales forecast, input into the S&OP and customer relationship management); procurement (supplier evaluation, buying and supplier relationship management); accounting and finance (billing customers, paying suppliers, S&OP and financial reporting);

●●

SC (inventory management, warehousing and distribution);

●●

operations (production, quality control and S&OP).

The figure also illustrates the importance of the three flows that link the internal functions and also highlights the external interfaces with suppliers and customers, together with the variables that are used to calculate key working capital figures, such as: ●● ●●

●●

the value of the organization’s closing inventory (goods in minus goods out); the accounts payables value on the BS (purchases ordered minus payments to suppliers); the accounts receivables value on the BS (sales invoiced minus payments received from customers).

The flows

Figure 3.7  WCM and the three flows 420k RM Distribution Centre INV 0k

420k RM

IPO 420k 420k GRN

1,680k FG Factory

GRN 1,680k 420k GRN

Supplier

PO 1,680k

420k GRN

PO 420k Invoice 420k

Payment 420k

Accounting Invoice 1,680k and Finance 3 way match

Customer

1,680k S&OP

Sales and Marketing

1,680k Forecast

Payment 960k

In summary, Dandelion Ltd is profitable and generates returns for the shareholders; however, it has cash flow issues. If we take a look at the cash flow forecast and BS again, we can see the factors that are causing the problem. First, cash is leaving the business in the first six months faster than it is coming in. Expenditure needs to be reviewed, including the purchasing of the non-current assets, which are £310,000. Currently Dandelion Ltd pays its component supplier in the same month and one option would be to extend its payment terms. However, the big issue is that Dandelion Ltd has £720,000 of accounts receivables on its BS that is trapping cash. If the company can find a way to liberate their cash, then its liquidity can be improved. There are numerous initiatives that are available to liberate cash and improve WCM and these will be introduced in subsequent chapters.

Functional integration It is essential in any business that the individual functions that exist within an organization are mindful of their relationships between one other, and importantly that a decision that may favour one function can have an

113

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The background

a­ dverse impact on another. Often these situations arise because functions tend to operate within their own silo, but they are also driven by KPIs that encourage dysfunctional behaviours that cause friction between functions and can result in a sub-optimal outcome for the organization as a whole. Therefore, it is essential that functions are aware of their linkages with other functions and the likely impact of their decision on another function, but also the business as a whole. Let’s just focus on WCM and within this strategically important area three components: inventory levels, customer payment terms and supplier payment terms.

Inventory levels If we were to ask the following question of a marketeer, an accountant and a logistician (sounds like an opening line to a joke), what do you think their individual answers will be? How much inventory do you think we should have in our supply chain?

Now immediately we will have different perspectives if each function reverts to their silo mentality (apologies for stereotyping functions, but it is important that we identify the worst-case scenario). By highlighting each f­ unction’s extreme position, we can then converge to an outcome that is favourable for the business as a whole, which requires functions to be collaborative, make trade-offs and grant concessions, from all the parties involved in the process of establishing inventory levels. The role of the marketing function, we would argue, is to create demand. Offering customer choice is essential (just look at the different models for a make of car, or the next time you walk down the washing up liquid aisle in your supermarket count the different variants), and by being able to differentiate customers into separate groups an organization can apply price ­discrimination and charge different prices for slightly different products or services (airline tickets). Another important aspect is customer service. If demand has been created but cannot be satisfied because the goods are not instore or there is insufficient supply of products in the pipeline, this will have an impact on both the top and bottom lines and also the organization’s reputation. If the decision is made to move from 95 per cent to 98 per cent customer service levels, this will require a significant increase in inventory levels. Now let’s focus on the accounting perspective. Inventory ties up cash and the cash is only released when the finished goods are sold to the customer when they are paid for. Christopher (2011) states that the cost of holding a

The flows

unit of inventory is 25 per cent of its net realizable value. Next time you visit a distribution centre just think of all the cash trapped in the inventory and how much it is costing to hold it. Inventory is a current asset and too much unnecessary inventory will have a negative impact on profitability (ROCE) and asset utilization (asset turnover) ratios. Generalizing (apologies before going further), the SC practitioner’s aim is to balance inventory levels between fulfilment, cost and risk. Over the last 20 years their efforts have been extremely successful in reducing inventory by adopting a number of approaches that we have introduced in the previous chapter. However, within the functions that make up the SC there are individual decisions to be made, for instance a supplier offers procurement an amazing price per unit, but they have to double their order size to achieve this offer. Do they take up the offer or not? If they decide to take up the offer, what are the implications for the business? Here is something for you to contemplate. Is Black Friday good or bad for a business? (It depends, we hear you say over the ether; our reply is, it depends on what?)

Customer payment terms The sales and marketing (a hypothetical extreme situation) function decides to increase its credit terms from 30 days to 60 days to attract new customers but also retain their existing ones. This results in additional demand for the company’s products and sales figures increase slightly. The accounts receivables on the balance sheet have increased as a large proportion of sales (increasing DSO) are on credit; additional inventory is also required to meet service levels (increasing DIO), but cash flow has decreased as the C2C time has also increased, resulting in a need for additional cash to keep the business going. If making a decision in isolation, it is important to anticipate the impact on other functions before making the decision.

Supplier payment terms The last hypothetical situation. In order to improve cash flow a decision is taken in isolation to double the standard accounts payable days from 45 to 90 days for all suppliers. This decision has angered suppliers and a number are considering stopping supplying; however, the power situation in the relationships favours the buyer and the suppliers need the business. ­

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The background

An ­unintended consequence for the focal firm of implementing the decision is that a small supplier who supplied a unique component is forced to close down because of poor liquidity. The end result is that this single event brings the whole SC operation to a halt as there is no substitute available. This impacts not only the suppliers – the focal firm cannot produce the finished product and customers cannot buy the product in the stores. One can only imagine the discussions between the focal firm’s CEO, CFO, CMO and other heads of functions across the board room, when reviewing the decision to extend supplier payment terms. These extreme hypothetical scenarios have been used to illustrate the potential friction between departments, when a single function may make a decision independently without considering the implications on other functions. However, maybe you can think of other examples to add to this section!

Summary This chapter has highlighted the evolution of SCM: from a set of individual discrete functions to an integrated and extended SC ecosystem built on a number of different relationships. A phrase often used in SC circles is that ‘it is SCs that compete, not companies’. It is important that SC managers manage not just the physical flows in their domain but also the information and financial flows associated with the SC. If SC managers do not recognize the importance of these flows, they can cause disruption and destroy value. A typical SC example illustrated the linkages between the three flows and, importantly, the impact of cash flow on WCM and the financial performance of a business. This provides an opportunity to adopt SCF initiatives to liberate cash for both buyer and seller, and this will be explored in the next part of the book.

References Alicke, K, Rachor J and Seyfert, A (2016) [accessed 22 January 2020] Supply Chain 4.0: The next-generation digital supply chain [Online] www.mckinsey.com/ business-functions/operations/our-insights/supply-chain-40--the-next-­ generation-digital-supply-chain# (archived at https://perma.cc/KRF2-JTSV) Camerinelli, E (2014) Supply Chain Finance: EBA European market guide, Version 2.0, Euro Banking Association, Paris Cargill [accessed 22 January 2020a] Responsible supply chain [Online] www.cargill. com/food-beverage/cocoa-chocolate/responsible-supply-chain (archived at https:// perma.cc/L2WH-7X5P)

The flows Cargill [accessed 22 January 2020b] Traceability through mobile banking [Online] www.cargill.com/story/traceability-through-mobile-banking (archived at https:// perma.cc/EJH2-93GU) Cargill [accessed 22 January 2020c] Financing affordable trucks [Online] www.cargill. com/story/financing-affordable-trucks (archived at https://perma.cc/EA5G-5QCT) Christopher, M (2011) Logistics and Supply Chain Management: Creating value-adding networks, 4th edn, Pearson Education, Harlow Christopher, M and Ryals, LJ (2014) The supply chain becomes the demand chain, Journal of Business Logistics, 35 (1), pp 29–35 Ellram, LM and Siferd, SP (1993) Purchasing: The cornerstone of the total cost of ownership concept, Journal of Business Logistics, 14 (1), pp 163–84 EY (2018) Working Capital Management, presentation by Dirk Braun Fair Labor Association (2016) Assessment of Nestlé’s standard cocoa supply chain (not Covered by the “Nestlé Cocoa Plan”) in Côte D’ivoire [Online] https://www.fairlabor.org/sites/default/files/documents/reports/assessment_­ nestle_standard_supply_chain_ivory_coast_august_2016.pdf (archived at https://perma.cc/3JXT-YS22) The Food and Agriculture Organization [accessed 22 January 2020] Chocolate: facts and figures [Online] www.fao.org/resources/infographics/infographicsdetails/en/c/277756/ (archived at https://perma.cc/XS94-SY9Y) Frohlich, MT and Westbrook, R (2001) Arcs of integration and international study of supply chain strategies, Journal of Operations Management, 19 (2), pp 185–200 Harland, CM (1996) Supply chain management: Relationships, chains and networks, British Journal of Management, 7 (s1), pp S63–S80 Heikkilä, J (2002) From supply to demand chain management: Efficiency and customer satisfaction, Journal of Operations Management, 20 (6), pp 747–67 Hesse, M and Rodrigue, JP (2004) The transport geography of logistics and freight distribution, Journal of Transport Geography, 12 (3), pp 171–84 Jain, J, Dangayach, GS, Agarwal, G and Banerjee, S (2010) Supply chain ­management: Literature review and some issues, Journal of Studies on Manufacturing, 1 (1), pp 11–25 Johnson, M and Templar, S (2011) The relationships between supply chain and firm performance: The development and testing of a unified proxy, International Journal of Physical Distribution and Logistics Management, 41 (2), pp 88–103 Jüttner, U, Christopher, M and Baker, S (2007) Demand chain management: Integrating marketing and supply chain management, Industrial Marketing Management, 36 (3), pp 377–92 Make Chocolate Fair (2020) [accessed 22 January 2020] Cocoa production in a nutshell [Online] https://makechocolatefair.org/issues/cocoa-production-nutshell (archived at https://perma.cc/HTQ9-K265) Mentzer, JT, Dewit W, Keebler, JS, Min, S, Nix, NW, Smith, CD and Zacharia, ZG (2001) Defining supply chain management, Journal of Business Logistics, 22 (2), pp 1–25

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The background Oliver, RK and Webber, MD (1982) Supply-chain management: Logistics catches up with strategy, in Logistics: The Strategic Issues, ed M Christopher (1992), Chapman and Hall, London, pp 63–75 Porter, M (1985) Competitive Advantage: Creating and sustaining superior performance, Free Press, New York. Ryals, L and McDonald, M (2008) Key Account Plans: The practitioners’ guide to profitable planning, Butterworth-Heinemann, Oxford Stevens, GC (1989) Integrating the supply chain, International Journal of Physical Distribution and Logistics Management, 19 (8), pp 3–8 Timme, SG (2003) [accessed 22 January 2020] The financial supply chain, mThink Knowledge [Online] http://mthink.com/article/financial-supply-chain (archived at https://perma.cc/M6UZ-84K9)

Study question You have been asked by some friends to help them prepare a cash flow forecast for their new venture, Mega plc. The bank manager has asked them to produce a cash flow forecast for their first six months of trading. The company will start trading on 1 January 20XX. You have been given the following information: ●● ●●

●●

●●

●●

The company will be started in January with £400,000 of share capital. Fixed assets will be purchased in the following months: £240,000 in January, £40,000 in April and £60,000 in May. Sales are to be £300,000 per month for the first three months and £500,000 a month for the next three months. Customers are given three months’ credit, so sales in January will be paid in April. Components are 25 per cent of sales value and paid in the month following their purchase.

●●

Fixed production overheads are £15,000 per month.

●●

Variable production overheads are 5 per cent of sales value per month.

●●

Wages are 20 per cent of sales value per month.

●●

●●

●●

Depreciation is charged on a straight-line basis and assets have a 10-year life with no scrap value. Tax is estimated to be £236,000 for the period and will be paid later in the year. The company is not proposing a dividend for the current accounting period.

The flows

You are required to: a Calculate the cash position at the end of the six months. b Calculate the profit the company made during the period. c Calculate the following financial ratios: {{

accounts receivable days;

{{

accounts payable days;

{{

cash to cycle days;

{{

EBIT percentage;

{{

return on total asset minus current turnover percentage (ROCE%);

{{

current ratio.

d Identify recommendations that could improve the company’s current cash flow position.

Study solution a. Table 3.5  Mega plc cash flow forecast Mega PLC Cash flow forecast for the 6 months ending 30 June 20XX Receipts £K

JAN

FEB

MAR

APR

MAY JUN

Share capital

400

0

0

  0

  0

  0

Sales cash

  0

0

0

300

300

300

Total receipts

400

0

0

300

300

300

Payments £k

JAN

FEB

MAR

APR

Non-current assets

240

   0

  0

  40

 60

  0

Fixed production overheads

 15

  15

  15

  15

 15

 15

Components

  0

  75

  75

  75

 125

125

Wages

 60

  60

  60

 100

 100

100

Variable production overheads

 15

  15

  15

  25

  25

 25

Total payments

330

 165

 165

 255

 325

265

Net cash flow £k

 70

–165

–165

  45

 –25   35

Balance brought forward

  0

  70

–95

–260

–215 –240

Balance carried forward

 70

–95

–260

–215

–240 –205

MAY JUN

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120

The background

Per Table 3.5, Mega plc has a cash deficit balance of £205,000 at the end of its first trading period; however, it would need an overdraft facility of £260,000 for February 20XX. b. Table 3.6  Mega plc forecast income statement Mega PLC Forecast income statement for the 6 months ending 30 June 20XX £k Sales revenue

£k 2,400

Less expenses Fixed production overheads

 90

Components

600

Wages

480

Variable production overheads

120

Depreciation

 14

1,304

Earnings before interest and tax

1,096

Tax

  236

Retained earnings

  860

Per Table 3.6, the company has an EBIT of £1,096k, which equates to 45.6 per cent.

The flows

c. Table 3.7  Mega plc forecast balance sheet Mega PLC Forecast balance sheet as at 30th June 20XX £k Non-current assets Property, Plant and Equipment

326

Current assets Accounts receivables Cash

1,500 0

Current liabilities Accounts payables

125

Tax payable

236

Bank overdraft

205

Total assets minus current liabilities

1,260

Equity Ordinary share capital

400

Retained earnings

860

Total capital employed

1,260

Using the forecast BS in Table 3.7, the ratios in Table 3.8 indicate that the company is profitable with an EBIT percentage of around 46 per cent and a ROTA-CL of 87 per cent (Figure 3.8). The company’s total assets minus current liabilities are generating £1.905 in sales revenue for every £1.00 of ­TA-CL. The working capital cycle is an issue as the company is paying its

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The background

Figure 3.8  ROTA-CL calculation TA-CLT/O 1.905

ROCE% 86.995%

EBIT% 45.667%

TA-CL £1.260m

Non-current Assets £0.326m

+

Working Capital £0.934m

Current Assets £1.500m

–

Current Liabilities £0.566m

Account Receivables £1.500m

Revenue £2.400m

–

Account Payables £0.125m

Total Expenses £1.304m

Tax Payable £0.236m

=

EBIT £1.096

Overdraft £0.205m

Table 3.8  Mega plc financial ratios Mega PLC Financial ratios Accounts receivable days

114

Accounts payable days

38

Cash to cash cycle days

76

EBIT percentage

45.7%

TA-CL turnover ratio

1.91%

Current ratio

2.65%

Return on total assets – current liabilities percentage (ROCE)

87.0%

suppliers before they get paid by their customers; consequently they have a liquidity gap of 76 days. However, the business has a current ratio of 2.65 due to the high level of accounts receivables. The three SC flows related to WCM are depicted in Figure 3.9 for Mega plc.

The flows

Figure 3.9  Mega plc WCM and the three flows

Distribution Centre INV 0k

600k RM

600k RM IPO 600k 600k GRN

2,400k FG Factory

GRN 2,400k 600k GRN

Customer

Supplier PO 2,400k 600k GRN

PO 600k Invoice 600k

Payment 475k

Accounting Invoice 2,400k and Finance 3 way match

2,400k S&OP

Sales and Marketing

2,400k Forecast

Payment 900k

d. Recommendations that could improve Mega plc’s current cash flow position: ●● ●●

start the business with additional share capital; negotiate early payments from its customers by offering them a settlement discount;

●●

factor its accounts receivables to generate cash;

●●

extend payment terms with its suppliers;

●●

postpone the purchase of fixed assets and rent or lease them in the short term;

●●

try to find a cheaper alternative components supplier;

●●

review wages and overhead costs.

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125

PART TWO The current practice

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127

The concept

04

A case for supply chain finance

O U TCO M E S The intended outcomes of this chapter are to: ●●

clarify the key definitions and general options of SCF;

●●

introduce the basic SCF approaches;

●●

ground the scientific background of SCF;

●●

identify the transitional stages of SCF;

●●

explain the network financing philosophy;

●●

show the business rationale of SCF;

●●

explain the concept of multiple-win situations.

By the end of this chapter you should be able to: ●●

understand the scope of SCF;

●●

draw the linkage between WCM and SCF;

●●

enumerate the different SCF schools of thought;

●●

understand the evolution of SCF practices;

●●

analyse the sources of finance in SCF;

●●

identify the economics of SCF;

●●

identify how multiple-win situations can be created in SCF.

Activities We recommend the following: Using the concept of SCF, analyse the manifold changes that could be made to a company’s SC in order to achieve multiple-win situations.

128

The current practice

Introduction Supply chain finance (SCF) has so far been considered as a collaborative WCM approach that mainly benefits the participants inside certain (dyadic) business relationships, which leads to win–win situations (WWS) for all SC organizations involved. In this chapter, we will examine if there really is a case and if so, what it looks like. Moreover, basic definitions and fundamentals of the SCF approach are given. We will place a specific focus on the new and enhanced roll of the financial service provider (FSP) as well as on that of specific promotors – the socalled SCF platforms. With global trade and sourcing options becoming more branched and therefore harder to monitor, the role of financial institutions and specialized service providers in providing adequate financing solutions is changing significantly. Although banks have been going through heavy storms following the 2008/09 global crisis (post financial crisis since 2010), the demand for SCF solutions is still rising. Within SCF, it is important to broaden the perspective beyond a single organization to address the phenomenon of the hidden costs of debt in SC.

Addressing the hidden costs of debt in supply chains The sales price of goods is mostly composed of two cost categories. On the one hand, there are costs for material and labour; on the other, there are costs tied up in capital. This tied-up capital is often financed with borrowed capital, which is why interest rates on borrowed capital are decisive for determining the cost of capital in supply chains. Since these costs are built into the sales price, and in practice have had limited visibility in the past, we can also speak of the hidden cost of debt. It should be noted that these costs are generated at each stage of the SC and are passed onto the next stage as part of the sales price. The debt costs therefore account for a significant proportion of the final selling price paid by the end consumer (Figure 4.1). Moreover, the costs depend on the duration of the capital commitment. This is where the SC aspect comes into play, because the later a buyer pays the bill, the longer the seller’s capital commitment. It becomes clear that the actors in an SC are in a mutually influencing relationship with regard to WC. This influence on SC partners becomes a problem as soon as every

The concept

Figure 4.1  Hidden financing costs in supply chains Exemplary supply chain

Total sales price

Labour and material related share

Retail prices

Wholesale prices

Laptop price

Share of cost of debt

2 Without SCF

Keyboard price

Plastic price

Crude oil price 1 With SCF

1 2 ∆ SCF

Note: prices incl. margins

company strives to improve its WC by paying the suppliers as late as possible, while the debtors are to be collected as quickly as possible. Consequently, the duration of the capital commitment on the part of the sellers increases. This results in higher borrowing costs. The basic economic principle requires the seller to include the additional costs in the sales price, so the buyer ultimately pays more. The return of these costs resembles the characteristics of a bounce back, the so-called ‘SC boomerang effect’. Since both parties involved have a disadvantage, a lose–lose situation prevails. However, it is often the case that larger companies attract lower interest on borrowed capital. It would therefore be better from an SC network point of view if the seller were to wait as short a time as possible for the outstanding invoices to be settled, assuming the buyer is a financially strong company. Early payment would lead to fewer DSO and thus to lower

129

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The current practice

financing costs, and the profit achieved could be evenly distributed (see ‘delta’ SCF in Figure 4.1). This would allow the seller to increase their margin while the buyer would receive a lower price or an early payment discount. This process represents a win–win cycle, as shown in Figure 4.2. Figure 4.2  Boomerang effects in supply chains Early payment

Win-win-cycle Lose-lose-cycle Less financing costs

Higher debt financing costs

–

+

Buyer

Supplier

Share win (obtained through lower costs)

Late payment

–

+

Higher price Early payment discount

Is there really a case for supply chain finance? In order to deepen the concept of SCF, we would like to examine some real cases that demonstrate the approach as a relevant and upcoming phenomenon for business practice. The following cases elaborate various aspects of SCF.

C A S E S T U DY   Financing SME suppliers The Unilever case The Indonesian economy was severely hit by the economic crisis in the late 1990s, which lasted until the early 2000s. Unilever’s more than 300 local suppliers in Indonesia, mainly small- and medium-sized enterprises (SME) that were Indonesian-owned, with 16 exceptions, came under massive financial pressure. The local currency was devalued and interest rates rose sharply. Among other

The concept

measures, Unilever recognized its suppliers’ need for quick and reliable payment of their AR and thus put special efforts into its own cash management. This benefited its suppliers as they received reliable and timely payments for the products and services that they sold to Unilever. On a permanent basis, Unilever supported its suppliers in Indonesia by acting as an intermediary between them and the local banks they were dealing with. In particular, Unilever helped them with advice regarding borrowing and loan repayment strategies, which in turn helped to improve the suppliers’ credit ratings. The two actions that Unilever took show that a multinational company can assume tasks that support the suppliers’ cash management and COC. It is in Unilever’s interest that its suppliers succeed in establishing a reliable and cheap capital base for their operations. Optimizing payment terms in the SC follows a similar thought process. Unilever provides its suppliers with (part of) their WC (Unilever, 2005: 38, 63).

Unilever’s conduct appears reasonable in several respects. First, by supporting its suppliers the corporation lowered their WACC and consequently enhanced their credit rating. Second, it was able to provide credit in times when its smaller suppliers were no longer able to find banks that would grant them credit. Third, Unilever was able to finance itself not only at a lower cost but also incurred lower transaction costs in the process. By intelligently setting payment terms, Unilever could pass on these advantages to its suppliers, meaning that by quick repayment of its AP to its suppliers, it improved the suppliers’ cash base. This may have resulted in higher costs for Unilever in the short run, but presumably also in benefits such as lower costs for its supplies and safeguarding access to resources in the long run. With lower funding costs suppliers were able to offer price reductions, which potentially generated COGS savings for Unilever in the long run.

C A S E S T U DY  Intermediaries in collaborative supplier financing The Knorr-Bremse case Deutsche Bank (DB) – as a financial institution – acts as an intermediary between Knorr-Bremse (K-B) and its suppliers. DB purchases K-B’s suppliers’ AR. It then pays the suppliers within say 30 days, but K-B repays DB only after 90 days. This way, the suppliers wait 60 days less for their AR to be paid, which thus

131

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The current practice

increases their available net WC. At the same time, K-B maintains its 90 days’ terms of payment. As the debt at DB is owed by K-B, K-B’s credit rating is relevant in determining the charge for the balance outstanding. Therefore, the cost of this credit is presumably lower than if the supplier were to directly take out a loan from the bank. The services that DB is offering to suppliers provides them with the necessary cash and WC (at relatively low cost) while not putting pressure onto the buyer company’s BS (Dahrendorf and Philipps, 2008).

The fact that financial intermediaries – like DB and many others – currently enter the field of supplier financing shows that there is great potential for such services. But it has to be noted that the financial intermediation in this case is not by way of securitization. The only goal is to achieve lower overall COC by including a financial intermediary in the SC that has a below average WACC (for the WACC please refer to Chapter 1).

C A S E S T U DY  Inventory financing by logistics service providers The SwissPostLogistics case SwissPostLogistics (SPL), the logistics division of the Swiss Post, provides an advanced service for Procter & Gamble (P&G) in Switzerland. SPL has taken over logistics and financing activities in the function of an intermediary SC party. For P&G, SPL is a bulk buyer and resells the goods to retailers while processing the physical flow of goods as well as the flow of finance. While getting a discount on P&G’s wholesale price for the logistics services provided, SPL strictly charges the buyers the price that P&G would usually charge them, plus a logistics and finance charge. Crucial to the financial side of this model is that SPL has a comparably low WACC due to its own size and the size of the SwissPostGroup as a whole. The role of SPL is similar to the role of a wholesaler. New, however, is that a logistics service provider (LSP) assumes these responsibilities (Hofmann, 2009).

This example shows the potential of (and thus the need for) innovative concepts for collaborative WC improvement.

The concept

C A S E S T U DY  Collaboration between financial service providers The case of RBS and GSCF The Royal Bank of Scotland (RBS), as one funder of many others and Global Supply Chain Finance (GSCF) based in Zug, Switzerland, as an SCF platform, are examples of market players that have established a track record in providing SCF solutions to both suppliers’ AP side and buyers’ AR side. RBS, serving corporate clients mainly in the UK and the United States, offers tailor-made receivables purchase agreements to suppliers as part of their overall SCF strategy. In line with these receivables programmes it is ensured that other services offered by RBS (eg e-invoicing) can be incorporated into these solutions. RBS states that the main catalyst for their increasing involvement in integrated SCF solutions comes from the shift from letter of credit (LC) to open account (OA) payments. Therefore, they aim to offer their clientele sector-specific solutions since the nature of their clients’ businesses is very diverse. RBS mentions significant challenges in the SCF environment. Trading relationships of RBS’s customers tend to reach further into emerging countries. When it comes to on-boarding partners in these less developed markets, a financial institution alone often may not have the resources and knowledge to establish the necessary links between the systems of the supplier, the buyer and itself. This is where SCF service providers (or FSPs) come in and is, for example, the reason why RBS signed a service agreement with GSCF (RBS, 2020).

GSCF is an example of a pure SCF platform provider. It offers solutions for both the financing of AP as well as AR. According to GSCF (2020), their core business is receivables-based financing (RBF), where they are able to cover buyers from more than 70 countries worldwide. The main services the SCF platform offers can be separated into two core activities. First, they provide a customized web-portal (reporting engine) that connects suppliers, buyers and funders in real time. Second, GSCF offers services in the financial analysis domain. They provide financial ratings of the buyers and make this information available to both funders and suppliers via a web-based ­platform. Furthermore, while using the SCF platform’s services, more transparency in payment flows can be established and a quasi ‘real-time credit monitoring’ seems to be possible.

133

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The current practice

What can we gather about SCF from the cases and what is missing? The cases described above show a heterogeneous set of aspects that demonstrate why the cost and supply of short-term WC is of high importance in business. From an inter-organizational perspective, we can emphasize that the financial benefit may be increased if a member company (or companies) with good access to financial resources (eg a relatively low WACC) provides the other parties with capital at its relatively cheap rate. This implies that a main constitutive characteristic of SCF is the shift away from ‘single company thinking’ towards ‘business network thinking’, thus considering ‘what is good for the network’ instead of simply ‘what is good for the individual company’. Furthermore, banks and specialized platform providers are additional parties on the financial side of the SC. Even an LSP can act as financial intermediary in the SC. Table 4.1 shows a brief overview of the examples mentioned in this chapter. It provides a condensed view of the fact that there are SCF examples from many industries that come from everywhere in the world and concern various value chain configurations. Table 4.1  Summary of practical examples on supply chain finance Geographical Supply Examples Industry location chain layout Key message 1

Consumer Asia Pacific goods (Indonesia)

many2one

Large corporate directly supports SME suppliers

2

Various

North America, Europe

many2one

Financial intermediaries buffer working capital issues between a principal and its suppliers

3

Logistics service

Europe (Switzerland)

one2many

Combination of logistics and financial intermediation services

4

Financial service

Europe (UK and many2many Switzerland)

Combination of financial services via a technology platform

The concept

Aside from the different use cases of SCF and their promises, not all of the examples will work without some quid pro quo. They require corresponding ‘compensation mechanisms’ for additional expenses that emerge for the companies accepting disadvantageous terms for themselves in order to increase the overall benefit for the SC sector considered. While presently companies are still mainly concerned with optimizing their own (corporate) financial base, the focus in future should shift towards an integrated inter-organizational view. To introduce and set out an agenda for discussion, the following key issues are addressed in this chapter: ●●

How do we define SCF correctly?

●●

What are the fundamental approaches of SCF?

●●

What is the scientific background of SCF?

●●

How have SCF practices evolved?

●●

What is the essence of the network financing philosophy?

●●

How is the net benefit of an SCF solution derived?

●●

Do multiple-win situations in SCF really exist?

Key definitions and general options The scope of supply chain finance We start by going back to the general definition of SCF in order to give as wide a set of options as possible and allow the reader to select the best fit with their situation. The term SCF often refers to a branch of WCM, and is connected to financial supply chain management (FSCM) as the ‘financial part’ of SCM. FSCM comprises the financial processes (eg customs clearance or invoicing) and payments within an SC, with the purpose of introducing measures to optimize planning, managing and controlling cash flows, to facilitate efficient material flows in inter-organizational settings. There are different understandings of SCF, as portrayed in Figure 4.3: SCF in the narrow sense (type A): SCF is understood as a financing solution that enables a buying company (customer) to (pre-)finance payables to suppliers. This form of supplier financing – also known as buyer-driven payables solutions – is the most common SCF practice. Such a widely used instrument is reverse factoring (RF).

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The current practice

Figure 4.3  Possible definitions of supply chain finance Type C

SCM SCF understanding in the broadest sense

Long-term financing solutions of all supply chain-relevant assets, resources and transactions = SCF

Type B

SCM

Financial supply chain management

Short- and mid-term financing solutions of WC in the SC = SCF

SCM

SCF understanding in the narrow sense

Financial supply chain management

Financing WC in the SC

Type A

Buyer-driven payables solutions = SCF

SCF in a wider sense (type B): However, SCF encompasses more. The concept covers the financial flows of the entire SC, which are linked to AP, AR and inventory. With short- and mid-term financing solutions, it aims to optimize cross-company WC and the integration of financial processes between suppliers, customers and external service providers (FSPs and LSPs). SCF in the broadest sense (type C): In the broadest definition, SCF covers not only the financing of all the transactions being done in the end-to-end

The concept

upstream and downstream SC (including WC), but also the long-term financing of all resources and capacities required for operating activities (NCA).   In particular, this includes moveable assets (eg vehicles), equipment (eg tools and machinery) and real estate (eg warehouses). To add to our own SCF definitions, we would also like to introduce the understanding of an important industry association. In support of standardization efforts by the Euro Banking Association’s Supply Chain Working Group, supply chain finance refers to (EBA, 2014: 44): The use of financial instruments, practices and technologies to optimise the management of the working capital and liquidity tied up in supply chain processes for collaborating business partners. SCF is largely ‘event-driven’. Each intervention (finance, risk mitigation or payment) in the financial supply chain is driven by an event in the physical supply chain. The development of advanced technologies to track and control events in the physical supply chain creates opportunities to automate the initiation of SCF interventions.

In this book, we will use in most of the cases the type B definition (SCF in a wider sense). In some explicit cases, either the narrow sense version or the broadest sense definitions are applied.

The general options of supply chain finance From an implementation point of view and an evaluation of the costs and benefits, it is usual to look at four main SCF options. This classification fits in particular with a WC perspective and was introduced in Chapters 2 and 3. Overall, the four main implementation approaches are: AP, AR, inventory and NCA.

Financing accounts payable AP options – also called buyer-led SCF approaches – include all the schemes that advance or delay payment based on the value of a transaction that is invoiced but has to be paid or settled. In a typical non-SCF process, a buyer receives the invoice from a seller and approves it in some internal review process before settling the amount via cash, cheque or bank transfer. The existing route is important as this often changes when an SCF solution is implemented. In addition, the mechanism for formal ‘approval’ may change or may even happen after payment, such as in an early payment SCF approach.

137

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The current practice

The ‘inalienability’ of accounts payable Even as we speak about ‘accounts payables solutions’ it has to be noted that liabilities are not defined in the narrow sense. An assignment of AP is, in contrast to AR, not possible. In the proper meaning, it is about receivables, which all refer to a single buyer (as the recipient/debtor). Because, simultaneously, these AR are equivalent to a buyer’s liabilities, we can equally speak about AP-centric SCF approaches.

Most companies segment their invoices by value, category and supplier relationship in order to apply the appropriate approval process given the associated risks of incorrect payment. So, for example, invoices may be paid when they match with a purchase order (PO), ie ‘two-way matching’; or when they match with a PO and a goods received note (GRN), ie ‘three-way matching’; or match with a PO, a GRN and a user approval, such as an executive sign-off, ie ‘four-way matching’. The level of process complexity generally increases with the value of the purchase and the risk of incomplete or quality issues. In such buyer-led SCF approaches, payment is held back or advanced compared to simply settling sometime after the approval process is complete. A key factor for the most common form of SCF, reverse factoring (RF), is that payment to the supplier may take place before all the matching and checking has been undertaken or independently from it. Such an approved payables financing approach changes the risk situation for the buyer in that they are not in a position to hold back payment if they discover a problem with the supplied goods or materials. However, with typical longer-term supply arrangements, the supplier is more concerned with future business than the value of one specific invoice and so is incentivized to resolve any quality issues even if they have already been paid and thus the real risk is limited. Financing as part of an AP solution is paid out in return for financial assets (supplier’s AR), ensuring that the funds are repaid to the FSP at a later date. It is therefore important to understand the legal aspects associated with this transfer. For example, the most common types of ownership transfer in RF are the sale of AR, the assignment of receivables and the pledging of AR:

The concept

●●

●●

●●

Sale of supplier’s AR: Suppliers’ AR are legally sold to an FSP, which then takes over the payment collection process. Assignment of supplier’s AR: The suppliers still retain ownership of the AR but transfer them to an FSP. Pledge of supplier’s AR: The suppliers create a loan-based certificate for pledging the AR to an FSP.

With RF in particular, it must be established whether the supplier’s AR relating to a procuring company have to be transferred to the SCF provider ­individually, or together, and whether the supplier has to sign a written declaration on the assignment of their receivables to the FSP. The most common SCF solutions concerning APs will be presented in detail in Chapter 6 – see ‘Accounts payable solutions’, page 228.

Financing accounts receivable When vendors sell goods or services to customers, they usually do so on credit. This means that the customer (buying company) does not have to pay immediately for the goods or services that it purchases. However, offering credit to customers ties up funds that the supplier might otherwise use to invest or grow its operations. To finance slow-paying AR or to meet shortterm liquidity, businesses may opt to finance their invoices. AR financing options – also called supplier-led SCF solutions – emphasize financing arrangements in which a company receives financing capital related to a proportion of its AR. AR financing agreements can be structured in multiple ways usually on the basis as either an asset sale or a loan. ‘Invoice financing’ and the ‘assignment of AR’ are two such typical ways. Invoice financing is a way for businesses to borrow money against the amounts due from customers, paying a percentage of the invoice amount to the lender as a fee for borrowing the money. A specific form of financing AR is the assignment whereby the borrower assigns AR to the lending institution. In exchange for this assignment of AR, the borrower receives a loan for a percentage of the AR. This percentage may be as high as 100 per cent. The borrower pays interest and a service charge on the loan and the assigned receivables serve as collateral. That is, if the borrower fails to repay the loan, the agreement allows the lender to collect the assigned receivables. The most common SCF solutions concerning AR will be presented in detail in Chapter 6 – see ‘Accounts receivable solutions’, page 238.

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Financing inventories The next option is to finance the inventories, or stocks. The options are applicable at the demand side (finished goods), within the company value network (WIP inventory), or at the supply side (raw materials and purchased merchandise). The basic mechanics of financing inventory are as follows: a buyer finances a supplier, or an intermediary such as an LSP, based on a level of goods or raw materials held by the supplier for the buyer under some form of commitment arrangement. For the supplier, this can reduce their cost of financing by effectively taking an early payment in advance of delivery or invoice. This cost saving can be shared or passed onto the buyer. For the buyer the arrangement can secure their supply, possibly at a more favourable price than would be available later on when the goods or raw materials were actually needed. As the materials or goods stay with the supplier or some other intermediary, the buyer is also not paying for the physical cost of storage. There is an obvious risk that the supplier may not be able to deliver when required, although this can be mitigated to some extent by having a charge or claim on the stock if the supplier gets into financial problems. Inventory financing is a popular financing option for small- to mediumsized retailers or wholesalers. Here, inventory financing can be understood as an asset-backed, revolving line of credit or short-term loan to empower a retailer or wholesaler to purchase products (trade goods) for sale. Those products, or inventory, serve as collateral for the loan if the retailer/wholesaler does not sell its products and cannot repay the loan. Inventory financing is especially useful for companies that must pay their suppliers in a shorter period than it takes them to sell their inventory to customers. It also provides a solution to seasonal fluctuations in cash flows and can help a company achieve a higher sales volume, for example by allowing a business to acquire extra inventory to sell during the holiday season. Approaches offered for import, export or in-transit financing are also forms of inventory financing. These latter models have been around historically since the earliest days of international trade. An intermediary takes a right to the goods in transit, a ‘charge’, and in return releases cash to pay the supplier before the goods have reached their final destination, which, given the distances and transit times of international trade, may be very long. As mentioned, these approaches are well established and are not covered further in this book. The most common SCF solutions concerning inventories will be presented in detail in Chapter 6 – see ‘Inventory financing’, page 244.

The concept

Financing non-current assets The final option is financing the NCA of an SC network. NCA include the whole SC infrastructure from an end-to-end perspective. This includes among others: vehicles, physical warehouses, transhipment equipment, machinery, terminals, information and communication technologies (ICT), etc. A key element of these NCA is the long-term asset characteristic, meaning they typically have a lifetime of more than one year. NCA financing can be illustrated as follows: a buyer supports its supplier by financing some of their capital costs, eg for new or upgraded equipment or tooling for production required by the buyer. While the effect is typically to advance funds to a supplier ahead of when goods or services are delivered (and so can be considered as SCF), the motivation is usually wider and often focused on establishing commitment to investment by a supplier so that they can build capacity or new technology before the buyer is able to formally order the associated goods or services. In certain cases, such as tooling or moulds in manufacturing environments, the buyer can retain an ownership right, or charge, on the items invested in. This allows the buyer to remove them and redeploy them to other suppliers if the initial one becomes unable to deliver for financial or other reasons. NCA financing can also be achieved by collaborative sale and leaseback. In this option, it is usual for a third party (an FSP, such as a specialist leasing company) to provide the funds. The cost of these funds, and so the benefit to the SC, is dependent on the perceived risk associated with the individual company but also on the stability and certainty of the SC into which the asset fits – will there be a continuous stream of work to pay the leasing charge? Unfortunately, the accounting rules on how the asset is recorded are complex – financing leases and operating leases are the two terms that need to be understood and considered (see outlines in Chapter 6).

Operating modes of the basic approaches Given the WC components (AP, AR and inventory), we can distinguish three basic SCF approaches. As the range of SCF solutions will be described and discussed in detail in Chapter 6, the core functionalities and operating modes of the three basic SCF approaches will be introduced at this point. Figures 4.4, 4.5 and 4.6 emphasize the three different basic approaches including the expected benefits for the various parties involved.

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Supplier-centric SCF approaches Figure 4.4   Scheme and benefits of the supplier-centric SCF model (export financing) Initiating supplier (corporate)

Affiliated buyers (customers)

1 2

Focal company

SCF solution provider (paying agent)

3

4 5

Bank

Benefits vendor • Decreasing DSO • Faster incoming cash flow • Balance-sheet neutral & non-recourse financing • Injection of liquidity into sales channel

6

Benefits SCF solution provider • Shortening C2C-Cycle • Improving debt ratio • Later payment of invoices • Receives part of fees

Expected benefits of the supplier-centric SCF approach Benefits buyers • Increasing DPO • Shortening C2C-Cycle • Improving debt ratio • Later payment of invoices

Benefits bank • Generating additional business • Cross-selling opportunities • Risk is covered

The most important steps of a supplier-centric, or an export financing transaction (Figure 4.4) are characterized as follows: 1 The first step is always that the buyer places an order with the respective supplier and the goods are delivered along with the invoice. 2 A copy of the invoice is also delivered to the SCF solution provider. 3 The SCF solution provider gives the affiliated buyer a payment advice. 4 In a next step, the SCF solution provider gives the bank a settlement advice and information regarding the creditworthiness of the buyer.

The concept

5 The bank then determines under what terms the funding can be granted to the supplier and pays the supplier. 6 The buyer then pays the invoice value to the bank plus a funding fee and possibly also transaction fees.

Buyer-centric SCF approaches Figure 4.5 Scheme and benefits of the buyer-centric, or import SCF model (reverse factoring) Affiliated suppliers (vendors)

1

Initiating buyer (corporate)

2

Focal company 4 5

SCF solution provider (paying agent powered by a single bank)

Benefits vendors • Liquidity ‘on demand’ • Trade risk reduction and enhanced transparency • Being still an approved and preferred supplier

3 6

Benefits bank and/or SCF solution provider • Risk is on corporate • Increase in business across business cycle • New customer relationships

Expected benefits of the buyer-centric SCF approach Benefits buyer • Reduction of payment and processing costs • Use of extended payment terms • Helping suppliers finance their receivables more easily

[‘One-funder-model’: the service provider and the funder form one unique entity]

The most important steps in an AP solution (Figure 4.5) within a ‘one-funder model’ – which consists of a leading bank providing a proprietary ­technology platform, meaning the service provider and the funder form one unique entity – can be summarized as follows: 1 In a first step, the buyer places a purchase order to the affiliated supplier (vendor). 2 The vendor then delivers the goods along with a copy of the invoice to the buyer.

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3 The buyer then approves the invoice and submits it to the SCF solution provider (paying agent). 4 The vendor also selects invoices for discount and sells them to the SCF solution provider. 5 The SCF provider then accepts the offer of those selected invoices and pays a net amount to the vendor. 6 After an agreed term of credit the buyer makes the bill payment to the SCF solution provider.

Inventory-centric SCF approaches Figure 4.6  Scheme and benefits of the inventory-centric SCF model (outbound) Initiating supplier (corporate)

Purchasing guarantee

Focal company 6 1

Logistics services provider 2

Affiliated buyers (customers)

4 5

3 Bank

Benefits logistics services provider Benefits buyers • Holds inventory • Cash otherwise tied up in inventory is • Generating additional business free to invest • Securing current business • Inventory funding on a revolving basis • Improving cash flow • Works with ‘average’ credit score Expected benefits of the inventory financing approach Benefits vendor • Decreasing DSO • Faster incoming cash flow • Additional liquidity

Benefits bank • Receives collateral • Risk is on logistics services provider • Generating additional business

Here there is a framework contract between the initiating supplier and the affiliated buyer. The initiating supplier also has a purchasing agreement with

The concept

the LSP. These are the foundations for the inventory financing. The typical steps of ‘outbound’ inventory (finished goods) financing (Figure 4.6) are: 1 In a first step the goods flow from the initiating supplier to the LSP. 2 The LSP then provides the bank with collateral. 3 In turn, the bank provides the LSP with funding. 4 The affiliated buyer then delivers payment directly to the LSP. 5 Upon receipt of the payment from the buyer, the LSP delivers the goods to the buyer. 6 In a last step, the LSP makes a payment to the initiating supplier. The ‘outbound’ inventory SCF model can be – of course – mirrored. Within such an ‘inbound’ approach, the initiating company is a buyer. The inventory categories being financed are raw materials or work in progress.

Scientific background The supply chain finance schools of thought The SCF literature includes six schools of thought (reverse factoring, asset, quantitative modelling, finance, risk and stakeholder) and each takes a different perspective to SCF, which are summarized in Table 4.2. Due to the range and complexity of the subject, no uniform view of SCF has evolved. As a result of the heterogeneity of areas of research, as well as the plurality of participants engaging in SCF, it is more appropriate to distinguish between schools of thought (Hofmann and Johnson, 2016). The reverse factoring school is restricted to one single financing arrangement (eg Dello Iacono et al, 2015; Wuttke et al, 2019), whereas the asset school focuses on financing specific resources relevant to SCM, eg warehouses (Lin et al, 2018), including sale-and-leaseback (Chapman et al, 2003). Subsequently, the quantitative modelling school (Zhao and Huchzermeier, 2018) centres on numeric decision models for SCF falling into two categories: (i) the supply chain external capital view, eg securitization of assets for financing the AR of cash-constrained companies (Tsai, 2008) or optimal credit line strategies in supply chains (Yan and Sun, 2013); and (ii) the supply chain internal capital view, eg trade credit financing in supply chain networks (Battiston et al, 2007), and internal supply chain financing (Pfohl and Gomm, 2009). Moreover, the financial chain school

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Table 4.2  The key proponents of the supply chain finance schools of thought School of thought

Focus

Proponents

Reverse factoring school

Singular focus on buyercentric instrument of reverse factoring

Dello Iacono et al (2015), Wuttke et al (2019)

Asset school

Optimization of a) working capital and/or b) logistics assets

Chapman et al (2003), Lin et al (2018)

Quantitative modelling school

Quantitative decision models for supply chain finance

Battiston et al (2007), Zhao/Huchzermeier (2018)

Financial chain school

Optimization of financial processes and transaction

Flynn et al (2010), Kristofik et al (2012)

Risk school

Risk mitigation in supply chains regarding a) financial resilience b) trade finance

Castermann (2012), Pellegrino et al (2019)

Stakeholder school

Focus on different supply Hofmann (2009), chain parties involved in SCF Silvestro/Lustrato (2014), Chakuu et al (2019), Martin/Hofmann (2017)

Figure 4.7  The remit of the supply chain finance schools of thought Supporting supply chain members 1

3

Flow integration Physical flow

3 Supplier

5

Collaboration

4

6

Information flow

5

Solutions

Flow integration

Operations SCF

6

2

Physical flow Information flow

4 3 Financial flow Finance 5 Environment Supporting supply chain members Supply chain stakeholders

3 Collaboration

Financial flow

6

Buyer

6

1

Reverse factoring school:

How does reverse factoring contribute to SCF?

2

Asset school:

Which assets in the supply chain require financing?

3

Quantitative modelling school: Which financing solution best meets the demand in SCF?

4

Financial chain school:

How does (IT-enabled) financial processes facilitate SCF?

5

Risk school:

Which major risks are relevant for SCF?

6

Stakeholder school:

Which supply chain parties are relevant for SCF?

5

The concept

addresses the optimization of financial processes and transactions of SCF (eg Flynn et al, 2010; Kristofik et al, 2012). The risk school considers two perspectives of risk mitigation in supply chains: trade spillovers and financial resilience (eg Casterman, 2012; Pellegrino et al, 2019). Finally, the stakeholder school examines the different supply chain parties involved in SCF (eg Hofmann, 2009; Silvestro and Lustrato, 2014), such as FSPs (Martin and Hofmann, 2017). The six SCF schools of thought are mapped onto an SCM transaction ­between supplier and buyer, as illustrated in Figure 4.7, and refer to them as the ‘remit of supply chain finance’. The SCF questions posed by the various SCF schools of thought will be revisited in subsequent chapters of the book.

Transition stages The evolution of supply chain finance practices The SCF approach first appeared in the SC literature in the early 1990s and has expanded over time into a broader set of integrated services (Hofmann, 2005; Hurtrez and Salvadori, 2010). In a nutshell, SCF rose in several transition stages (Figure 4.8): The first stage, the basic WCM oriented level, focused purely on the benefit of one individual organization, ignoring the consequences for the other affiliated SC members most of the time to the disadvantage of weaker parties in the SC. Instruments used in this stage maintained LC approaches or classical factoring programmes, all of them mostly based on manual processes. The main target was liquidity-oriented with a strong local respectively domestic orientation. In a second stage, SCF evolved by combining domestic trade finance with SCM through RF, which was defined as an innovative invoice financing arrangement (RF oriented stage). Initially, RF was only offered by banks as a domestic service for selected industries, especially the automotive sector. As many large corporates started sourcing their raw materials from SMEs around the world, a further development emerged; the companies intensified their dyadic business relationships with their suppliers and, consequently, they switched from LC to OA approaches. This develop­ ment was accompanied by some technological progress, enabling more and more (semi-)automated processes (eg seamless documentation).

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Figure 4.8  Transition stages: the rise of supply chain finance Maturity of solutions and scope of activities

high Stage 4 (from 2020)

Stage 3 (~ 2010-2020)

Stage 2 (~ 2000-2010)

low

Smart SCF-solutions with fully automated and flexible interconnected processes (e.g. decentralized availability of blockchain-based and tokenized transaction data, smart contracts, machine learning-based optimization, deep-tier network-oriented) … broadened perspective on ecological and social aspects

Integrated SCF-solutions and automated processes with tightly involved third parties in the global supply chain (e.g. SCF platforms, dynamic discounting, reverse securitization, highly developed trade community network, centralized supply chain-oriented)

Developed SCF-products and semi-automated straight through processes connecting different importing and exporting supply chain partners (e.g. open account practices, reverse factoring approaches, seamless documentation process, dyadic relationship-oriented)

Basic SCF-functionalities (focused on classical working capital requirements) and mainly manual processes across Stage 1 (until 2000) undifferentiated supply chain parties (e.g. letters of credit, factoring, intra-firm-oriented) low

Geographical and inter-organizational reach

high

These developments also made it possible for multiple credit providers to connect and compete on financing. This stage was characterized by a strong risk orientation. The third stage aimed at achieving a WWS for all parties involved in the process of value creation. It was widely recognized that business is performed in a more globalized way with more multinational corporations involved in transactions. Multi-user platforms emerged, where specialized and neutral platform providers took over a role in between corporates of the physical SC (like suppliers and buyers) and FSPs (like banks and corporate investors). The SCF platforms enabled integrated solutions as dynamic discounting (DD) or reverse securitization (see ‘Accounts payable solutions’ in Chapter 6, page 228). By integrating procurement, logistics and distribution as well as invoicing and financing into one single system, this stage can also be characterized as centralized SC-oriented. The fourth and last stage is still ongoing. The SCF solutions are becoming smarter, meaning they are integrating big data and machine learning features more and more. A specific SCF ecosystem has been evolved and more focused market players are appearing (like transaction hubs or SCF

The concept

marketplaces; see Chapter 5). Corporates are using different SCF solutions in parallel (SCF applications in breadth), even at the supply (AP) or the demand (AR) side. Based on technology progress (especially artificial intelligence, blockchain technology and smart contracts; see Chapter 9), companies are now able to handle financing issues beyond the tier 1 supply chain partners (SCF applications in depth). This ‘deeptier financing’ stage will become an additional development boost, as further SC transparency, decentralized systems and tokenization will be disseminated. The use of one centralized and proprietary platform may be replaced by the application of decentralized and open source infrastructure. In addition, the perspective will be increasingly broadened on ecological (environmental) and social aspects.

Deep-tier, or multi-tier, financing Deep-tier financing ensures that suppliers along the supply chain get access to multiple sources of liquidity, eg via an online, fully automated, secured platform or – alternatively – based on a tokenized infrastructure (see Chapter 9). This concept works with (i) either the help of a third party injecting liquidity (eg a bank), or (ii) by using the cash directly from an anchor corporate (eg a large buyer). Instead of refinancing sub-suppliers based on their bad credit score (eg BBB rating), deep-tier financing aims to provide liquidity to sub-suppliers based on the best credit score of the anchor company (eg based on a AAA rating). This mechanism is called interest rate arbitrage. Companies offering deep-tier financing solutions include DBS bank (www.dbs.com), BiggTech (www.biggtech.co/deep-tierfinancing/) or TallyX (www.tallyx.com/product/).

Network financing philosophy The fundamental backbone of all supply chain finance solutions Traditional financing approaches are confronted with a certain set of limitations when transferring them to the SC setting. The following dimensions have to be taken into account in this respect: (i) the individual company; (ii) the sales and buying markets; and (iii) the financial markets:

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(i) With regards to the individual company, today’s highly volatile markets demand constantly monitoring the company’s decisions on whether to hold cash amounts in excess of what is actually required. If the company does so (increase net working capital), it will reduce risk on the one hand, but, on the other, sacrifice profitability (Garcia-Teruel and Martínez-Solano, 2007). Nevertheless, this is a trade-off that each individual company has to assess on its own. There are also other factors that influence how much each company ties up in liquid assets. For example, stock listed companies rely to a lesser extent on cash holdings. However, they make a point of hoarding cash when it is expected that external finance might become expensive and, as a precautionary measure, to ensure they can still pursue investments even when cash flow is too low. (ii) The notion of excess cash holdings is also connected to the sales and buying market (trade settlements). If firms are not able to collect their outstanding receivables in a timely matter and have to increase days of AR (DSO), it will also lead them to employ more cash resources than would optimally be needed. Furthermore, if days of AP (DPO) are extended in the light of keeping cash resources on a higher level, then it could potentially cause a deterioration in the relationship with the supplier, and the buying firm could likely face higher prices at some point. (iii) The last point concerns the financial markets and the fact that individual firms find themselves in situations where access to capital is limited or can only be obtained at high rates and costs. Credit ratings (influenced by Basel III regulations for banks and FSPs) are nowadays restricted to a single company perspective, despite the policy of low interest rates, without taking the embeddedness of other firms within their SCs into account. From a broader risk point of view, a company that is situated between financially strong suppliers and customers should have a much more favourable rating than firms that are not. Typically, traditional trade activities in an international context have to deal with the following situation: the supplier (exporter) would like to reduce days of AR (DSO) as much as possible and the buyer (importer) wants to extend days of AP (DPO). Additionally, there is an inherent conflict with regards to the form of payment. While the supplier (exporter) seeks to find a way that exhibits surety (eg an LC) that it will receive the payment at a predefined date, the buyer (importer) would likely opt for OA terms since that would allow them more flexibility in regard to the payment term. However, very often firms have insufficient or even incorrect information

The concept

about their financial flows along their inbound and outbound SCs, which also makes the task of determining the appropriate level of cash more challenging. Such non-transparency is even worse for an interconnected bank. The FSP is in the dark!

International trade Letter of credit vs open account A letter of credit (LC) is simply a letter from a bank guaranteeing that an importer’s payment to the exporter will be received on time and for the correct amount. LCs, also known as ‘documentary credits’, represent a secure compromise between the buyer and the seller of the goods. There are usually at least four parties involved: the applicant (an importer), the issuing bank, the beneficiary (the exporter) and the advising/confirming bank. An LC gives the seller the security of knowing that payment can be collected once the goods have been shipped. And it gives the buyer the security of knowing that shipment of the goods has taken place before the payment has to be made. Therefore, an LC is the right and secure trade finance tool if certain risks prevail, such as an unstable political or economic situation in the exporter’s country, or if a country’s regulations specifically requires it. In the case where the parties to the contract cannot assess one another, or are in new, less-established trade relationships, an LC may also be recommended. By contrast, when a buyer and seller agree to deal on open account (OA) terms, it means that the seller will dispatch their goods to the buyer and will also send an invoice requesting payment. The exporter loses control of the goods as soon as they dispatch them. For this payment method, the exporter bears the entire risk regarding the ability and willingness of the importer to pay for the goods received. Therefore, an exporter will only agree to this term of payment if their counterpart is reliable and also if the political situation and the foreign exchange situation in the importing country are considered as being stable. When dealing on OA terms, the banks only play a role when the buyer hands in the foreign payment order. This linkage between the physical supply and the payment process is only brought about through the provision of credit and is not as important as it is in the case of LCs.

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In international trade there might be times where LCs are unnecessary expenses. In these circumstances, OA may be more appropriate. Prior to the financial crisis with the global economic downturn, trade finance was moving away from LC secured transactions towards OA transactions, since trade credit was relatively easy to obtain. However, post September 2008, mutual trust between the exporter and importer as well as their dependency on each other required a secure trade-financing tool. At that time LC came back into play and gained popularity once again. Nevertheless, OA trade can result in greatly improved efficiency and considerable savings in time by streamlining processes for both exporters and importers. If the importer refuses to accept the goods, the exporter incurs interest costs on the already paid pre-financing. Dealing on OA terms consequently needs a certain degree of trust for the importer and is mainly used between contractors with established business relationships. Furthermore, OA terms are a lot cheaper than LCs. As a rule, a commercial LC transaction has more than one fee and provides a guarantee for a limited time, often four months. Some fees are assumed by the seller, others by the buyer. Roughly, for an LC in excess of US $100,000, a typical Figure 4.9  Development of foreign trade exports (OA vs LC) In billion USD 20000 Open account

LCs

18000 16000 14000 12000 10000 8000 6000 4000 2000 0

1978

1986

1993

1999

2005

2013

SOURCE  Data for analysis retrieved from WTO, Berne Union and Factors Chain International (2015)

The concept

buyer’s fee is 0.75 per cent for OECD transactions; in underdeveloped countries, it can range from 1.5 per cent upwards. The seller’s total fees will probably be less, but there will be 5 to 10 different charges, each ranging from US $25 to US $150, for postage, courier services, bank-to-bank reimbursement charges, authenticating the LC and other required services. Currently LCs account for 15 per cent of the world trade volume, while OA terms stand for more than 85 per cent of the world trade volume; nonetheless the costs are not considered to be the only reason for this development (Figure 4.9).

In short, there is a certain ‘need for action’. While the involvement of banks in OA trade flows – and especially in SCF programmes – has grown as a share of their trade financing portfolios, year on year, the majority of OA flows are supported by the trading parties’ own resources, for example nonbank entities such as service providers offering logistics, e-invoicing and other financial solutions. Furthermore, OA trade is no longer reserved for transactions involving established trading relationships or for trade within low-risk markets. The shift to OA trade is near global in scope and, thus, so is the relevance of SCF techniques and structures. As a consequence, banks are compelled to offer their corporate client’s products that are in line with these developments, supporting continuous and cost-efficient processing combined with payment assurance and financing options (GSCF Forum, 2015). Additionally, the reputation and credit ratings of firms that minimize net working capital at the expense of their SC partners might be at stake. Therefore, a collaborative approach to payment flows and finance – under consideration of third-party providers (like banks and SCF platforms) – is needed between network partners.

Conception of network financing philosophy The SCF approach builds on the notion that partners in the SC domain have more options available to generate cash sources, than an individual firm. A basic foundation of SCF is network finance (Hofmann, 2005: 11). This approach aims to achieve an integration of the ‘financial chain’ from an endto-end perspective for the supply side as well as the demand side of the SC, while distinguishing between financing sources obtained inside a network (SC) and sources coming from outside of the original SC. Service providers may provide interfaces allowing the involved SC partners to leverage on more efficient mechanisms in the invoice-order processing. Looking at the

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internal financing perspective, the service providers may act in a broader sense as consultants to suppliers and buyers that engage in ‘collaborative C2C cycle optimizations’ (Hofmann and Kotzab, 2010). The conventional wisdom of internal financing can be criticized as being too ‘static’. Normally, the internal financing capability for a single firm is largely determined by its annual financial statements. The flow orientation, which is a distinguishing characteristic of SCF, does not target such a static approach. A goal is to efficiently allocate financial resources to the place (SC members) where they are most beneficial. In such a flow orientation, direct cash inflows represent a source of financing only; retained earnings or other static accounting figures are left out of the picture (Hofmann, 2005). Similar to traditional financing, the network approach distinguishes between internal and external sources of financing: Internal financing is not limited to the options a single company may possess but also includes financial resources that originate from their collaborators (buyers or suppliers). External financing is then obtained if these resources stem from partners outside the supplier–buyer relationship (network entity). Network finance includes a host of SCF solutions, of which some can be seen as established ‘tools’ in the supply chain arena, while others have just recently received more attention (Table 4.3). Table 4.3  Network financing philosophy within SCF Network-level financing Source of financing

Single-company financing

Financing approaches

Methods in practice

Financing sources located inside the firm or network

Traditional firmbased internal financing (eg retained earnings)

Inside network internal financing

Collaborative CCC or inventory approaches (eg VMI), marketplaces (eg providers like C2FO.com), dynamic discounting

Inside network external financing

SCF platform solutions (especially RF), purchaseorder financing, on-balance inventory financing

Outside network external financing

Reverse securitization, trade receivables securitization, off-balance inventory financing

Financing sources located outside the firm or network

Traditional firmbased external financing

The concept

Categories of network financing The first category, inside network internal financing, includes initiatives that aim to optimize the financial flows between SC partners by freeing up WC that has previously been tied up internally in the SC. The initiatives are more closely connected to the physical flows (such as VMI or JIT warehouse management) by which the collaborative C2C cycle improvement can be tackled. This also includes collaborative inventory management initiatives and DD approaches (see Chapter 6 ‘Accounts payable solutions’ on page 228) or marketplaces approaches.

Working capital marketplaces An example of an SCF marketplace is C2FO (https://c2fo.com/). This financial technology company developed and now operates a marketplace platform where suppliers, on the one side, can periodically claim discounts on invoices that they wish to speed up. On the other side, buyers upload their approved invoices to the platform, set a threshold and allocate a cash budget. It’s an ‘up to’ rate, and C2FO usually gets a discount to that rate as long as it meets buyers’ stated return objectives. Note that there is no assignment of invoices. The network effect enables the marketplace (i) to connect pre-approved suppliers and buyers, and (ii) to supply liquidity across many SCs, all with a single sign on. In consequence, if a supplier is looking for a certain amount of money and has large corporate buyers, they can pull cash. For instance, a supplier could put a global offer saying they willing to pay up to 2 per cent for early payment across any of its customers.

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Accordingly, the goal should be to increase the ‘self-financeable growth rate’ for all network partners that participate in the SCF initiative (Churchill and Mullins, 2001). Practically, one could assume that this financing mechanism is taken into consideration where network partners already have close ties and are geographically less dispersed due to the nature of the close relationship needed when handling, for example, inventory in a collaborative way. The second category, inside network external financing, approaches include financial instruments or cooperative arrangements, through which one company is able to obtain additional external funding from other partner firms operating within the same supply chain network. Such financial tools include SCF platform solutions (especially RF), purchase-order financing (POF), or an on-balance inventory financing solution. Financing is obtained by either a firm-driven or service provider-driven organization and streamlining of the financial flows in the SC. Technology providers are the main enablers of SCF. Such SCF service providers facilitate the process of reconciliation, invoices, credit notes, payments and related information as well as helping integrate this information between the different supply chain constituents. In addition, they can offer services such as credit risk management, the setup of SCF programmes and the legal infrastructure for SCF participants. The last category, outside network external financing, entails collaborative efforts to obtain financing from (SC network) external partners. Whereas external financing for a single firm has been extensively researched, it is most likely that this is less discussed from the enhanced network perspective, both in theory and practice. Investors or lenders outside the network provide capital to the SC members – even to facilitate and grant trade or to endow SC initiatives – while the conditions are tailored. From a more practical viewpoint one could argue that specific trade receivable finance securitization schemes, such as observed in the commodities industry, could be allocated to this financing category. Thereby, trade finance receivables as well as reverse securitization approaches, which were previously held by financial institutions, are now offered to private investors on the capital market (see, for example, the programme of www.crxmarkets.com). Though these transactions may resemble a single-company oriented financing mechanism initiated by a focal company, the fact that more financing (or at more favourable conditions) could be obtained may translate to a network benefit. Furthermore, the inter-organizational ‘network view’ in these new capital market transactions is likely to be more apparent since the cost of financing is indirectly determined by the financial health of all internal and external partners.

The concept

The sources of finance in supply chain finance SCF uses the supply chain to fund the organization, and uses the affiliated organizations to fund the SC. There are three fundamental financing models available, eg to provide the cash to change the normal terms of trade: banks, intermediaries or self-financing.

Bank financing With bank financing, the corporate’s bank or one of their banking partners provides the finance. Given the bank’s knowledge of their client, the buying or selling corporate, they should be in a position to understand and manage the financial risks and provide a competitive pricing for the finance as part of their overall banking service. Citi, Santander, RBS are examples – see Chapter 5 for a more complete list of banks that offer SCF as part of their overall corporate banking offering.

Intermediary financing With intermediary financing, often associated with third-party provided SCF services or platforms, one or more sources of finance are accessed that are focused solely on the transaction profile of the SCF, rather than the overall financial status of the affiliated supply chain corporates (suppliers or customers). These sources of finance may be governments (eg World Bank), alternative non-bank lending such as crowd funding, or other third parties (investors). They manage their lending risk by spreading the funding across many buyers, suppliers and transactions. Typically, they focus on the larger volume SCF service providers or platforms (see Chapter 5 for a comprehensive list).

Self-financing Self-financing is an approach adopted by large corporates who have sufficient cash to commit a portion of it to support their suppliers or customers with the objectives of lowering the overall supply chain costs, improving the financial security of the suppliers or customers, improving the dyadic relationship, or, finally, for positioning strategically as a ‘preferred supplier’ or a ‘preferred customer’. In some cases, the buying organization can regularly and consistently pay early. If this is communicated and their payment performance is reported, the suppliers should recognize this reduces their own financing needs and so over time offer better pricing or service priority in return. This is the approach

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often adopted by governments or other public bodies, eg the UK government ‘SCF Scheme’ as described in Chapter 8. Alternatively, the buying organization can offer the financing for an explicit discount or rebate off a price list or off a benchmarked price.

Economics The basic benefits of supply chain finance SCF solutions bring many benefits. For companies that have not yet implemented an SCF solution, the main reasons are reduction of net debt and the improvement of WCM processes. In particular, these include the standardization of payment objectives and improved information links with suppliers and/or customers. For companies that have already implemented an SCF solution, greater financing flexibility and the reduction of SC risks (particularly suppliers’ risk of default) are also significant perceived benefits. We would like to present the economics of SCF within the following example, as illustrated in Figure 4.10 (according to Greensill, 2010). The ­example consists of a dyadic supply chain relationship with a smaller supplier and a large buying company (customer). As highlighted, the financing costs for the supplier, buyer and in total are based on a US $6 million invoice presented in three ­different situations: In the initial situation 1, it is assumed that the buyer does not provide any financing activities to the supplier. Consequently, the supplier does not benefit from an SCF solution and thus has an annual financing rate of 12 per cent. Additionally, the costs of financing are based on the initially agreed payment terms of 45 days. In situation 2, the buyer decides to extend the payments vis-à-vis the supplier by 15 days. Thus, the supplier again does not benefit from an SCF solution. In contrast, the costs of financing are based on the average payment terms of 60 days (as an industry standard). This results in a longer DPO and lower cost of capital for the buyer but also a proportionately longer DSO and higher COC for the supplier. Even worse, from a broader SC perspective, the total costs for the SC rise, leading to a win–lose situation. In situation 3, the supplier benefits from an SCF solution and thus has a new annual financing rate of 6 per cent. The costs of financing are based on average payment terms of 60 days (industry standard), likewise. This results in the same COC for the buyer compared to situation 2 but in a lower COC for the supplier and thus in lower total costs for the SC.

The concept

Figure 4.10  Economics of supply chain finance Assumptions case example: •

6 Mio. € invoice presented

•

Average term of payment (industry standard) = 75 days

•

Initially agreed term of payment = 45 days

•

Annual financing rates (360 days per year) •

Supplier without SCF = 12%

•

Supplier with SCF = 6%

•

Buyer = 5%

Cash conversion cycle $6m invoice presented

Invoice approved

Invoice paid by buyer

Financed Financed by supplier by supplier

Financed by buyer Cost comparison Supplier Buyer Total

1) Initial situation (agreed term of payment = 45 days)

$115,000 $90,000

12%

Cost of financing

12%

5%

$20,000

Day 0

$25,000

$25,000

$70,000

10

45

75

60

Cost of financing

2) Extended payment terms without supply chain finance (new payment terms = 60 days) Extend 15 days 12% 12%

$120,000

5%

$20,000 Day 0 10

$100,000

$132,500

$12,500

$12,500 45

60

75

3) Reduced financing costs for supplier due to SCF programme

Benefit to buyer, but proportionate higher cost to supplier (compared to situation 1)

$70,000

$82,500

Cost of financing

12%

$20,000

Day 0

10

6%

5%

$50,000

$12,500 45

60

$12,500 75

Generation of savings for both supplier and buyer (compared to situation 2)

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­ he potential financing cost reduction in this specific scenario is US T $50,000. But with higher payment terms the financing cost savings are even greater. In practice, the current win–lose situation could be corrected by introducing an SCF solution to create a WWS. Within the examples, the respective costs are calculated as follows: Costs of financing =

Invoice ∗ financing rate ∗ days of financing days per year

In addition to the benefits highlighted in the example, the adoption and implementation of an SCF solution brings additional advantages. Additional benefits for the buying company are, for instance (Greensill, 2010): ●●

●●

●●

●●

Their financial SC becomes more resilient as key suppliers have greater financial certainty and are therefore in a better position to fulfil orders on time, reducing risk in the buyer’s financial SC. The cost of processing is reduced as the number of supplier queries, inhouse payment processes and payment fees are reduced. Relationships with suppliers are improved, with the potential to achieve better commercial terms without negatively impacting on suppliers. An SCF programme does not compromise a company’s ability to source other forms of financing and does not impact on its credit rating.

For the supplier, the benefits are comparable, for example: ●●

●●

●●

Cash flow is predictable, as invoices are settled on time by the buyer’s bank. WC requirements are therefore reduced and cash flow becomes less constrained. Suppliers may also be able to offer more competitive terms as the cost of late payment does not need to be factored into invoices. There is the option to seek early payment as a means of financing. This financing is effectively pre-approved and is not subject to the supplier’s financial standing. For companies that could not otherwise source financing, or where the cost would be prohibitive, this can be a major benefit. For those with alternative means of financing, credit lines are released for other purposes. Reconciliation, account posting and management reporting are enhanced as remittance information is provided in a format that can be integrated with internal systems.

The concept

The basic costs of supply chain finance The implementation of an SCF solution does not just produce benefits but also involves personal expense, charges and costs (see Chapter 6 for detail). Two types of costs are generally incurred: (1) the on-off costs and (2) the recurring costs. 1 The one-off costs of SCF solutions are: {{

{{

Implementation costs: During the selection, introduction and integra­ tion of the chosen SCF solution into the existing ERP system, various costs are incurred for hardware, software, licences, process migrations and creditworthiness checks of the procuring company. Training costs: To ensure successful implementation, all in-house em­ ployees, particularly from the procurement and treasury departments, must be notified of the changes and receive appropriate training. The level of costs depends significantly on the number of entities required to receive training. Some providers include the training costs in the licence fee.

2 The recurring costs of an SCF solution comprise the following: {{

{{

{{

{{

Financing charges: These are made up of the interest rate and the spread. The latter indicates the risk premium that the SCF finance provider receives as compensation for the financing risk assumed. The interest rate in Europe is generally based on Libor or Euribor, depending on the country in which the SCF solution was set up. Staff costs: Personnel expenses that are not always easy to define are incurred through the introduction of an SCF programme. As well as the employees in the legal and finance departments, these also include staff from the procurement department who negotiate the contractual details with the suppliers and who are responsible for supplier onboarding. IT operating costs: Capital and operating costs are incurred for the operation of the SCF solution. The costs for IT services and support depend on the time required and should ideally be defined in specifications. Consulting services: Particularly in global SCF programmes, operating costs are incurred for various services, such as the administration of the SCF solution in other countries, with a view to tax law and accounting.

Aside from the manifold cost aspects, there exist other obstacles of SCF to take into account. However, one also has to be aware of the limitations of the network finance approach. Suppliers and buyers might be part of multiple

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supply chains and networks. This will most likely require them to operate in numerous ‘financial nets’. If a platform solution is aimed for, then it would also be desirable that these instruments exhibit a certain compatibility such that the flows occurring in the different financial nets can be captured efficiently. Participating firms will lose a certain autonomy with regards to the decision-making process in their financial operations. This might be especially the case where network financing agreements are designed as longterm contracts and involve joint investments, for example. More about the (financial) benefits and cost of SCF will be presented in Chapters 6 and 7.

Win–win situations A constitutive characteristic of supply chain finance From early literature on SCM it can be inferred that the term win–win had been closely associated with the idea of an integrated SC (Towill, 1997). Integration hereby mainly referred to closer collaboration of the involved parties in the physical product or material flow. In order to derive a WWS, firms are required to enter into some form of ‘cooperative scheme’ (Vlachos, 2004: 172). The collaboration should in turn lead to a mutual benefit for the involved parties over an extended period of time. Furthermore, the terms ‘win–win relationship’ and ‘long-term strategic alliance’ are often used simultaneously, which again emphasizes the time issue.

Definition of a win–win situation In simple terms, a WWS can be described as a partnership that creates a synergistic SC in which the entire chain is more effective than the sum of its individual parts (Maloni and Benton, 1997: 420). These partnerships are often related to an increased FP as well as to a reduction in uncertainty (risk) for the involved partners. Giannoccaro and Pontrandolfo (2004: 132) give a similar definition and state that a win–win condition in SCM occurs if under the contract every SC partner obtains a higher profit than they would do without the contract. Otherwise the SC actor would not be prompted to adopt the contract.

The concept

Whereas the first definition does not narrow down the term exactly enough, the second definition is more precise and clearly suggests that a (financial) benefit should be a necessary outcome of a WWS. However, from both definitions one can infer that each ‘participation’ should derive some utility from a given partnership, collaboration or SC contract. But what does this mean exactly? Does a real WWS not imply that all parties involved benefit from the partnership? An answer to this question can be found by illustrating the so-called prisoner’s dilemma. Researchers such as Van der Veen and Venugopal (2000) show that firms maximize profits if mutual collaboration (collaboration hereby refers to predefined pricing agreements) and information sharing is intensified. Their WWS is solely driven by profit constraints and the model itself incorporates two scenarios: 1 In the superior ‘partnership scenario’ the total SC profits are maximized if a buyer is sharing the information about the demand function with its suppliers. 2 If both parties jointly agree on the final price levied to the end consumer, both parties may find themselves in a superior position compared to the less profitable ‘solitaire scenario’. Whether WWS may occur in practice depends largely on how the involved partners will allocate the benefits within the SC. So-called revenue-sharing contracts are therefore an appropriate approach to derive WWS in a longterm perspective (Giannoccaro and Pontrandolfo, 2004). Further drivers for WWS in SCM are joint investments related to technologies, such as IT-systems (Corbett and DeCroix, 2001; Vlachos, 2004) or open-book accounting practices (Kajüter and Kulmala, 2005; Rajagopal and Rajagopal, 2009). Additionally, there is a stream of literature that suggests individual firms may be willing to accept lower benefits than they enjoyed prior to the set-up of an SC partnership, if the overall SC performance can be enhanced (Lanier et al, 2010; Wetzel and Hofmann, 2019). This is in line with the growing opinion that the success of a single company in the long term is strongly dependent on a successful SC (from a network perspective). We can conclude: a ‘successful’ partnership between two independent SC members presupposes that both of them should benefit from the relationship and cooperation. Both parties should also give something of their own resources in order to receive the benefit. Both parties have, however, ­differing value scales based on their own corporate governance and interests for the partnership. These value scales predominate the perception of the net b ­ enefits

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achieved; and a positive net benefit is essential to both parties. But is this also true for SCF?

Win–win situations in supply chain finance: a question of perspective The academic contribution to specific win–win partnerships in SCF is rare and often limited to conceptual discussions. Generally, two different WWS can be distinguished in the context of SCF (Hofmann and Zumsteg, 2015): 1 Suppliers and buyers engage in SCF solutions because they are driven by the constant goal to optimize net working capital and would like to minimize risks in the financial flows. 2 The banks involved would like to enhance their relationship with their corporate client base. Their customers can access funds through innovative financing mechanisms, which simultaneously allow the financial ins­ titution to increase their share of wallet. Focusing on the first mentioned WWS, the performance of working capital management is often measured by the C2C cycle. An SCF solution from a win–win perspective should therefore have a positive impact on the C2C metric for both the supplier and the buyer. This notion, however, is in contrast to Randall and Farris II (2009) who stated that individual firms often have to accept an increase in their own C2C cycle if they aim to support partners in their network. Their analysis is based on case studies that targeted C2C time reductions for an SC without the support of an external party (FSP). The significance of ‘good practices’ in WCM and their link to company profitability has been proven both for firms domiciled in OECD countries (eg Deloof, 2003, for a set of Belgian firms) and non-OECD countries (eg Raheman and Nasr, 2007, for a set of Pakistani firms). From a similar viewpoint, Seifert (2010) establishes a connection between the win– win notion and trade credit strategies. In Collaborative Working Capital Management in Supply Networks, he outlines three potential trade credit strategies, namely ‘win–win’, ‘follow’ and ‘squeeze’. The win–win strategy is based on an RF solution. It is suggested this advanced financing technique be applied for strategically important business relationships. This enhances either capital access to SC partners or reduces outstanding days to eliminate unnecessary costs. Furthermore, Seifert’s empirical results indicate that both buyers and suppliers can lower their WC exposure on average by 13 per cent when implementing RF approaches.

The concept

But the benefits from SCF solutions are not limited to reducing net working capital; administrative advantages or risk benefits could also arise for the involved actors. A ‘true’ WWS in SCF goes beyond a simple adaption of payment terms; it should also take into account the efforts to manage the whole WC in a more efficient way. It is therefore also a question of ‘operational efficiency’ (eg platforms that allow electronic processing of additional relevant information that was previously exchanged physically). Electronic billing and payment systems such as EBPP (Electronic Bill Presentment and Payment Systems) promise lean, streamlined and mediaconsistent processes.

Electronic Bill Presentment and Payment Systems In simple terms, EBPP is when a corporation sends its bills over the internet and receives the payment from its customers electronically. The idea behind EBPP is to improve on the inefficiencies of paper-based billing that are based mainly on the media inconsistencies as well as duplication of work. This can greatly reduce the length of the billing and payment process. The second WWS mentioned focuses more closely on the financial institution and how it could become a winner in the SCF context. Here, there is a clear lack of academic work and empirical insights. The value added from LSPs (for the ‘physical flows’) and IT service providers (for the ‘information flow’) on the SC is well demonstrated, while the same effect from financial institutions on the supply chain is not. However, banks and other financial institutions should serve as providers of offerings and services around the ‘financial flow’ (compare Chapter 3). Therefore, one may draw from literature on relationship banking and suggest that a closer collaboration (both in scope and depth) may lead to a more appropriate solution for the bank but won’t necessarily do the same for the involved corporate client due to lock-in effects (Boot, 2000). Due to the closer and better collaboration, the bank may acquire more information, which could lead to a reduction in credit risk. This in turn may or may not be passed onto the end customer in the form of lower interest rates. An important source of WWS that financial institutions can generate refers to an ‘SC-specific interest rate arbitrage’. This does not refer to the bank’s funding margin but rather to a situation where either a supplier or buyer can get access to loan facilities at the same (or similar) rate as the betterrated buyer or supplier.

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We can state that the benefits of SCF are not only due to the possibility of reducing the net working capital but also the possibility of increasing operational efficiency. Furthermore, SCF may allow for a more appropriate solution for the bank due to the closer collaboration as well as the possibility of interest rate arbitrage in the SC.

Is there a case for triple- or even multiple-win situations in supply chain finance? The question arises, on the one hand, which role a financial institution would take on in the SC (as the third relevant actor) and, on the other, what the benefits for the parties involved could look like. Up to this point, it has been argued that financial institutions are external parties, outside the (supply chain) network between suppliers and customers. Shifting the focus to the network-level financing categories introduced above, we can state that the inside internal category does not necessarily need the support of a financial institution. Where external services are demanded, the scope of services offered by banks is rather limited and might just be a by-product of the underlying financial flows (eg currency hedging). The pure external financing category, however, relies heavily on financial institutions. It is difficult to establish a framework in which all parties involved ‘win’. Yet, while any sort of securitizations of trade receivables will grow in popularity, the commission-based income of financial institutions might also be positively affected.

Definition of ‘trade receivables’ and ‘trade receivables securitization’ In its simplest form, a trade receivables securitization consists of the sale of a company’s trade debts to a purchaser special purpose vehicle (SPV). The SPV funds the purchase either by an asset-backed commercial paper (ABCP) conduit, loans and/or the issuance of term debt. As trade receivables are short dated and the size of the pool to be financed fluctuates with the fortunes of the seller, revolving financings (such as ABCP conduit financing) tend to be preferred (Accounting Tools, 2020; Structured Finance in Brief, 2020).

The concept

The triple- or even multiple-win idea concerns, however, include the nucleus of the physical SC (vendors and buyers) as well as one or more financial institutions. Recurring transactions will allow the financial institutions to learn more about the creditworthiness of the SC members and may lead to more beneficial financing terms for all the parties in the long term. Within an SCF programme, a supplier might reduce its AR and be able to access funds earlier. The buyer can stretch its AP and the financial institution may extend the credit facilities to the network partners. Triple-win situations are likely to occur in this financing alternative if the bank owns the platform by itself. These banks aim to provide a holistic trade finance solution by capturing the full flow of information (physical and financial), which will allow them to get a better picture of the underlying (credit) risks (Camerinelli, 2009). In comparison to the firm internal financing alternative, the role of the financial institution is more extensive and can be clearly ­related to the specific financial flows since it provides, directly or in conjunction with, a tangible service (platform) provider through which the respective transactions are intermediated. Figure 4.11 illustrates the different constellations of the involved parties in a win–win, triple-win and even a multiple-win situation. A simple WWS involves only the suppliers and the buyers, whereas a triple-win situation in SCF also involves LSPs in the physical form and FSPs in the financial triplewin situation. In multiple-win situations in SCF, all of the parties mentioned above are brought together across the platform. Figure 4.12 illustrates the overall business rationale of SCF. It gives an indication of what is needed in order to derive a favourable situation for the suppliers, buyers, financial institutions and even the platform provider. The aggregated benefits derived by the involved parties have to exceed the costs that occur by engaging in a network financing alternative. Even though financial institutions or other external service providers may play a role in all of the alternatives, one can infer that SCF platform solutions have the greatest potential to create such multiple-win situations in SCF. As stated above, the main condition of the SCF rationale is that there must be a positive net benefit for the SC members included. This means that the sum of all of the SC network parties’ net benefits must be positive: ∑Net BenefitSC > 0 Obtaining a positive net benefit means that the benefits of the SC outweigh the overall costs. It needs to keep in mind that the benefit of SCF includes monetary benefits (eg lower COC) as well as qualitative benefits (eg stronger

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Figure 4.11  From win–win to multiple-win in supply chain finance Win-win-situation in supply chain finance (bilateral) Supplier(s)

e.g. dynamic discounting

Win-win-situation characteristics: Involvement of only suppliers and buyers

Buyer(s) Direct interaction of suppliers with buyers

Triple-win-situation in supply chain finance a) Physical form

Triple-win-situation characteristics: Involvement of only suppliers, buyers and LSPs

LSPs

Supplier(s)

e.g. inventory financing

Buyer(s)

b) Financial form Supplier(s)

Interaction of suppliers with LSPs and of LSPs with buyers

Triple-win-situation characteristics: e.g. reverse factoring

Buyer(s)

Involvement of only suppliers, buyers and FSPs Interaction of buyers with FSPs and FSPs with suppliers

FSPs

Multiple-win-situation in supply chain finance

Multiple-win-situation characteristics: Involvement of suppliers, buyers, LSPs and FSPs

LSPs

Coordination over a platform Supplier(s)

Platform

Buyer(s)

FSPs

relationships with SC members). The same logic applies to the cost side of the equation, which comprises ‘intangible’ expenditures (eg coordination activities or ‘sunk costs’) and ‘tangible’ costs (eg implementation payments or ‘fees’). The qualitative benefits and costs perceived by each party involved are driven by their individual values and interests and can therefore vary among parties of the supply chain (Figure 4.13). In addition to the sum of the net benefits needing to be positive, the net benefit for each party involved must also be positive. Without this additional condition, a party with a negative net benefit (ie a net loss) would not

The concept

Figure 4.12  T owards an inter-organizational business rationale of supply chain finance Logistics service provider Physical area

BenefitsLSP – CostsLSP

BenefitsS+B+FI+LSP ≥ CostsS+B+FI+LSP Supplier

Buyer

BenefitsS – CostsS

BenefitsB – CostsB Financial area

Platform provider

Financial service provider BenefitsFI – CostsFI

Market

Other banks

Credit insurance

Figure 4.13  Classical net benefit scheme of a single company Values & interests

CQ BQ

CM Qualitative benefit and cost elements are largely influenced by the values and interests of the company

BM

Monetary benefits

Qualitative costs

Qualitative benefits

Monetary costs

Net benefit

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The current practice

have any incentive to participate in the SC. This additional condition can be fulfilled if they receive monetary compensation from the other parties of the SC. With a large enough monetary compensation, a win–loss situation can be turned into a WWS, as illustrated in Figure 4.14. It is also possible that all the parties of the SC have a positive net benefit from the SC, which would mean that no monetary compensation is necessary. Figure 4.14  W  in–lose situation before and win–win situation after compensation in supply chain finance Supply chain company A (with positive net benefit out of the SCF programme)

Win-lose-situation

Supply chain company B (with negative net benefit out of the SCF programme)

CQ BQ CM

CQ Net loss

BQ

BM CM

Net benefit

Monetary costs

Qualitative costs

Qualitative benefits

Monetary benefits

BM

Win-win-situation due to compensation

CQ BQ CM

CQ

Compensation

BM

BQ

BM

Net benefit

Monetary costs

Qualitative costs

Qualitative benefits

CM Monetary benefits

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The concept

Summary What have we learnt so far? SCF has to be understood as the exertion of three distinct levers: SC collaboration, SC technology and SC financing. First, a successful use of SCF requires profound collaboration between all relevant parties in which all parties pay careful attention to the impact their own decisions have on others in the SC. In order to be able to holistically see the financial flows in the SC, third-party service providers, like FSPs, LSPs or SCF platforms, should be included in SCF initiatives. Second, the collaborative information sharing and the provisioning of funding should be powered by a technology solution. Such ‘digital’ SCF solutions often have to be individualized depending on regional and ­ ­industry-specific requirements and must be compatible with existing business processes in the SC. They have to be compatible with all SC partners and in situations when companies have more than one bank relationship. Moreover, SCF technologies nowadays are able to fully automate all major processes in the financial SC. These solutions enhance the visibility into financial streams within the SC and, based on cash flow forecasting and automated decision trigger systems, enable access to the SC financing mentioned above. Finally, specific IT platforms promise to ensure that the physical and the financial flow of information are interconnected and decisions in the former are automatically inserted into the latter and vice versa. Third, SCF includes the financial and funding aspect. Financing can either be provided by a cash-rich corporate in the SC itself or by an external financial institution. It can be available during all stages of a transaction within the SC, ie starting with the sourcing of raw materials through to the final export of the goods. Moreover, it is based on the leverage of the best credit ranking in the supply chain, reducing financing costs for less creditworthy SC parties. Different forms of financing, which are all based on OA trade service, can be used. These include factoring or reverse factoring of off-­balance-sheet inventory financing, among others. In addition, SCs can benefit by extending payment terms or making use of early payment discounting. SC collaboration, technology and financing used together can significantly improve financial flows – especially the net WC required as well as the operational efficiency to ‘manage’ these CA – and thus the financial health and stability of SCs. SCF thus increases the effectiveness (less tied-up net WC) and efficiency (lean(er) process and less ‘waste’ of operational resources) in this network of separate but integrated companies, while reducing operating, financial and compliance risks (Figure 4.15). As highlighted,

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Figure 4.15  General goals of SCF programmes

Less net working capital (bounded capital)

Lean process and less waste of operational resources

Supply chain finance

Reduced risks in the supply chain

SCF programmes reduce operating costs by lowering the costs of goods and lowering COC by leveraging the highest credit ranking in the supply chain. Additionally, by shortening the C2C cycle time for the entire supply chain, it enables all parties involved to release hidden liquidity and to collaboratively optimize working capital.

References Accounting Tools [accessed 22 January 2020] Trade receivables [Online] www. accountingtools.com/ (archived at https://perma.cc/GZR8-Y8DF) Battiston, S, Delli Gatti, D, Gallegatti, M, Greenwald, B and Stiglitz, JE (2007) Credit chains and bankruptcy propagation in production networks, Journal of Economic Dynamics and Control, 31 (6), pp 2061–84 Boot, A (2000) Relationship banking: What do we know? Journal of Financial Intermediation, 9, pp 7–25 Camerinelli, E (2009) Measuring the Value of the Supply Chain, Gower, Aldershot Casterman, A (2012) Modernising global trade finance practices, Journal of Payments Strategy & Systems, 6 (3), pp 225–31 Chakuu, S, Masi, D and Godsell, J (2019) Exploring the relationship between mechanisms, actors and instruments in supply chain finance: A systematic literature review, International Journal of Production Economics, 216, pp 35–53

The concept Chapman, RL, Soosay, C and Kandampully, J (2003) Innovation in logistic services and the new business model, International Journal of Physical Distribution & Logistics Management, 33, pp 630–50 Churchill, N and Mullins, J (2001) How fast can your company afford to grow? Harvard Business Review, 79 (5), pp 135–42 Corbett, C and DeCroix, G (2001) Shared savings contracts for indirect materials in supply chains: Channel profits and environmental impacts, Management Science, 47 (7), pp 881–93 Dahrendorf, S and Philipps, F (2008) Collaborative supplier financing: A ‘triple win case study’, Association des Trésoriers d’Entreprise à Luxembourg Dello Iacono, U, Reindorp, M and Dellaert, N (2015) Market adoption of reverse factoring, International Journal of Physical Distribution & Logistics Management, 45 (3), pp 286–308 Deloof, M (2003) Does working capital management affect profitability of Belgian firms? Journal of Business Finance & Accounting, 30, pp 573–87 Euro Banking Association (2014) [accessed 22 January 2020] EBA Market Guide on Supply Chain Finance, version 2.0 [Online] www.abe-eba.eu/media/azure/ production/1348/eba-market-guide-on-supply-chain-finance-version-20.pdf (archived at https://perma.cc/82TW-ATTE) Flynn, BB, Huo, B and Zhao, X (2010) The impact of supply chain integration on performance: A contingency and configuration approach, Journal of Operations Management, 28 (1), pp 58–71 Garcia-Teruel, P and Martínez-Solano, P (2007) Effects of working capital management on SME profitability, International Journal of Managerial Finance, 3 (2), pp 164–77 Giannoccaro, I and Pontrandolfo, P (2004) Supply chain coordination by revenue sharing contracts, International Journal of Production Economics, 89, pp 131–39 Greensill, L (2010) Cash and liquidity management: Free your suppliers, The Treasurer, 4, pp 22–24 GSCF [accessed 22 January 2020] Website, www.gscf.com/ (archived at https:// perma.cc/HZB5-XHY6) GSCF Forum [accessed 22 January 2020] Standard definitions for techniques of supply chain finance [Online] http://supplychainfinanceforum.org/ICCStandard-Definitions-for-Techniques-of-Supply-Chain-Finance-Global-SCFForum-2016.pdf (archived at https://perma.cc/AH2N-L5UY) Hofmann, E (2005) Supply chain finance: Some conceptual insights, in Logistik Management: Innovative Logistikkonzepte, ed R Lasch and C Janker, pp 203–14, Verlag, Wiesbaden Hofmann, E (2009) Inventory financing in supply chains: A logistics service provider approach, International Journal of Physical Distribution & Logistics Management, 39 (9), pp 716–40 Hofmann, E and Belin, O (2011) Supply Chain Finance Solutions: Relevance – propositions – market value, Springer Verlag, Berlin/Heidelberg

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The current practice Hofmann, E and Johnson, M (2016) Supply chain finance: Some conceptual thoughts reloaded, International Journal of Physical Distribution & Logistics Management, 46 (4), pp 1–8 Hofmann, E and Kotzab, H (2010) A supply chain-oriented approach of working capital management, Journal of Business Logistics, 31 (2), pp 305–30 Hofmann, E, and Zumsteg, S (2015) Win-win and no-win situations in supply chain finance: The case of accounts receivable programs, Supply Chain Forum: An International Journal, 16 (3), pp 30–50 Hurtrez, N and Salvadori, MG (2010) Supply Chain Finance: From myth to reality, Working paper, McKinsey on Payments, McKinsey, London Kajüter, P and Kulmala, H (2005) Open-book accounting in networks: Potential achievements and reasons for failure, Management Accounting Research, 16, pp 179–204 Kristofik, P, Kok, J and de Vries, S (2012) Financial supply chain management: Challenges and obstacles, ACRN Journal of Entrepreneurship Perspectives, 1 (2), pp 132–43 Lanier Jr, D, Wempe, W and Zacharia, Z (2010) Concentrated supply chain membership and financial performance: Chain- and firm-level perspectives, Journal of Operations Management, 28, pp 1–16 Lin, Q, Su, X and Peng, Y (2018) Supply chain coordination in confirming warehouse financing, Computers & Industrial Engineering, 118, pp 104–11 Maloni, M and Benton, W (1997) Supply chain partnerships: Opportunities for operations research, European Journal of Operational Research, 101, pp 419–29 Martin, J and Hofmann, E (2017) Involving financial service providers in supply chain finance practices: Company needs and service requirements, Journal of Applied Accounting Research, 18 (1), pp. 42–62 Pellegrino, R, Costantino, N and Tauro, D (2019) Supply chain finance: A supply chain-oriented perspective to mitigate commodity risk and pricing volatility, Journal of Purchasing and Supply Management, 25 (2), pp 118–33 Pfohl, H-C and Gomm, M (2009) Supply chain finance: Optimizing financial flows in supply chains, Logistics Research, 1 (3/4), pp 149–61 Raheman, A and Nasr, M (2007) Working capital management and profitability: Case of Pakistani firms, International Review of Business Research Papers, 3 (1), pp 279–300 Rajagopal and Rajagopal, A (2009) Buyer–supplier relationship and operational dynamics, Journal of the Operational Research Society, 60, pp 313–20 Randall, W and Farris II, M (2009) Supply chain financing: Using cash-to-cash variables to strengthen the supply chain, International Journal of Physical Distribution and Logistics Management, 29 (8), pp 669–89 RBS [accessed 23 January 2020] GSCF and Royal Bank of Scotland sign a Service Agreement [Online] www.gscf.com/wp-content/uploads/GSCF_News_ August_2011.pdf (archived at https://perma.cc/B6P5-7UZW)

The concept Seifert, D (2010) Collaborative Working Capital Management in Supply Networks, Dissertation, École Polytechnique Fédérale de Lausanne Silvestro, R and Lustrato, P (2014) Integrating financial and physical supply chains: The role of banks in enabling supply chain integration, International Journal of Operations & Production Management, 34 (3), pp 298–324 Structured Finance in Brief [accessed 22 January 2020] Trade receivables ­securitisation [Online] www.structuredfinanceinbrief.com/ (archived at https:// perma.cc/ZWJ2-WK6Z) Towill, DR (1997) The seamless supply chain: The predator’s strategic advantage, International Journal of Technology Management, Special Issue on Strategic Cost Management, 13 (1), pp 37–56 Tsai, C-Y (2008) On supply chain cash flow risks, Decision Support Systems, 44 (4), pp 1031–42 Unilever (2005) Exploring the links between international business and poverty reduction: A case study of Unilever in Indonesia, Oxfam GB/Novib Oxfam NL/ Unilever, Oxford/The Hague/London Van der Veen, J and Venugopal, V (2000) Win-win situations in supply chain partnerships: A tutorial, OR Insight, 13 (3), pp 22–28 Vlachos, IP (2004) Critical success factors of business to business (B2B) e-commerce solutions to supply chain management, in Supply Chain and Finance, ed P Pardalos, A Migdalas and G Baourakis, pp 161–75, World Scientific Publishing, London Wetzel, P and Hofmann, E (2019) Supply chain finance, financial constraints and corporate performance: An explorative network analysis and future research agenda, International Journal of Production Economics, 216, pp 364–83 Wuttke, DA, Rosenzweig, ED and Heese, HS (2019) An empirical analysis of supply chain finance adoption, Journal of Operations Management, 65 (3), pp 242–61 Yan, N and Sun, B (2013) Coordinating loan strategies for supply chain financing with limited credit, Operations Research Spectrum, 35 (4), pp 1039–58 Zhao, L and Huchzermeier, A (2018) Supply Chain Finance: Integrating operations and finance in global supply chains, Springer, Berlin

Study questions Question 1 Read the case study ‘The power of securitization in supply chain finance’ carefully and answer the study questions at the end.

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C A S E S T U DY  The power of securitization in supply chain finance An international leading food and beverage company (‘Buyer’) operates one of the largest worldwide SCF programmes. In order to provide sufficient liquidity for its suppliers’ financing demand the Buyer has had to enter into and integrate eight single-bank SCF solutions over the past 10 years. Each bank programme requires an individual set-up with regard to technical implementation, process reporting and legal structure. Hence, running multiple single-bank SCF solutions in parallel has become highly resource-consuming and difficult to manage (Figure 4.16). Figure 4.16  Process overview of SCF with CRX’s Multi Investor APF 2

1

Supplier

4

Supply & invoice

Buyer

3

Request early payment

Invoice upload

www.crxmarkets.com Portal

7

True sale of invoices

5

Bundling & auction

8

Payment of due invoices

SPV

9

Redemption of notes

6

Investors

Invoice approval

Issuing of notes

The concept

Following an extensive RfP process the Buyer has selected CRX Markets’ Multi Investor APF solution to replace the individual bank SCF programmes by a single fully integrated platform. The securitization process Figure 4.17 illustrates that only a few changes are required compared to bank SCF programmes to achieve a structure with multiple investors providing funding to the same SCF programme. Figure 4.17  Trade receivables securitization on the timeline (schematically)

1 T-2 Supplier

S

Buyer

R

CRS/SPV

2

3 T-1

4

5

T

T+1

6

7

T+2

8

9

M-1

M

S/R S R

S A

A

A

R/S R/S

R

S/R

Investor S = send; R = receive; A = action;

S R

T = trade day; M = maturity day

1. Invoice receipt

At T-2 the buyer receives an invoice from the supplier.

2. Upload

Until 15:00 CET at T -1 the buyer uploads approved invoice.

3. Bundling & registration

After 15:00 CET at T -1 CRX bundles invoices based on given bundling criteria. CRX sends registration criteria to WM Datenservice.

4. Auction

Auction takes place at 09:30 at T (T stands for trade day).

5. Origination of note

CRX sends global note and terms and conditions of the note to Clearstream bank for origination of the note.

6. Settlement of note

Based on German settlement standards the delivery (of securities) vs. payment (of cash) transaction occurs 2 business days after the trade (T+2).

7. Supplier payment

Payments to the suppliers are triggered by a successful securities settlement. The same day the settlement occurs (T+2) the supplier will be credited by the SPV. As long as the supplier has not received a payment the receivables have not been transferred to the SPV (conditional assignment of receivables).

8. Invoice payment

The buyer needs to pay the invoice until 13:00 CET latest in order to enable a timely redemption of the note.

The investors are paid by the paying agent (CACEIS), by an 9. Redemption of note fully automatized redemption process that is managed by the CSD (i.e. Clearstream Banking AG).

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Questions 1 What is the difference between a multi-funder model, a funder-pool model

and a securitization-based model of SCF as proposed by CRX Markets? 2 Elaborate the multiple-win situation of the securitization-based SCF model.

Are there only winners? 3 Is the principle of securitization as offered by CRX Markets transferable to

other SCF approaches, like advance factoring or inventory financing? Discuss what adjustments might be necessary for such an expansion.

Question 2 Modern SCF solutions are digitized, sector-specific and are introduced based on specific company characteristics. Discuss within your team, in particular, the following issues in order to ensure a smooth process management. Look from the perspective of a large corporate introducing a reverse factoring programme. 1 Do the suppliers have to carry out payment collection for the SCF finance provider? 2 Is the SCF finance provider obliged to provide financing if certain defined conditions are met or not? 3 Which ERP process migrations must be carried out? 4 Can the original due date be changed to produce a consolidated due date for all invoices in a certain period? 5 Can the payment terms or discount limits be changed by the SCF finance provider? 6 When does the purchasing company confirm the supplier invoices? 7 How much time does the SCF finance provider have to settle the supplier invoice (after receipt of the request from the supplier)? 8 By when does the purchasing company have to repay the invoices to the SCF finance provider? 9 How many currencies are available for the financing?

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05

Who is involved in supply chain finance?

O U TCO M E S The intended outcomes of this chapter are to: ●●

explore the functional linkages within a typical user organization;

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identify the different types of organization or party involved in SCF;

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describe their roles, capabilities and motivations.

By the end of this chapter you should be able to: ●●

list those organizations and functions relevant to your SCF situation;

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understand their likely positions and potential motivations;

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develop an appropriate plan to engage with each of them, possibly in the form of a RACI (Responsible Accountable Consulted Informed) diagram.

Activities We recommend the following: Explore the organizations that are already connected to your organization, or one you know, and check if they are in a position to provide the appropriate service and support for SCF.

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Introduction The aim of this chapter is to identify the different types of organizations and companies involved in SCF and to describe their roles, capabilities and motivations that position them to collaborate or compete – an ‘ecosystem’. As SCF develops new opportunities arise. New parties enter the market and existing parties merge, are acquired or leave the industry. For example, investors experiencing low interest rates in traditional finance markets are increasingly attracted by the relative security and higher interest rates available from funds that finance SCF programmes. Given the multifunctional nature of SCF, we will also explore the components within a typical ‘user’ organization that are required to propose, approve, implement and operate SCF. The objective is to provide a framework or checklist so that readers can engage with the appropriate organizations, and the functions within them, that fit with their situation and their requirements. Who are these ‘stakeholders’? What do they do and why?

Agenda This chapter is divided into sections, each covering a type of organization or company often involved in SCF. After a general introduction, there are nine sections, as depicted in Figure 5.1: ●●

users of SCF;

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logistics service providers (LSPs);

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financial service providers (FSPs);

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service or systems providers – SCF platforms;

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consultants;

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advisers;

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industry and professional associations and consortia;

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governments;

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academia.

As has been shown in earlier chapters, SCF is not a wholly new concept; it is more the coming together of a number of traditional financing requirements, the increasing use of electronic exchange of data between organizations and the emergence of alternative sources of finance. Consequently, there are many existing categories of organization or party that have ­experiences, products

The ecosystem

Figure 5.1  Supply chain finance arena Ecosystem ‘The supply chain finance arena’

Corporate and Public Sector users ‘The core’

Subsuppliers

Supplier

Buyer

(End-) Consumers

Demand side Logistics service providers (LSPs)

Service or system providers (SCF platforms)

Financial service providers (FSPs)

Offer side Consultants

Advisers

Industry and professional associations

Affiliated services Governments

Academia Other issues

and, most importantly, opinions in the field. A downside of this divergence of background is that there are existing models and languages that are understood by some but that may confuse or complicate the opportunities for ­others. As an example, the pros and cons of letters of credit (LC) versus bank payment obligations (BPO) may be clear and understandable to someone with a trade finance background, but LC and BPO are unlikely to be common phrases in use by an SME discussing payment terms with suppliers and customers who are just ‘round the corner’. (For a discussion on LC and BPO, see Chapter 4.) Yet at a more general level, the availability of finance or lending based on the commitment to the supply of goods or services associated with agreed terms of payment is a concept understood by all traders. For some common definitions, please refer to standard definitions for techniques of SCF published by the Global Supply Chain Finance Forum (GSCFF, 2016).

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Before describing the different organizations, we will outline the overall shape of the SCF ecosystem and how the organizations and parties fit together. Ecosystems are ‘groups of firms that produce products or services that together comprise a coherent solution. Successful ecosystems require firms to balance competition and cooperation’ (Hannah and Eisenhardt, 2018). Moving from two to four parties, we start with a buyer and a seller, being customer and supplier. The physical transaction (flow of goods and services) and the information exchange will take place directly between the two supply chain parties. Except for direct payment by cash, each party usually has to involve a bank or other FSP to pay out and receive the payment respectively (see Figure 5.2). Figure 5.2  Four-party model Seller’s bank

Seller

Financial flow

Information flow Flow of goods and services

Buyer’s bank

Buyer

However, the buyer and the supplier may want different payment terms from each other – the buyer may want to spread the cost over time; the seller may want rapid payment, or even pre-payment, to cover immediate costs. Hence, sources of finance have developed to fund this gap, often provided by the bank operating the transaction for one of the two parties but sometimes by a completely different party. Most academic studies into SCF include two additional parties to the typical buyer–supplier bilateral exchange, introducing financial providers and transaction or platform providers. However, there are more parties involved in SCF in either direct or indirect roles. Camerinelli (2010) defined the constituent parties in a broader context and, in addition to the four operational players, the following parties are identified: consultants, logistics service providers, credit card providers, associations and governments. By 2019, consortia had appeared to help tackle the growing challenge for suppliers of having to integrate with the many platforms that their different customers use. Marco Polo Finance and we.trade are examples that we explore later in this chapter.

The ecosystem

In many SCF approaches the invoice is a critical element – the data, timing and legal standing of the invoice are often the triggers for how a trade is financed, as well as for the core purpose of settling the trade. Hence standardization of the invoice becomes a requirement of widespread adoption of  SCF models and many organizations have an interest in setting the ­standard – these include banks, payment providers, software companies as well as new entrants providing e-invoicing services, governments and trade bodies. As the value of the information contained on the invoice is recognized, it becomes even more important and we see a multitude of ‘rich ­invoice data’ initiatives. As examples, the invoice can be used to forecast future cash flows or foreign exchange transactions. So, we have a multi-party, multi-industry interest in SCF with academics increasingly researching and publishing in this arena, providing independent and analytical content to the rationale and practices. As with many business activities, this breadth of involvement also occurs within organizations, not just across organizations, with many corporate functions involved from, for example, Treasury, Finance, Procurement and IT. For larger organizations, there may be specialist functional areas, while for smaller companies the requirement for such functional understanding in order to benefit from SCF can be a real limiting factor and a barrier to adoption.

Users of SCF The primary ‘users’ of SCF are the sellers and buyers of goods and services who may apply SCF as part of a transaction with their customers or suppliers, respectively. Included in the agreement are the financial arrangements for the buyer to pay the supplier. Depending on the industry, local custom and the relative negotiating power of the buyer and supplier, these arrangements can vary considerably. In practice, the efficiency of both parties’ processes and their respective motivations have a significant effect on when suppliers are actually paid. One sign of a conscientious and committed buyer is that they measure, monitor and take action on how long they actually take to pay their ­suppliers. The following is an example from the UK’s Network Rail (2020): Commit to paying suppliers in compliance with government targets: 80% within 5 days; 100% within 28 days. [performance] To be published by ‘Network Rail Shared Services’. Each 4-week period commencing December 2019.

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We will now look at the functions and departments in an organization that are impacted by an SCF solution: Boards, Sales, Procurement (or Purchasing), Manufacturing and Service Operations, Logistics, Corporate Finance, Treasury, Legal and IT.

Boards CEOs and their boards are primarily concerned with business strategy, corporate leadership, financial choices and the short- and long-term economic return achieved from the business. A key component of a business’s ongoing investment is the amount of working capital (WC) it has, which includes the effect of supplier payments and customer financing (see Chapter 2): Over the last decade, a virtual who’s who of industry leaders have generated billions of dollars in operating cash flow by implemented SCF… with several companies generating over $1 Billion in incremental cash flow each, including companies such as AT&T, Lowe’s, P&G, Unilever, Nestle, Honeywell, Volvo, Caterpillar, Whirlpool, Electrolux, DuPont. (Kramer, 2017)

In addition, companies taking a strategic approach to putting in place and developing a competitive supply chain increasingly focus on the financing of the whole supply chain and the risk, particularly the financial risk, of the participants. One study identified the common features of those most interested in SCF, Wang (2017): ●●

Industries with higher working capital needs and long payment terms;

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Industries with large and complex supply chains;

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Companies who want to improve working capital;

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Companies who have long-term relationships with suppliers, specifically: Retail, Pharmacy, Manufacturing, Telecoms and Automotive.

So, SCF should be a board level topic impacting both the level of funding the business needs internally as well as its investment in a competitive supply chain.

Sales SCF is often considered as an opportunity in the supply base, but looking at customers’ financing needs has long been an opportunity – providing supplier finance is one way of facilitating sales, particularly of high cost or

The ecosystem

capital-intensive items. A recent development, built on the increasing ­availability of remote monitoring and management of equipment, is the selling of ‘uptime’ or ‘hours’ by manufacturers such as Rolls Royce and Caterpillar. This has the effect of stretching the payment for a product over its service life (Ryals and Rackham, 2012). In business-to-business transactions, one company’s sales is another company’s procurement, so these points should mirror those for procurement below and customer financing should be included in financing the e­ nd-to-end supply chain.

Procurement This functional group identifies requirements to buy goods or services, plans and implements supplier arrangements, and monitors and revises them as necessary. Typically, different categories of external spend are managed separately depending on their scale and importance to the organization. Also, typically, the scale and importance of a supplier determines how much focus is put into negotiating and agreeing specific deals. For instance, a commodity supplier might be paid on industry standard terms while another may have negotiated different terms as part of an overall specification-quantityprice agreement. Hence Procurement (or Purchasing) has a key role incorporating relevant terms of payment into their negotiations and using them as a lever to get the overall best deal, in total cost of ownership (TCO) terms. Peter Smith, Spend Matters Network (2014) says: Payment is the final stage in the transactional, purchase to pay cycle, and logically if anyone should take responsibility for that entire process, it should be procurement and the CPO. Payment efficiency and effectiveness depends so much on the earlier stages of the process, from supplier adoption to requisitioning and ordering.

Manufacturing and Service Operations Manufacturing, or Operations in services organizations, is a very general term but usually covers planning and management of production and the key linkages within a business such as long-term capacity planning, Sales and Operations Planning (S&OP), scheduling and Material Resource Planning (MRP). While not directly influenced by financing up or down the supply chain, these activities often provide key triggers in the process such

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as Purchase Orders (POs) and Goods Received Notes (GRNs) and raise ­supply issues that might affect payment such as late or incorrect deliveries. In addition to these process linkages, performance can be significantly impacted by the motivations and incentives on suppliers to deliver timely and quality goods and services and to respond to changing circumstances. Operations would like the suppliers to consider their company as the supplier’s ‘best’ customer and so deliver way beyond the contracted levels of service. For suppliers to classify a buyer as one deserving extra efforts, their experience on how and when they are paid is one critical component. At the other end of the scale, delay and uncertainty over when a supplier will receive its cash can lead to it experiencing extra banking costs, delayed deliveries and ultimately to a business failure, which becomes a critical operational risk.

Logistics Logistics typically manage inbound and outbound transport, receiving and dispatching, physical handling and warehousing and shipping, including management of customs and duty payments. Their involvement in SCF is similar to that described above for Service Operations, but the connection is often more direct and linked to steps in the SCF process. There is also a key linkage to externally provided logistics and transportation services, often from Logistics Service Providers (LSPs), who are described below.

Corporate Finance The Corporate Finance function covers a wide range of activities from tran­ saction accounting to financial strategy, management and reporting and so has a major role in deciding the appropriate SCF strategy and then operating the resulting processes. In most organizations, the responsibility of the end-to-end Purchase to Pay (P2P) process is divided between Procurement and Finance, in broad terms the Purchasing and Paying, or AP, respectively. Some innovative companies streamline the operations by having a single coownership for the basic transactional P2P flow while, at a higher level, Procurement focuses on putting in place supplier agreements and monitoring supplier performance, and Corporate Finance focuses on putting in place the financial strategies and processes and monitoring their performance. Similarly, the Order to Cash (O2C) process links the Sales and AR activities and deals with credit/supplier risk assessments/know your customer (KYC) and opportunities to finance supplier sales.

The ecosystem

In the SCF strategy phases, Corporate Finance is concerned with the link to the overall finance strategy of the organization, specifically its long-term debt, working capital and cash plans. The main operational decisions Corporate Finance has to make are the implementation of the appropriate financial controls through the new processes, the accounting and internal reporting of the transactions, and the changed roles and responsibilities for approvals and payments inherent in any SCF model. Within most large organizations, separate groups look after Accounts Payable (AP) and Accounts Receivable (AR): ●●

●●

The typical steps in an AP function are purchase order – receipt – invoice – match – approve – pay. Depending on the SCF solution chosen, this process and the supporting tools and technologies will change. A number of organizations have stated that having an automated, stable and efficient P2P process is critical to effective SCF, otherwise the level of process breakdown, rework and retrospective approvals mitigates the benefits. The typical steps in an AR function are invoice – factor or discount – payment. Similarly to AP, there will be changes to the AR processes, data and reporting.

The accounting treatment of SCF is discussed below in the section on Accountants; this is a key issue for the Finance function and, particularly, for the CFO.

Treasury In larger organizations, there is a dedicated Treasury team responsible for cash management, ensuring the business has sufficient access to short- and long-term cash and that the return from any cash balances is maximized. Treasury also manages the ‘pooling’ of cash across subsidiaries and geographies to net out the organization’s overall external funding requirements. There are two distinct approaches to financing SCF programmes: selffunding or external funding. In the first, the business commits part of its available cash to finance suppliers (or customers) with non-standard terms for some form of discount, fee or other benefit. Clearly this impacts the overall cash requirements of the business, it removes cash from the immediately available cash pool, and it also changes the credit or risk position. This approach is often applied to dynamic discounting but is used in other SCF models. For SCF programmes, this can be seen as an ‘in-house’ bank.

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In the second approach, an FSP such as a bank or an SCF solution provider funds the supplier (or customer) often in a linked way by bringing forward any payments to the business or postponing payments from the business. While this may positively benefit the cash balances available to the business, it does also impact the overall business credit and risk profile. Treasury leaders have stated in interview that they have to be actively engaged to manage the overall relationship with all the business’s providers of financial liquidity. An additional challenge when using an external finance provider is to ensure the arrangements continue to be accounted for as working capital, either trade debtors or trade creditors, payables or receivables depending on your lang­ uage, and that they are not reclassified as financial debt or bank lending. As an example of treasurers’ interest in SCF, an agenda item for the Association of Corporate Treasurer (ACT)’s Working Capital Conference 2018 was ‘Suppliers, buyers and the banks: bridging the gap through supply chain finance’ (ACT, 2018).

Legal For most SCF, changes are required to establish the correct contract arrangements for payment, ownership of invoices and responsibilities for any errors and performance resolution. Although standard terms are available from best practice and solution providers, there are often organization specifics that require working through. More difficult is where non-standard terms of payment have been agreed as part of overall supply agreements leading to the challenge of reopening and renegotiating complete supply agreements with, possibly, only marginal benefit to both parties from SCF.

IT SCF usually requires a more complex transaction flow, particularly as an additional party, often a new FSP or SCF provider, is now integrated into the process. Electronic communication and exchange of information, as opposed to paper-based transactions, is probably the only way to deal with this extra complexity and, in practice, most businesses are already linking with their customers and suppliers directly, or by an API or through some form of hub or interface service. Therefore, plans have to be put in place to ensure the appropriate information is available, formatted and transmitted in a secure and timely fashion to support the new processes.

The ecosystem

As mentioned elsewhere, the importance of measuring and monitoring performance of the new processes is key to making sure they are delivering benefits and then making changes if they are not. This may require changes and additions to data collection and reporting.

Size as a determining factor In this section on users, it is worth exploring the particular issue of scale, or size, and how this changes the opportunities and challenges of SCF. SME often struggle to find finance and especially affordable finance (see Chapter 4), so the opportunities to improve their cash positions through earlier payments from customers, inventory finance and other SCF approaches should be substantial. However, many SMEs are not equipped to analyse the costs and benefits from SCF programmes versus traditional sources of cash and so do not seek them out. More reactively, SMEs do not have the functional knowledge or expertise to decide on and implement a specific SCF programme offered by a key customer, who is often larger and better resourced with appropriate specialist skills. Thus, any approach to an SME or group of SMEs needs to be appropriate to their circumstances and particularly in communication, engagement, agreement and operational linkages. In addition to these barriers, a number of research projects have shown that some SMEs are well funded or are less concerned about payment terms. This is particularly true in certain industries, for example aerospace, where long product development cycles require long-term financial commitment to capital. In such situations, the most appropriate SCF model may be tooling finance or some form of longer-term supply commitment that backs the SME’s own financing efforts. Multinational companies often trade in developing or emerging economies where local finance for SMEs is even more difficult and expensive than smaller companies experience in, say, Europe or North America. In these situations, providing finance can be the best route to invest and grow suppliers. This is explored in more detail in Chapter 8.

Summary on users So, to summarize this section, there can be many internal stakeholders within the user organization. As an example of the cross-functional requirements, the following is taken from Koninklijke Philips N.V.:

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The current practice [they] should be managed centrally by Procurement, to have a close access to our supply base, but fully supported by experienced local teams… in full alignment with related functions, where: – Procurement nominates suppliers, leads negotiations and manages supplier risk; – Treasury provides the selection of partnering banks and solutions as well as processes payments; – Finance operations ensure short invoice processing time via AP BPO. Supplier financing should be maintained through best-in-class IT solutions and lean processes and with full adherence to international accounting and legal requirements. (Brabander and Wandachowicz-Krason, 2014) (Note: customer or inventory SCF would have different roles and responsibilities.)

A number of approaches have been developed for who ‘owns’ the SCF programme. Experience from a number of organizations is that the finance area, either Treasury or Corporate Finance itself, is often the responsible group (see Figure 5.3). However, overly finance-driven initiatives, particularly those focused on working capital improvements, can disturb effective supplier relationships. Guidance on who should own the programme within the focal or initiating company is covered in the following chapter. Figure 5.3  SCF functional ownership

Treasury 50% Finance 40% Procurement 10%

SOURCE  Extra (2011)

Logistics service providers LSPs often offer and deliver a range of services for their customers beyond basic transport provision. Third-party logistics (3PL) providers are so called because they link the two other parties of a trade together, ie they organize

The ecosystem

the transport from the seller to the buyer using a mix of transport modes, depending on the 3PL’s own capabilities and their partner networks. The phrase Fourth Party Logistics (4PL) has been coined to describe LSPs that go beyond that, generally providing a service overlay integrating some or all of planning, warehousing, financing, insurance, systems, customs management and subcontracting other transport providers to bring a more complete solution. In some cases, they go even further and are part of the pre- or postproduction process, sometimes called ‘contract logistics’: eg for computers this could include final consolidation of items and configuration and set-up of software. UPS, DHL, Damco and K&N are examples. Due to their activities and systems, LSPs have visibility of the goods through the supply chain and hence have data associated with their status (location, ownership, customs status) that impacts the cost and risk of financing this inventory. This specific and real-time data can reduce the financial risk to one or more parties and so lower the cost of funding. The general scope for LSPs’ financing of inventory is shown in Figure 5.4 and is explored in detail in Chapter 6. Some LSPs offer inventory financing directly; in other situations they provide the transactional data to other processes that drive SCF triggers, such as departure or arrival of goods at certain locations. The following example is taken from the UPS website: Nobody understands transportation and logistics like UPS. And while you’ve probably never thought of a UPS company for financing and insurance services, our global supply chain expertise uniquely positions us to help protect companies from risk, and leverage cash in their supply chains. Insurance companies and banks can’t say that. (UPS, 2020)

Figure 5.4  Possible inventory financing opportunities for LSPs Supplier

Factory

Warehouse Transport eg sea or air

Warehouse

Warehouse Transport eg road or rail

Warehouse

Inventory financing opportunity

Buyer

Factory

End consumer

Retail store

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The current practice

Another example is Maersk Line, the Danish container shipping group: In-transit Export Finance funds the export of your goods on the water. We provide you early funding during the ocean transit period where in-transit inventory is often treated by lenders as ineligible collateral. (Maersk, 2020)

International trade requires complex ownership, transaction and payment processes integrated with the customs processes in the exporting, intermediary and importing countries. This has led to the development of specialist trade service providers to manage these activities, often linked with or coordinating the logistics operation. So LSPs can support SCF in the form of inventory finance directly or with an FSP, but this can be taken one step further to include interim ownership of the goods, as described by Hofmann (2009), taking advantage of the information asymmetry and the lack of transparency in credit lending. The LSP buys the goods from the manufacturer and becomes the interim owner before selling them to the buyer. Collaborative in-transit inventory financing is offered by several 3PLs, including Switzerland-based SwissPostLogistics, Germany-based DHL, US-based UPS and Japan-based Mitsui. 3PL inventory financing is depicted schematically in Figure 5.5.

Figure 5.5  Example of an LSP-based inventory financing Funders

Grants inventory financing

Sends payment instructions

Pledges collateral

LSP and SCF platform Provide purchasing guarantee

Supplier

Physical flow

SOURCE  Adapted from Hofmann (2009)

Framework contract

Physical flow

Buyer

The ecosystem

Financial service providers Banks have traditionally financed individual organizations taking into ­account their individual credit risk, assets and so forth. This includes lending against invoices, ie expectations of eventual payment from a buyer, in the form of factoring and invoice discounting. While they take a view on the strength of the economic situation, the industry and the customer base, the primary focus is the individual entity that seeks finance. However, their ­established banking relationships can be challenged by new SCF models where organizations are being financed by their customers’ or suppliers’ trading arrangements. This can reduce the scale of business between a bank and its customer so changing the relationship, economics and profitability but more importantly changing the risk profile by excluding some of the assets, eg invoices, from the securities. Despite this, banks would still appear to be the natural providers of funds and platforms for SCF. Examples of banks with well-established SCF offerings are Bank of America, Banco Santander, BNP Paribas, Citibank, Deutsche Bank, HSBC, JPMorgan, Standard Chartered and Sumitomo Mitsui Banking Corporation (CAPS, 2016). However, banking regulation is limiting the reach of bank-led SCF as the banks are required to undertake extensive due diligence on parties they transact with, known as ‘know your customer’ (KYC). This adds complexity, time and cost to customer adoption. As a result, banks often partner with SCF platforms, for example HSBC with GT Nexus (now Infor Nexus) in April 2017 and Tradeshift in July 2017 (SCF Briefing, 2020a). There are a number of models evident in how banks offer SCF. Some are ‘full service’ providing integrated finance and platform solutions. Others provide funds to the SCF solution providers, described in the next section, and some focus their finance towards the buying party that is offering the SCF programme to their suppliers. Here are some examples of the banks’ own definitions of their services, taken from their websites: ●●

●●

Citi Group: ‘Supplier Finance Solutions: Leverage Citi’s Supply Chain Finance products to improve liquidity for you and your supply-chain partner through sophisticated Working Capital, Discount Management, and Days Payable Outstanding strategies’ (Citi, 2020). JPMorgan: ‘Our supply chain finance solutions help buyers and suppliers meet their working capital, risk mitigation and cash flow objectives… a

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The current practice

global, multilingual and multicurrency platform, links to more than 12,000 suppliers… Supplier Finance… Receivables Purchase… Receiv­ ables Finance… Pre-Export Finance’ (JPMorgan, 2020). ●●

●●

●●

HSBC: ‘HSBC’s Supplier Finance Management solutions focus on increas­ ing the efficiency of transactions and payment terms to reduce the cost of funding – both for your organisation and for your suppliers. Our tailored supplier finance programmes aim to deliver competitively priced working capital to your suppliers, helping you better fund the supply chain’ (HSBC, 2020). Deutsche Bank: ‘Many corporations are looking for innovations to streng­ then relationships with core suppliers and improve the economics of their supply chains… Pre-Shipment finance… Post- Shipment finance… Confirmed payable… Distributor Finance… Receivable Finance’ (Deutsche, 2020). Santander: ‘Our Supply Chain Finance solutions provide an effective way for companies to manage their working capital, improve P&L and reduce risk as well as strengthening relationships with suppliers’ (Santander, 2020).

Banks can also be segmented into those who have a national market focus and those who provide multinational services. The former group tends to see SCF as a development of invoice factoring. The latter group sees SCF as an extension of trade finance, the age-old service of supporting importers and exporters through LC and other traditional instruments. Depending on this focus, SCF can be part of corporate banking or trade finance groups respectively. In other banks, SCF is part of global transaction services and linked with cash management, trade services, foreign exchange and payments or settlements. Figure 5.6 shows the division between the transaction focus and the banking focus. Figure 5.6  SCF positioning within banks

Global Transaction Services 66% Corporate Banking and Trade 33%

SOURCE  Extra (2011)

The ecosystem

There are many banks with SCF offerings and a longer list comes from the EBA Market Guide (EBA, 2014): ANZ, Bank of China, Bank of TokyoMitsubishi, Barclays, BNP Paribas, Citi Group, Deutsche Bank, HSBC, ING, JP Morgan, RBS, Santander, Scotia Bank, SEB, Standard Chartered and Unicredit. It should be noted that this is not an exhaustive list and there are many new entrants, mergers, acquisitions and new product/services offerings each year. An example report in 2019 for Asia includes: ICBC launched online supply chain finance services. CITIC Bank launched next-generation electronic supply chain services. Ping An Bank upgraded supply chain finance services. JD.com collaborated with Bank of China to launch supply chain finance service. NetSun announced new online supply chain finance with Shanghai Pudong Development Bank. (Lam et al, 2019)

Financial intermediaries With an increasing volume of invoices and other SCF assets being managed through common platforms, banks and other financial institutions have the opportunity to bundle them up and borrow against them, a process known as securitization. As described in Chapter 6, the bundles are often held by separate companies, termed Special Purpose Vehicles (SPVs). For investors experiencing lower interest rates in the financial markets, SCF is an interesting investment opportunity given the associated risk profile, eg default in final settlement of the invoice or other asset and the durations, eg 30/60/90 days: An integral part of the CRX Supply Chain Finance Platform is the CRX Multi-Investor APF module which enables banks and institutional investors to purchase corporate approved payables of a Buyer bundled by currency and maturity and issued in securities format. 

(CRX, 2020a)

Moody’s has given an A-bf bond rating to GAM Greensill Supply Chain Finance Fund SCSp… The fund invests in a portfolio of ‘buyer-confirmed trade receivables’ (ie supply chain finance) with the underlying credit risk insured by insurance companies with Insurance Financial Strength rating of A2 or higher. 

(SCF Briefing, 2020b)

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The current practice

Credit card service providers Credit card providers are often banking institutions and a number have introduced corporate purchasing cards where organizations use the core credit or debit card transaction service to pay for, typically, small value items bought from smaller or infrequently used suppliers. The supplier payments can often complete overnight and generate certainty regarding payments, avoid individual invoices and prepayment matching checks, and the card statement information can be used for reconciliation, budget allocation and other analysis. A physical card is not necessarily used; often the card is a virtual card embedded in the electronic purchasing and payment processes. However, there are usually transaction charges due to the card providers at the buyer and supplier end and these are often seen as a barrier to their use. These are called merchant provider and merchant acquirer charges and often amount to 3–5 per cent. These relationships are shown in Figure 5.7. Examples of firms in each category in the United States are (CAPS, 2016): ●●

●● ●●

Issuer: American Express, Bank of America, Citi Group, JPMorgan, Wells Fargo. Transmitter/processor: American Express, Mastercard, Visa. Merchant acquirer: First Data, Bank of America, Global Payments, JPMorgan.

The effect of using corporate credit cards is to deliver a number of the benefits of SCF, particularly prompt and early payment to suppliers, while offering the customer a delayed payment, often monthly, of the consolidated Figure 5.7  Example of a corporate card process Merchant Acquirer

Seller

Interchange Processor

Card Issuer

Flow of goods and services

Buyer

The ecosystem

amount. The fit with other SCF options is explored in Chapter 6. As examples of credit or corporate card offerings, the following statements are taken from their respective websites: ●●

●●

●●

VISA: ‘Prompt and guaranteed payment. Visa payments are automatically processed by your acquiring bank, which typically credits your account in two to four days, removing stressful uncertainty and giving you useful liquidity’ (VISA, 2016). Mastercard: ‘is a technology company in the global payments industry. We operate the global payments processing network, connecting consumers, financial institutions, merchants, governments and businesses in more than 210 countries and territories. Mastercard’s products and solutions make everyday commerce easier, more secure and more efficient for everyone’ (Mastercard, 2020). American Express has extended beyond Corporate Card with Early Pay: ‘a supply chain finance and dynamic discounting solution. Eligible large U.S. companies who buy goods and services from U.S.-based suppliers can leverage the solution as a way to increase cash flow, generate working capital, and make their supplier payment process more efficient. In turn, suppliers can access the easy-to-use digital platform to have their eligible invoices paid earlier than their original payment due date at a competitively-priced early payment discount’ (AXP, 2020).

Alternative finance providers Competing with these more traditional financial institutions is an emerging group of new entrants with alternative financial backing, sometimes built on non-bank funding models such as direct investment and even peer lending and crowd funding. These are also often linked to or are part of a systems offering, in which case they are described as ‘fintechs’. Typically, the premise of their financial offering is a focus on a specific financing model and so a distinct and measurable risk–return model. In the case of SCF, intercompany trades are described as a relatively secure asset as the credit risk of the buying company can be established and monitored. Many of these alternative funding providers can also serve SMEs where traditional banks are less competitive given their overheads and risk models. While these alternative FSPs may not be regulated banks, they may receive funding and investments from banks so they can often be considered as providing indirect bank funding.

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The current practice

The alternative funders rely heavily on spreading their risk across many companies and many transactions. As an example of the scale of funding, C2FO stated: By the end of 2017, C2FO was providing $1bn of funding per week to businesses in more than 100 countries, making the company one of the world’s largest non-bank providers of working capital. The company is projecting an increase to $1bn of funding per day by 2021. 

(SCF Briefing, 2020c)

Other examples on non-bank financial providers are Advance Global Capital, Apex Peak, Greensill Capital, GemCorp, Proopel and Tower Trade Group (CAPS, 2016). There is a range of alternative finance suppliers connected with other core businesses. The group, such as General Electric and General Motors, have developed customer finance solutions that provide finance to customers as well as to suppliers. However, these business units can become ‘noncore’ and GE sold a number of their finance businesses including their SCF unit to Wells Fargo in 2016, and in 2019, ‘MUFG Union Bank is to acquire GE Capital’s supply chain finance platform Trade Payable Services (TPS). The TPS platform provides early payment services to over 42,000 GE suppliers worldwide’ (SCF Briefing, 2020d).

Risk managers, credit rating agencies and insurers The link between SCF and corporate risk is particularly relevant and notable in economic downturns or company distress. For example, the following comments were made concerning the demise of Carillion: The company’s liabilities to banks related to overdrafts and loans stood at £148mn on its 2016 balance sheet, whereas there was in fact a possible further £498mn owed to banks under the reverse factoring scheme, Moody’s said. 

(GTR, 2020a)

How a SCF solution impacts on the risk and credit rating of a buyer or seller depends on the risk inherent in the specific solution. For instance, the credit rating agencies and insurers are mostly interested in the goods themselves for inventory financing, while for invoices/AR the final purchaser or focal company is the key. Buyers and suppliers often take insurance to manage the risk of non-­ delivery or non-payment respectively, especially where the trade is crossborder and so with the potential risk associated with different legal systems.

The ecosystem

This leads to the involvement of insurance providers who are tied into the transaction flow, needing to know when the risk is theirs and when it has moved onto the next party, based on ownership or some other trigger in the supply process. Non-payment insurance is generally provided by credit insurers. Credit insurers are closely involved in factoring and can even compete with specialist factoring providers.

SCF risk mitigation via credit insurance In all three types of SCF financing, receivables, payables and inventory, the FSP usually requires a risk mitigation solution via the credit insurance market. Credit insurance also initiates credit checks and monitoring of the purchasing companies at home and abroad so that losses on receivables do not arise in the first place. There are two different approaches to credit insurance: 1 Single-contract model: a master agreement by an FSP with a credit

insurer to insure the debts they purchase from their customer. The management of credit insurance is therefore the responsibility of the FSP. 2 Two-contract model: the SCF ‘customer’ is the credit policyholder,

entering into a framework contract with a credit insurance provider and managing the policy directly. In this case, the financier/factor is either ‘co-insured’ in the policy or is explicitly listed as ‘loss payee’, ie the person entitled to be paid out for claims. The two-contract model usually has the advantage that the customer can continue the credit insurance even if the business relationship with the financier/factor has been terminated for whatever reason. Private credit insurances usually cover and monitor the exporter’s loss of receivables in the event of the buyer’s insolvency or default via a so-called ‘whole turnover’ or portfolio approach (all debtors or a group of debtors defined before conclusion of the contract). In addition, for certain countries the political risk (seizure, expropriation, nationalization or other encroachments on ownership rights, payment prohibition, convertibility, transfer restrictions, war, civil war, strike, terrorism, civil unrest) can also be insured. The state export credit insurers (eg SERV in Switzerland) insure country and buyer risks that private insurers usually do not cover. The cover provided by state credit insurers for maturities and country risks generally

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The current practice

exceeds that provided by private export credit insurers. Ultimately, the principle of subsidiarity applies to credit insurance. State cover supplements cover where the private sector cannot or does not wish to represent sufficient risk assumption. The global credit insurance market is oligopolistic. There are only a few providers that can really offer their services worldwide. The world’s leading providers are Atradius, Coface and Euler Hermes, followed by AIG, AXA, Credimundi and Zurich Insurance, which are no longer active in all markets and regions. All other market participants (around 45 other insurance companies) are highly specialized in terms of regions, industries, product types and runtimes. The credit insurance market grew from €1,200 billion in 2005 to more than €2,600 billion in 2018. What does credit insurance cover? ●●

The risk of bad debts to protect liquidity and profitability.

●●

The risk of a default is calculable by a specialist credit insurer.

●●

●●

●●

●●

●●

New customers can be pre-checked, then – depending on the result – payment terms and conditions can be defined individually. The existing customer portfolio is actively monitored and bad debt losses reduced or even eliminated. The entire insured debtor base can be analysed, evaluated and controlled individually or cumulatively. Competencies and responsibilities can also be outsourced to an independent third party. In the case of larger companies, the hedging of debtors plays a positive role in the rating process and rating agencies such as Standard & Poor’s, Moody’s and the Fitch Group rate risk mitigation positively.

Section on credit insurance was written by Jörn Volk, Member of the Executive Board of see finance Switzerland AG.

The local legal and tax architecture also has an effect because in some legislations specialized factoring and leasing companies operate outside regulatory supervision and thus have a cost advantage over their competitors from the banking and insurance industry (Bakker et al, 2004). A recent example of a risk-focused SCF offering comes from France. Launched in 2019, the SCF solution has an explicit risk model to set the cost/price of the finance.

The ecosystem

The French risk-based SCF solution (Hillion, 2019) sets out: ●● ●●

●●

●●

●●

Scope: Working capital upstream finance – inventory, equipment, tooling. Strategic partnership with large corporates in various industries (aero­ space, energy, automotive, shipbuilding): {{

Cascade to second and third tier suppliers;

{{

Identify ‘critical’ lower tier suppliers whom they want to support;

{{

(Note that first tier often large with appropriate financing in place).

Financed by an investment fund (focused on SME finance, €20bn, 50 per cent debt/50 per cent equity) based on risk score. Risk scoring – measure, model: {{

Financial, typical credit risk;

{{

Operational, performance and supply risk;

{{

Environmental or sustainability;

{{

Risk score drives rate for SCF.

Will offer a ‘rights to exploit’ so it can be used widely.

SCF platform providers As was stated in the introduction to this chapter, SCF increases the transaction complexity by adding some form of financing to the traditional buy–sell transaction along with additional inter-organizational and intra-­organizational steps and one or more new participants. In fact, in a number of studies, electronic exchange of information (EDI) is seen as a requirement for SCF. In the case of reverse factoring, strong internal purchase-to-pay (P2P) capability in the buying organization is also cited as a prerequisite. For these reasons, information technology, systems integration and electronic communications are both a key enabler and often a key implementation challenge and cost factor. We now look at a whole range of service providers who have as a core component of their offering a system or set of software solutions to support SCF. Many of these providers will, no doubt, not consider themselves as simply technology companies, but this technology is usually a differentiating factor and its processes and style reflect a specific approach to SCF that the potential user needs to understand and make choices around.

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The current practice

Existing systems providers are introducing SCF capabilities alongside their existing services that link buyers and sellers, ie purchasing and selling tools. Many of these systems providers have core businesses providing comprehensive corporate systems delivering the ubiquitous ERP. As organizations seek to increase their electronic linkages with their customers and suppliers, the ERP vendors have built or bought extensions to support electronic commerce. These include, for example, collaborative planning, e-invoicing, specific SCF solutions and links to real-time event tracking. SAP and Oracle are pre-eminent examples. In April 2016, SAP Ariba announced that it would integrate PrimeRevenue’s SCF solution into its P2P solution. However, in early 2019 this agreement ended (SCF Briefing, 2020e) and later in the year new arrangements were announced with Standard Chartered in Asia Pacific, Amex in the United States and RBS in the UK to bring a wider range of SCF choice (SAP Ariba, 2020). In 2019, Oracle announced an arrangement with Greensill in the United States to facilitate supplier payments in construction (Greensill, 2020). In addition to the ‘big’ systems providers, more focused software providers are also adding SCF capabilities. Those involved with electronic ­invoicing and payment systems are a good example. Some of the traditional process automation providers in, for example, real-time event tracking or inventory visibility, have taken the opportunity to provide tools to support SCF. The development of ‘transactional’ tools to provide added value services has allowed the providers to move into the next tier of SC utility and so, hopefully, higher margin business (see Figure 5.8). However, there are many new entrants building on the lack of integration between buyers and suppliers to provide a ‘plug-in’ service to manage the

Figure 5.8  Financing pyramid for SCF platform providers

Finance Information

Data

Transactions

Increasing added value

The ecosystem

complex financial transactions required to implement earlier or later payment, decoupled from the typical buyer–supplier processes. Often these providers have access to finance to bridge the timing gap between the supplier receiving payment and the buyer settling the invoice. PrimeRevenue and C2FO are examples here, taken from their websites: PrimeRevenue has the largest and most diverse global funding pool of more than 80 funding partners. PrimeRevenue’s supply chain finance network supports 30+ currencies on a single cloud-based, multi-lingual, crossborder network which sees a volume of more than $200 billion in payment transactions per year. (PrimeRevenue, 2020) C2FO… turn receivables into cash flow and payables into income… Our mission to release $43T in liquidity for the world’s businesses. (C2FO, 2020)

Some platforms focus on dynamic discounting (DD); Basware is an ­example: On-demand dynamic discounting offers a more tailored and flexible payment plan to meet suppliers’ needs, helping to build stronger supplier relationships, support their cash flow needs and ensure supply chain resilience. (Basware, 2020)

While others focus on client-specific supplier financing: Woodsford TradeBridge work with so-called ‘mid-market buyers’ which are typically smaller than the investment grade clients that the main bank funded SCF programmes target. In this market the traditional value proposition for large reverse factoring programmes seldom works so we focus instead on niche markets and adapt our programmes to suit the specific needs of our clients (buyers and suppliers). For example, over 50% of our programmes are buyerled, a particular requirement for buyers purchasing from Asian suppliers where the early payment discount is negotiated into the price already. Woodsford TradeBridge have in excess of £100m in active supply chain finance facilities across some 50 buyers, both in the UK and internationally. (Coxhead, 2019)

One major trend is the evolution of capability as organizations expand their offering or focus on specific markets. Taulia – an example of a growing and evolving platform provider elabo­rates: ●●

Initial focus on Dynamic Discounting (using client organization’s own cash for supplier discount)

●●

Now DD and SCF (Reverse Factoring) – SCF first sold in 2014

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The current practice ●●

Technology expanded to cover strategic working capital

●●

Bank/funder agnostic (DD usually internally funded by client)

●●

250 million invoices, $1 trillion invoice value, 1.6 million suppliers on board (Mitchell, 2019)

Other companies in this area are CRX Markets, Kybiba, Orbian, PrimeRevenue, Propell, Taulia, Tower Trade and Tungsten (Hofmann et al, 2018). To demonstrate the migration of services as companies look to provide a broader range of services, Figure 5.9 has been developed from a McKinsey analysis and shows exemplarily some of these organizations’ starting points and developments across the P2P scope. Figure 5.9  Examples of developing capabilities of SCF platform providers

Process scope: Starting point:

Sourcing

Ordering

Financing Invoicing

Reverse factoring or Dynamic discounting

Examples: Demica PrimeRevenue

Examples: Tungsten Taulia

E-invoicing

Procurement

Examples: SAB Ariba Oracle

SOURCE  Adapted from Herath (2015)

Transaction hubs In addition to providing interface technology, the transaction hubs create platforms that enable many parties to collaborate in SC and trade m ­ anagement

The ecosystem

by creating electronic transaction exchanges known as ‘hubs’. Different hubs have different capabilities and added services, but the core is usually a common set of interfaces and data definitions that allow an organization to link once with a hub and communicate with many buyers or suppliers without having to implement multiple or many-to-many interfaces. For example, SAP-Ariba, Infor Nexus (formerly GT Nexus), C2FO and others network suppliers and buyers together for tendering, setting up supply arrangements, ordering and paying. Adding the functionality to manage the financing of these transactions is an obvious extension, as well as a way to enter the new area of business, that of financing the trade itself. The following are taken from their respective websites: SAP Ariba: Ariba Network is a dynamic, digital marketplace where millions of buyers and suppliers, operating in more than 190 countries, will transact $3 trillion in business commerce this year. (SAP Ariba, 2020) Infor Nexus (formerly GT Nexus): The world’s leading network for multienterprise supply chain orchestration. The network connects businesses to their entire supply chain – from suppliers and manufacturers, to brokers, 3PLs, and banks… 65,000 companies on the network, $1Trillion in trade managed, $50 Billion global payments processed. (Infor Nexus, 2020)

Marketplaces By an online marketplace, we mean a site where product and services can be viewed, selected and purchased. Best known for their consumer businesses, marketplaces are increasingly evident in the business world where buyers and sellers find each other and make purchases, eg Amazon Business expanding from its US base, Alibaba in China and Mercateo in Europe. Unlike the consumer P2P cycle where the buyer pays on order by credit card or payment service such as PayPal or ApplePay, businesses want consolidated monthly invoices and longer payment terms. This can be achieved by using corporate payment cards, as described earlier in the chapter, or by taking advantage of the financing options available on the marketplace itself – ­effectively another service offering from the marketplace. Here are two current examples from Amazon Business and Alibaba: ●●

Amazon Business provides an online shop for business to business purchasing. Pay by Invoice allows bigger business customers to pay on standard terms and Amazon’s SCF offering covers the gap. ‘Sellers that

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The current practice

want cash faster than 30 days can pay an additional 1.5 percent of the invoiced amount’ (CNBC, 2020). ●●

Alibaba’s SCF offering is aimed at exporters. It ‘has partnered with more than 25 banks and credit rating agencies globally to provide cross-border trade financing for SMEs as well as a new credit reporting service’ (SCMP, 2020).

Trade facilitation In this section on systems, we should also include those who have come from a trade documentation background, such as those systems that manage letters of credit, customs, bills of lading, etc that set up and record most cross-border trade. The information contained in these documents, including changes of formal ownership, can be used to trigger changes of financing and risk position of the parties along the trade. A number of the suppliers of these tools are expanding into the SCF world on the back of this information. Examples include Finastra, the 2017 merger of Misys and D+H, and Amber Road acquired in July 2019 by E2open (E2open, 2020). To conclude this section on SCF providers, TXF Trade and Treasury published a guide to SCF providers (TFX, 2016). While not comprehensive and likely to be dated quickly by organizations developing their services and new entrants, it does provide an overview of the range of providers and, more importantly, a set of dimensions on which to judge them: ●●

geographical scope;

●●

dynamic discounting;

●●

supplier on-boarding;

●●

languages;

●●

local currency financing;

●●

self-funding;

●●

funding sources;

●●

messaging;

●●

financing rates;

●●

compliance checks;

●●

analytics/reporting.

The ecosystem

In summary, SCF platforms are increasingly available from existing software providers where their scope of service includes interface or communication between trading organizations, the parties to buying and selling. As with any emerging area, a range of specialist service and systems providers are also building solutions to support SCF, often accompanied by some of the new financing approaches.

Consultants Consultants typically bring experience of previous implementations from other clients along with functional skills and additional resources. For the purposes of this chapter, we are considering management consultancies separately from other external professional advisers who are covered in the next section. Consultants can help investigate the opportunities and challenges specific to the situation and apply benchmarks and guidelines to set expectations on the costs and benefits. In this role, their credibility is being used to support the case for change and the choice of approach. Their prior knowledge of the changes required to processes, IT and organization as well as the effort required for internal and external engagement can be used to build a more robust plan and mitigate the risks of the programme. The second key role is to provide experienced resources to undertake some or all of the strategizing, planning and implementation, in particular the project or programme management, the supplier engagement and onboarding, and the development of the new processes and procedures. These skills may not exist inside the organization or not in sufficient numbers to support the one-time effort required. However, as with all consultant engagements, it is important to understand which skills will be required longer term in-house and acquire and develop them. Depending on the source of the interest within the organization, consultancies from different backgrounds operate in the SCF world. As an example, specialist Treasury consultancy firms have developed strong positions in understanding and advising on the credit, risk and accounting opportunities and challenges, while larger generalist consultancies have developed specialist offerings in SCF and can often provide local support in multiple countries. Examples of the smaller or niche consultancies are Zanders Treasury and Finance Solutions, and M3 Consultancy. Examples of the larger or broader scope consultancies are Accenture, Deloitte, IBM, KPMG and PwC.

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The current practice

Advisers In this section we consider the external professional advisers who are typically involved in SCF projects. The main roles are legal and accountancy, which are covered below.

Legal advisers It is likely that there will be changes to existing supplier or customer terms and conditions. Some of these changes will require new contracts, which in turn imply a renegotiation process. Hence, internal or external legal input is often required with specific knowledge to make the appropriate changes and sufficient resource to make the changes in the appropriate timescale. Depending on the nature of the asset being used to support the SCF, the complexity can vary considerably. For RF, legal ownership of the invoice, and roles and responsibilities for collecting payment and dealing with defaults all need to be defined. With inventory or stock financing, the legal situation can be substantially more complex as the asset backing the payment may not yet exist. If the programme is implemented in multiple legal jurisdictions, then legal advice may be needed in each. However, there are a number of established SCF mechanisms with welldeveloped legal and contractual bases and, as described in the sections below, various industry bodies are aiming to develop and support the adoption of standards and common terms and conditions. An example of a law firm’s interest in SCF is the steady stream of hires in the area, for example ‘Law firm Fieldfisher hires SCF funding and fintech expertise’ (SCF Briefing, 2020f).

Accountants and auditors Similarly, there may be changes to the accounting treatment of the payments. For RF, it is important to get the right approach in place or the benefit will be eroded as the classification of the amounts outstanding can be moved from AP to debt. This issue is described in a number of specialist publications in detail, but here is a summary from CRX (2020b): ●●

Is the buyer released from the obligations of the trade payable through an early payment to the supplier?

The ecosystem

●●

●●

Does the early payment create a new obligation for the buyer towards a bank or does the original trade payable persist? Are there significant changes to the terms of the trade payable as a result of the reverse factoring transaction?

Similarly, a key criterion for inventory financing is how the activity is recognized in the company’s accounts. According to IFRS® Standards (IASB, 2014), the recognition hinges particularly on the transfer of significant risks and rewards. Therefore, a prudently designed framework contract is paramount in inventory financing. In sale and lease back (SLB), a mechanism to reduce capital employed, the recognition of the leasing is key because the local accounting standards can tip the scale for the overall value proposition. Generally, a leasing transaction is either classified as a finance lease or operating lease. The latter offers the possibility to take leased items off the balance sheet, depending on the risk and reward transfer and substance of the transaction. The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) have revised the accounting standards for leasing, as described in Chapter 6.

Industry and professional associations Various industry groups and professional bodies are active in the area of SCF, bringing together experts in a particular field in order to exchange information, discuss relevant topics, provide education and develop standards.

ICC The International Chamber of Commerce (ICC) created the industry standards for documentary trade finance instruments and recently further developed this for SCF: Five leading business associations have joined forces with the International Chamber of Commerce (ICC) Banking Commission to undertake a major project to standardize and harmonize market terminology for global supply chain finance products and services... the newly formed Global Supply Chain Finance (SCF) Forum seeks to clarify existing definitions and supply chain finance terminology. (ICC, 2014)

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The associations referred to include: ●● ●●

Euro Banking Association; Bankers Association for Finance and Trade – International Financial Services Association;

●●

Society for Worldwide Interbank Financial Telecommunication;

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International Trade and Forfaiting Association;

●●

Factors Chain International.

These associations are described below.

EBA The Euro Banking Association (EBA) is an association for payment and transaction banking practitioners. In 2011 the EBA Board launched the EBA Supply Chain Working Group (SCWG). The initial objective of the SCWG was to carry out a study of the SCF market and in 2014 they published the second edition of the EBA Market Guide on supply chain finance. In 2016, as a member of the Global Supply Chain Finance Forum, Standard Definitions for Techniques of Supply Chain Finance was published (EBA, 2020).

BAFT-IFSA Bankers’ Association for Finance and Trade – International Financial Services Association (BAFT-IFSA) – is a global association for organizations actively engaged in international transaction banking and has published terms and definitions for trade finance and supply chain finance instruments: the BAFTIFSA Product Definitions for Trade Finance, 2012 and the BAFT-IFSA Product Definitions for Open Account Trade Processing and Open Account Trade Finance, 2011 (BAFT-IFSA, 2011 & 2012).

SWIFT The Society for Worldwide Interbank Financial Telecommunication (SWIFT) is a consortium service provider owned by its member banks. SWIFT provides a transaction platform for settlement of payments between the buyer’s and supplier’s banks, TSU, a matching and workflow engine for bank p ­ ayment obligation (BPO), which in turn can support SCF. SWIFT describes BPO as a

The ecosystem

‘trade settlement instrument [that] offers buyers and suppliers (irrespective of size, geography and industry) a new payment method to secure and finance their trade transactions’. However, it announced recently that this service would stop from the end of 2020 due to limited adoption (GTR, 2020b).

ITFA International Trade and Forfaiting Association (ITFA) has this announcement on its website: The ITFA Board is pleased to announce that ITFA in collaboration with the London Institute of Banking and Finance (LIBF), have assisted in the creation of a professional qualification course titled Certificate in Supply Chain Finance (CSCF). (ITFA, 2020) Trade finance industry body, the International Trade and Forfaiting Association (ITFA), has had discussions with rating agencies in an effort to persuade them not to view all trade payables as debt, and has developed guidelines entitled Payables Finance: What can we learn from the Abengoa and Carillion experiences? for the industry to help banks and other finance providers assess whether SCF programmes are being misused. The guidelines, released last October, outline various warning signs or ‘red flags’ banks should keep an eye out for, such as the extension of payment terms far beyond industry norms and the relative large size of programmes compared to the size of other liabilities owed to banks. (GTR, 2020a)

FCI Many SCF implementations have factoring or RF at their core and there are a number of industry associations in this area. Factors Chain International (FCI): ‘an umbrella organization for independent factoring companies… the world’s representative factoring network and association with close to 400 members in 90 countries’. This association has recently launched its own SCF initiative: 27 June 2017 – FCI… announced today that its new supply chain initiative FCIreverse will be based on the Demica platform. FCIreverse will enable FCI’s network of 400 banks and independent factoring firms to easily partner and fund their clients’ suppliers anywhere in the world. (Business Money, 2017)

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The current practice ●●

Factors Chain International (FCI) and International Factors Group (IFG) merged in 2016 to create FCI+IFG.

●●

IFG and FCI have published rules (GRIF) that govern international factoring (EU Federation for the Factoring and Commercial Finance Industry (EUF), 2020).

Other industry associations As described earlier, electronic invoicing and payments are a critical component of SCF and the two organizations below are industry bodies that cover this area and have active roles in SCF: ●●

●●

European e-Invoicing Service Providers Association: ‘EESPA is an international not-for-profit association… a trade association at a European level for a large and dynamic community of e-invoicing service providers, drawn from organizations that provide network, business outsourcing, financial, technology and EDI (electronic data interchange) services’ (EESPA, 2020). European Payments Council: ‘The purpose of the European Payments Council (EPC), representing payment service providers (PSPs), is to support and promote European payments integration and development, notably the Single Euro Payments Area (SEPA)’ (EPC, 2020).

Professional associations have started including SCF in their activities, particularly news, conferences, education and standardization activities. In most countries there are professional groups who represent accountants, treasurers, procurement, logisticians and legal practitioners. For illustration, we give some UK examples, but there are equivalent ones in most countries: ●●

●●

●●

●●

Accountants: Two main bodies publish information to their members on SCF: Chartered Institute of Management Accountants (CIMA, 2020) and the Institute of Chartered Accountants in England and Wales (ICAEW, 2020). Treasurers: The Association of Corporate Treasurers (ACT) has included sessions on SCF at its annual conferences and includes links to the subject on its website (ACT, 2018). Purchasers: The Chartered Institute of Procurement and Supply (CIPS) includes SCF in its academic curriculum (CIPS, 2020). Logisticians: The Chartered Institute of Logistics and Transport (CILT) has a supply chain finance forum as one of its focus groups (CILT, 2020).

The ecosystem

Alongside these functional associations, many general business organizations have views on SCF. As an example, the Confederation of British Industry (CBI) has an active interest in SCF, stating: ‘Supply chain finance. A key form of alternative finance for growing businesses’. Matthew Fell, director at the CBI, said: Boosting the use of supply chain finance is an innovative way to ease the funding squeeze for many smaller businesses, but it is dependent on the nature of individual supply chains to work effectively so is not a one size fits all solution. (Telegraph, 2012)

SCF consortia Consortia are forming to increase the level of interconnection and reduce the burden of suppliers, particularly having to interface with multiple SCF platforms. Marco Polo and we.trade are examples (see also Chapter 9): The Marco Polo Network is the largest and fastest growing trade and working capital finance network in the world… provides an open enterprise software platform for trade and working capital finance to banks and corporates and a distributed, blockchain-powered solution that allows for the seamless and secure exchange of data and assets between participants. (Marco Polo, 2020) we.trade is a joint-venture company owned by 12 European banks (originally under the name of Digital Trade Chain)… with IBM… [It] developed a digital trade platform… to simplify the trade finance processes by digitalizing the management, tracking and security of domestic and international trade transactions. we.trade is the first blockchain-based trade platform for banks and their commercial clients in Europe. (Trade Finance Global, 2019)

Governments and other public bodies A number of factors, beyond simply shortening business cash cycles in general, encourage governments and international bodies to get involved in SCF, including: ●●

developing small- and medium-sized enterprises (SMEs);

●●

encouraging exports;

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supporting the economies in developing countries.

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In addition, the way public tax authorities regulate payments, debts and credit can have a major impact on the practical implications of SCF in each country and their impact on the future of SCF in a global context is explored in more detail in Chapter 8. In this section we will look at both the positive and negative impacts of public policy and financial regulation on SCF.

SME support As standard payment terms set by regulation do not fit all supply market situations, governments and economics ministries have embraced SCF, often in conjunction with programmes to encourage or enforce prompt payments or payment to a common standard or regulatory term. One mechanism used by a number of governments is to support and sometimes even fund common transaction platforms in order to reduce the barriers to smaller companies getting on board: ●●

●●

●●

In the UK, the British Business Bank sponsors MarketInvoice, ‘helping busi­ nesses take charge of their cash flow, quickly and easily… [providing] a range of working capital solutions, including invoice finance and business loans… fast, flexible funding to help companies do everything from pay suppliers and staff to launch new products and grow’ (BBB, 2020). In the Netherlands, the Dutch Ministry for Economic Affairs supports and subsidizes the ‘Betaal Me Nu’ (Pay Me Now), which ‘seeks to unlock €2.5 billion in liquidity for Dutch SMEs in the next five years. It aims to do this by mobilizing 50% of the top 1,000 corporates to offer their suppliers the opportunity of faster payment, or fast financing, of their invoices’ (BMN, 2016). In Italy, the creation of a national hub and the requirement from 1 January 2019 for all businesses to use electronic invoices via this hub creates the opportunity for a step change in the adoption of SCF, whether that be RF, DD, confirming or other approaches (Caniato, 2019).

Another mechanism is to ‘sign up’ big business to support SME payment programmes. There are examples in the United States and the UK. The following press release was made in 2014: President Obama’s SupplierPay Initiative Expands; 21 Additional Companies Pledge to Strengthen America’s Small Businesses. Today, the White House and the Small Business Administration announced an expansion of President

The ecosystem Obama’s SupplierPay initiative, a partnership with the private sector to strengthen small businesses by increasing their working capital, so they can grow and hire more workers… As part of the SupplierPay initiative, companies pledge to pay their small suppliers faster or enable a financing solution that helps them access working capital at a lower cost. (White House, 2014)

In the UK, an early SCF initiative was sponsored by the coalition government in 2012: ‘UK Prime Minister announces supply chain finance scheme 23 October 2012’ (Cabinet Office, 2012). This has led a number of larger companies to commit to better supplier payment approaches. An interesting innovation in the UK is the Project Bank Account developed to support construction industry suppliers, ‘pioneering a new way of paying supply chain members in construction projects through Project Bank Accounts (PBAs). PBAs will see construction SMEs working in government projects receiving payment in five days or less from the due date’ (Cabinet Office, 2014). See also Chapter 8 for further discussion on the SCF opportunities for SMEs.

Exports A second motivation for government focus on SCF is the linkage with exports: companies exporting generate national earnings but are often constrained by long payment terms while the physical product is shipped to its customers. Facilitating earlier payment reduces cash constraints and borrowing costs for exporters and so should lead to more exporting. In the United States, international trade is supported: The EXIM Bank Supply Chain Finance Guarantee (SCFG), offered to lenders, assists U.S. exporters and their suppliers through accounts receivable financing. It is designed to increase liquidity in the supply chain and provide suppliers, particularly small businesses, with access to capital faster and at a lower cost. (Exim, 2019)

Developing economies While this applies to all exporters, there is a particular focus by governments to promote growth in less developed economies with support to smaller companies that need working capital, particularly early payment for exports to the richer economies. The World Bank through its IFC operation

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has selected and developed an SCF solution to facilitate the payment of suppliers in developing countries: The Global Trade Supplier Finance (GTSF) Program provides short-term financing to suppliers selling to large domestic buyers or exporting to international buyers, by discounting invoices once they are approved by the buyer… Since the Program launch in 2012, IFC’s GTSF program has disbursed about US$3 billion to close to 1,000 suppliers across 14 countries. The average invoice size financed was approximately US$13,000. (IFC, 2020)

A number of public sector bodies are also promoting SCF to support trade within their regions. For example, European groups have engaged to support the development of standards and have funded a number of initiatives: ●●

European Commission’s Expert Group on e-Invoicing;

●●

EU Multi-Stakeholder Forum on e-Invoicing;

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European Payments Council;

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Single Euro Payments Area (SEPA) initiative.

Regulation While the above descriptions would seem to indicate wide governmental support for SCF, it is important to recognize some of the barriers that legislation and regulation can create. The tax treatment of factoring transactions, which is how many SCF models are classified by tax authorities, often makes factoring prohibitively expensive (Klapper, 2006). In some countries, interest payments on commercial lending are tax deductible, while interest on factoring arrangements is not. In some, value added tax (VAT) is charged on the entire transaction and stamp taxes apply to each AR. Furthermore, capital controls may prevent non-banks from holding foreign currencies, which impedes a global management of the financial flow through factoring. To add to the complications, in factoring or RF the risk underwriting standards affect the anticipated costs and efficiency for the factor because they define the environment in which the factor engages in collection activities. In summary, there is clear evidence of government support for SCF, but governments also set the fiscal and regulatory system in which SCF solutions

The ecosystem

can operate. SCF solutions may have to have many sub-categories to abide by the prevailing legal frameworks in each country.

Academia A number of universities, business schools and other academic institutions are involved in SCF through a range of research, undergraduate and postgraduate courses and industry engagement. The SCF Community (http://www.scfcommunity.org/) organizes the annual Global Student Challenge, an international competition that addresses the need for knowledge and product development in the area of SCF and attempts to bridge the gap between the academic world and the corporate sector. The 2015/16 round attracted almost 2,500 students and more than 250 teachers, representing over 700 universities from 96 countries (Global Student Challenge, 2020). As well as this general interest, a number of academic institutes have signalled an increased focus on SCF, such as the London City University Cass Business School, which has developed a revised Master’s programme to directly include the topic: ‘MSc Logistics, Trade and Finance revamped with supply chain finance motivation… will be known as MSc supply chain, Trade and Finance (SCTF)’ (Cass, 2016). Many supply chain postgraduate degrees include modules in SCF; for example, the Supply Chain Management MBA at Rutgers Business School in the United States and the Logistics and Supply Chain MSc at Cranfield School of Management in the UK. In fact, there are now a number of academics with SCF in their titles and the Chair of the Supply Chain Finance Community, Michiel Steeman, was selected as the inaugural holder of the Supply Chain Finance Professorship at Windesheim, NL; Federico Caniato is Professor and Director, Osservatorio Supply Chain Finance at Politecnico di Milano; and Erik Hofmann (one of the authors) is head of the Supply Chain Finance Lab at the University of St Gallen, Switzerland. The research agenda is also well represented with an increasing level of university publications with SCF in their titles or abstracts, as shown in Figure 5.10. What is also evident is the cross-functional or cross-discipline nature of the interest, as shown in Figure 5.11. However, a number of studies have shown the lack of consensus and gaps in the existing research, as well as differences between academic views and practitioner experience, so clearly there is some way to go here.

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Figure 5.10  Research interest in SCF 900 800 700 600 500 400

Extrapolated

300

Actual

200 100 0 05 006 007 008 009 010 011 012 013 014 015 016 017 018 019 2 2 2 2 2 2 2 2 2 2 2 2 2 2

20

SOURCE  Google Scholar (2020)

Figure 5.11  Cross-discipline SCF interest Logistics or Supply Chain Management 54% Banking 5% IT 5% Finance and Accounting 34% Business Management 2% SOURCE  Yi (2013)

Summary Existing and new organizations are building experience, skills and capabilities in the area of SCF, with significant ‘churn’ since the first edition of this book was published. Most importantly for the user, there is an increasing level of awareness of the opportunities and challenges, which leads to more informed decision making on whether to adopt SCF, as well as choosing the right solution and implementing it efficiently. It is also clear that different backgrounds and starting points have spaw­ned many divergent approaches and standards. This can lead to confusion, ­particularly when small suppliers are being asked to join different SCF programmes. However, we see an increasing number of industry, trade and professional organizations, governments and educational establishments e­ ngaging in SCF, leading to wider understanding and appropriate policy making.

The ecosystem

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The current practice ICC (2014) [accessed on 23 January 2020] Banking industry announces major ­undertaking to harmonize Supply Chain Finance terminology [Online] https:// iccwbo.org/media-wall/news-speeches/banking-industry-announces-major-­ undertaking-to-harmonize-supply-chain-finance-terminology/ (archived at https://perma.cc/PSY6-HDZT) IFC [accessed on 23 January 2020] Global trade supplier finance [Online] www.ifc. org/wps/wcm/connect/industry_ext_content/ifc_external_corporate_site/ financial+institutions/priorities/global+trade/gtsf2 (archived at https://perma.cc/ R7PN-V326) Infor Nexus [accessed 23 January 2020] Real-time supply chain insight [Online] www.infor.com/en-gb/products/infor-nexus (archived at https://perma.cc/ EZ4E-MX6A) ITFA [accessed 23 January 2020] Certificate in Supply Chain Finance (CSCF) – brought to you by ITFA in collaboration with LIBF [Online] https://itfa.org/ certificate-in-supply-chain-finance-cscf-brought-to-you-by-itfa-in-collaborationwith-libf/ (archived at https://perma.cc/Y5QK-QXWV) JPMorgan [accessed 23 January 2020] Supply chain finance [Online] www. jpmorgan.com/tss/General/E-mail_Supply_Chain_Finance/1320519389962 (archived at https://perma.cc/C84R-C3LW) Klapper, L (2006) The role of factoring for financing small and medium enterprises, Journal of Banking & Finance, 30 (11), pp 3111–30 Kramer, R (2017) Supply chain finance accounting: The tyranny of litmus tests, The Secured Lender, March Lam, HKS, Zhan, Y, Zhang, M, Wang, Y and Lyons, A (2019) The effect of supply chain finance initiatives on the market value of service providers, International Journal of Production Economics, 216 (C), pp 227–38 Maersk [accessed 23 January 2020] Structured trade finance solutions [Online] www.maersk.com/solutions/shipping/cargo-and-financial-services/trade-finance/ products (archived at https://perma.cc/AF9C-8K6B) Marco Polo [accessed 23 January 2020] About the Marco Polo Network [Online] www.marcopolo.finance/about/ (archived at https://perma.cc/5UPW-YELN) Mastercard [accessed 23 January 2020] Mastercard® Modern Slavery and Human Trafficking Statement [Online] www.mastercard.co.uk/en-gb/about-mastercard/ corp-responsibility/social-sustainability/mastercard-modern-slavery-and-humantrafficking-statement.html (archived at https://perma.cc/3SKW-MYUR) Mitchell, L (2019) Lewis Mitchell, Senior Director, Taulia interviewed on 5 July 2019 Network Rail [accessed 23 January 2020] SME action plan [Online] https://cdn. networkrail.co.uk/wp-content/uploads/2019/11/SME-action-plan-final.pdf (archived at https://perma.cc/66P9-5WTM) PrimeRevenue [accessed 23 January 2020] About us [Online] https://primerevenue. com/about-us/ (archived at https://perma.cc/M6ET-23B8)

The ecosystem Ryals, L and Rackham, N (2012) Sales implications of servitization, Cranfield School of Management, February Santander [accessed 23 January 2020] Supplier payments [Online] www.santandercb. co.uk/financing/day-day-banking/supplier-payments (archived at https://perma.cc/ ZP32-TGQF) SAP Ariba [accessed 23 January 2020] About us [Online] www.ariba.com/about/ news-and-press# (archived at https://perma.cc/SL7Y-2V9B) SCF Briefing [accessed 23 January 2020a] HSBC signs deal with Tradeshift platform to offer SCF [Online] www.scfbriefing.com/hsbc-signs-deal-withtradeshift-platform-to-offer-scf/ (archived at https://perma.cc/P587-KVYE) SCF Briefing [accessed 23 January 2020b] Moody’s assigns ‘A’ bond fund rating to GAM Greensill SCF fund [Online] www.scfbriefing.com/moodys-assigns-a-bondfund-rating-to-gam-greensill-scf-fund/ (archived at https://perma.cc/6DTC-654J) SCF Briefing [accessed 23 January 2020c] C2FO raises $100 million from new and existing investors [Online] www.scfbriefing.com/c2fo-raises-100-million-fromnew-and-existing-investors/ (archived at https://perma.cc/BR5L-4RNS) SCF Briefing [accessed 23 January 2020d] MUFG Union Bank buys GE Capital’s SCF platform [Online] www.scfbriefing.com/mufg-buys-ge-capitals-scf-platform/ (archived at https://perma.cc/CUY2-LCD8) SCF Briefing [accessed 23 January 2020e] SAP Ariba ends PrimeRevenue supply chain finance agreement [Online] www.scfbriefing.com/sap-ariba-ends-supplychain-finance-agreement-with-primerevenue-after-three-years/ (archived at https://perma.cc/8EXG-EPWA) SCF Briefing [accessed 23 January 2020f] Law firm Fieldfisher hires SCF funding and fintech expertise [Online] www.scfbriefing.com/law-firm-fieldfisher-hiresscf-funding-and-fintech-expertise/ (archived at https://perma.cc/W3VA-BSEH) SCMP [accessed 23 January 2020] China’s Alibaba partners with banks, agencies to introduce B2B financing and rating services [Online] www.scmp.com/ tech/e-commerce/article/1900654/chinas-alibaba-partners-banks-agencies-­ introduce-b2b-financing-and (archived at https://perma.cc/2FSV-G6E8) Smith, P (2014) [accessed 23 January 2020] Late payment – File on Four doesn’t quite get to the heart of it [Online] https://spendmatters.com/uk/late-paymentfile-on-four-doesnt-quite-get-to-the-heart-of-it/ (archived at https://perma. cc/2V2L-Q5U2) Telegraph (2012) [accessed 23 January 2020] Tesco, GSK and Vodafone lead sign-up for David Cameron’s supply chain finance scheme [Online] www. telegraph.co.uk/finance/newsbysector/banksandfinance/9628634/Tesco-GSKand-Vodafone-lead-sign-up-for-David-Camerons-supply-chain-finance-scheme. html (archived at https://perma.cc/2HLH-V7RM) TFX (2016) [accessed 23 January 2020] TXF Trade and Treasury’s Guide to Supply Chain Finance Providers [Online] www.txfnews.com/ TXFMDCommonFileStorage/files/A2%20wall%20chart.pdf (archived at https://perma.cc/9PKN-YVSY)

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The current practice Trade Finance Global (2019) [accessed 29 February 2020] Blockchain & DLT Trade Finance Projects [Online] www.tradefinanceglobal.com/posts/dlt-in-tradefinance/ (archived at h ­ ttps://perma.cc/W7YZ-E2YX) UPS [accessed 23 January 2020] UPS Capital acquires Parcel Pro [Online] www.investors.ups.com/news-releases/news-release-details/ups-capital-acquires-­ parcel-pro (archived at https://perma.cc/R2N7-Z2G2) VISA [accessed 25 January 2020] Website, visa.com (archived at https://perma.cc/88KN-RBR7) Wang, X (2017) Supply chain finance: New horizons, unpublished MSc Thesis, Cranfield School of Management White House (2014) [accessed 23 January 2020] President Obama announces new partnership with the private sector to strengthen America’s small businesses; renews the Federal Government’s QuickPay initiative [Online] https:// obamawhitehouse.archives.gov/the-press-office/2014/07/11/president-obama-­ announces-new-partnership-private-sector-strengthen-amer (archived at https://perma.cc/46YY-7CEX) Yi, C (2013) Identify the opportunity of applying supply chain finance to enable the provision of additional product capacity in a manufacturing environment: A structured literature review, unpublished MSc Thesis, Cranfield School of Management

Study question Complete a RACI table for those who are involved in SCF within your organization.

Look ahead 1 There are new entrants providing services in SCF – how will you keep up to date with them? 2 Who is developing the standards to provide common SCF approaches that matter to you? 3 Join the SCF Community as a source of information and support.

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The value proposition

06

Solutions for supply chain finance

This chapter was co-authored by Philipp Wetzel, research associate and project manager, Supply Chain Finance-Lab, Institute of Supply Chain Management, University of St Gallen, Switzerland

O U TCO M E S The intended outcomes of this chapter are to: ●●

identify the different SCF options;

●●

understand their key components and characteristics;

●●

explore the decision process to select an appropriate SCF solution.

By the end of this chapter you should be able to: ●●

explain the options and their relative pros and cons;

●●

develop the structure of a business case and outline the key elements.

Activities In order to understand the value proposition for your particular organization, we suggest the following: ●●

●●

Using your own organization’s customer or supplier ABC segmentation, develop an alternative segmented analysis focusing on their financial situations, particularly their need for finance. Use this segmentation to estimate the opportunities for SCF – the macroeconomic benefits from a new financing model involving earlier or later payments.

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Looking ahead We recommend the following: collecting cost and benefit benchmarks from existing implementations in your industry and geography by accessing information from service and platform providers, through industry networks and via the SCF Community.

Introduction In this chapter we set out an overview of the most common SCF solutions in use. The economic case for SCF was developed in Chapter 4 where representative options are described and justified. The aim of this chapter is now to identify, characterize and compare a more comprehensive list of SCF solutions and applications and to provide example net benefit calculations. In other words, we help you answer the question of ‘which one do we implement and why?’ SCF builds the connection between the financial and the physical supply chain (SC) to improve the cash or cost of finance position for one or more of the parties in the chain. So, for the purposes of this chapter, we will include all approaches that change or modify the standard buyer–supplier terms of payment, whatever these typically happen to be for the industry, commodity, country or legal environment. The key criteria for selecting between SCF options is a better net benefit for one or another, or hopefully all, parties along the chain. There are then subsidiary criteria, such as implementation costs, operating costs, risk and reputation to be considered. Despite the existence of a wide variety of SCF solutions and applications, a consistent definition for the universe of possible tools has, to the best of our knowledge, not yet been established. In our approach, we distinguish between three main categories: supplier-oriented or Accounts Receivable (AR) solutions, buyer-oriented or Accounts Payable (AP) solutions and focal company (FC) specific solutions that may be applied by both suppliers and buyers for inventory and other assets. Of the three, the AR and AP options are more numerous and technologically well developed. However, although least mature, inventory financing solutions exhibit great funding opportunities and cost-saving potential. The objective of the chapter is to help guide readers towards the most suitable SCF approach and an appropriate business case.

The value proposition

Overview of chapter contents As illustrated in Figure 6.1 the universe of SCF solutions considered covers 16 approaches, with six in each of the AR and AP spaces and four focused on inventory and fixed asset financing. The next three sections of this chapter deal with each of these in turn. All of the solutions enable a situation-specific management of WC, either stretching or shortening average ­payment timings. They can also generate added value in various different areas: funding advantages, trade risk reduction, administrative cost savings, reporting benefits and enhancement of SC relationships. The main risks are in i­mplementation, Figure 6.1  Overview of supply chain finance solutions Supply chain section WCM reference point

Inbound supply chain

Approved payables financing

Accounts payable

Purchase order financing Dynamic discounting Reverse factoring

Inventories Collaborative inventory management

Inventory financing - On-balance - Off-balance

Reverse securitization AP based buyer leasing Supply chain internal Financing models Supply chain external

Outbound supply chain

Liquidity

Procurement cards SCF solutions

Company focus

Buyer

Accounts receivable Collective invoices Sales offer financing Invoice discounting Factoring Invoice securitization

Fixed assets financing in supply chain

Focal company Single-FSP Multi-FSP Multi-investor

AR based vendor leasing

Supplier

Approved receivables financing

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c­ ustomer or supplier engagement, reputation and access to s­ ufficient funding at attractive rates. Thereafter we cover other SCF approaches that do not fit into the above. This is followed by cost-benefit examples for invoice factoring (IF), r­ everse factoring (RF) and dynamic discount (DD). We then provide a set of decision trees to help the user identify the best solution. In the penultimate section we look at SC techniques that are complementary to SCF and in the final section there is a summary and a comparison table for all the solutions discussed.

Accounts payable solutions Procurement cards (P-Card) A P-Card enables organizations to bundle payments together and settle them periodically rather than individually. However, suppliers are usually paid within a few days by the card provider. A procurement or purchasing card is, in essence, similar to a corporate card used by company representatives for their business expenses except that it is used for B2B purchases and often ‘imbedded’ in a purchasing system. It can usually be set up with special characteristics, such as user permissions and spend value limitations, and reporting will provide more detailed information than using an individual employee’s corporate card directly with a supplier. The P-Card can be seen as a buyer-centric SCF tool that connects a buyer, various suppliers and a financial services provider (FSP) that handles the transactions and allows the buyer to pay on a frequency agreed upon with the FSP. Its key benefits for both main parties, buyer and supplier, emerge especially through its usage with small value transactions or with one-off or ad hoc suppliers that would otherwise burden a buyer’s and a seller’s accounting departments. In these transactions, a P-Card achieves a reduction in average time needed to initiate a purchase, removes the need for a full purchase order (PO)/invoice process for each purchase, avoids having to set up new suppliers in the buyer’s systems but still enables itemized/line item tracking (Graves, 1998). Usually, buyers pay on a 15- or 30-day period. Transactions are directly linked with a corporate accounting and expense system to recorded individual line items to enable integrated cost reporting. Usually, P-Cards do not carry any interest for the buyer as long as invoices are paid in the agreed upon timeframe. As payments go through on a ­periodic

The value proposition

Figure 6.2  Procurement cards (1) Purchase order Buyer

Suppliers (3) Ship goods

(2) Pay invoices for buyer company

(5) Pay monthly P-Card bill

Financial service provider

(4) Report spending to accounting system

basis, this also achieves an increase in average DSO for the buyer. However, suppliers usually pay a transaction fee, often a percentage, that can be seen as the price of having certainty of when they will be paid. Illustrated in Figure 6.2, the buyer commits to a P-Card program from an FSP (most banks offer such a program to their corporate clients). (1) The users order from the suppliers often through a purchasing or catalogue system and without having to raise a PO. The supplier is paid by the card provider (2) often after a percentage charge is deducted for the service. The goods are shipped (3) and the link between the financial institution’s P-Card system to corporate accounting tools enables control of transactions and spending (4). Consolidated payments are made on pre-agreed timetables, usually 15 or 30 days (5).

Purchase order (PO) financing In its simplest form, a buyer may make a financial commitment or a prepayment to a supplier before delivery in order to secure the order and to reduce the supplier’s need for finance and thereby the associated cost and risk. PO financing is an externally funded version. In a typical transaction, there are three parties: a buyer, an FSP and various suppliers. This buyer-centric approach enables a buyer to support delivery of orders it would not be able to otherwise, due to limited financial resources of its suppliers and limits to its own ability to fund the suppliers directly. It is very attractive during periods of rapid growth or the introduction of new products

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when WC at both buyer and supplier is stretched. It is also a solution for ­capital-intensive products. The funding can be used by the supplier to finance both the raw materials as well as the manufacturing itself. This funding comes at a cost, usually a fee to the FSP or in the form of a discount to the sales price offered to the buyer. The PO is the collateral for the FSP (GSCFF, 2016: 55ff). The key risks are the performance of the supplier in manufacturing the goods and the ability of the buyer to settle at some later date (GSCFF, 2016: 54). Hence, it is usually the case that long-term and strong relationships are in place. The pre-shipment finance process may take a number of variations, of which two are displayed in Figures 6.3 and 6.4. In Figure 6.3 the buyer issues a PO (1) and would like to obtain financing for the supplier. The purchaser submits a financing request with an FSP using the PO (2). The FSP will conduct a credit assessment of both the buyer and the supplier. If the FSP accepts the credit risk, or a proportion of it, it pays the supplier(s), usually for a fee to the FSP or a discount to the buyer against the sale price (3). Once the suppliers ship the goods or after shipment has taken place (4), the buyer settles its obligations, maybe including interest payments for the loan with the FSP (5). Figure 6.3  Purchase order financing (1) Purchase order Buyer

Suppliers (4) Ship goods

(2) Submit financing request

(3) FSP pays supplier before goods are delivered Financial service provider

(5) Repay FSP (incl. interest for financing activity)

SC PO financing This variation illustrated in Figure 6.4 is built on a chain-based relationship between suppliers, the focal company buyer, a customer and an FSP. The buyer receives a PO from a customer (1), which triggers the buyer’s need to

The value proposition

Figure 6.4  Supply chain purchase order financing (2) Raw material order

(1) Purchase order (Trigger) Buyer

Suppliers (5) Deliver raw material

(6) Manufacture & deliver goods

(3) Submit financing request

(4) FSP provides financing for raw material production

Customers

Financial service provider

(8) Pay outstanding balance

(7) Pay buyer receivables

source components from a supplier (2). The buyer applies for financing for its supplier using the customer PO as collateral (3). The process then follows a similar cycle as in the first variation.

Dynamic discounting In dynamic discounting (DD), the buyer and the supplier collaboratively adjust the standard payment terms dynamically (Kischporski, 2015: 53). In a traditional discounting approach, a buyer offers earlier payment of an invoice against a fixed sales discount. The DD approach uses variable payment durations and the amount of the discount declines proportionally as the normal time to settle approaches. The discount is often a linear function of the time outstanding. Additionally, while in traditional discounting the buyer offers a set early payment date in exchange for a certain discount, in DD suppliers may usually trigger early payments at a time of their choice. The main parties are a buyer, various suppliers and optionally an SCF platform that provides the IT infrastructure and sometimes external funding. The solution is a buyer-centric approach, but DD may be beneficial for both suppliers and buyers. Being able to select which invoices are to be paid early, as well as the timing of the invoice payments, enables suppliers to better manage their liquidity position. They are able to reduce their DSO and shorten the CCC. On the buyer side, a DD solution may increase supplier

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The current practice

loyalty as it enables a company to provide its suppliers with their payments earlier. Innovative DD providers have started to introduce a marketplace model where prices and time of realization are flexible, and a buyer’s desired rate of return and supplier offers are matched automatically. Historically, most DD has been internally funded using the buyer’s existing financing arrangements. However, the platform providers who support DD are increasingly providing access to external finance as described in the section on ‘Funding models’ below. Illustrated in Figure 6.5, the supplier delivers its goods or service and invoices the buyer (1). The buyer releases those invoices eligible for early payment on the SCF platform and proposes the associated DD offer, which can change over time (2). The suppliers select invoices for which they would like Figure 6.5  Dynamic discounting (1) Provide goods & send invoice Buyer

Suppliers (5) Payment of outstanding amount

(3) Request early payment

(2) Release eligible invoices

SCF platform (4) Update ERP

Standard discounting (static)

Dynamic discounting

2.5%

2,5%

2.0%

2,0%

1.5%

1,5%

1.0%

$$

1,0%

0.5% 0%

0,5% 10 Days

30 Days

0%

$$

$$

$$

5 Days 10 Days

30 Days

The value proposition

to receive early payment and accept the respective discount (3). The information gets updated in the buyer’s systems (4) and the payment of the net amount outstanding to the supplier is released (5). In the case of external financing, the final step is the settlement by the buyer to the funder, usually at some fixed period – similar to reverse factoring (RF), as described in the next section. Note that only eligible payables can be financed. For example, payables must be free from any liens or security interests and not have been previously pledged or sold (Aite Group, 2014: 10).

Reverse factoring RF enables a buyer to finance its suppliers using the buyer’s credit rating. This compares with traditional invoice factoring where the supplier itself gains funding against an invoice. The SCF solution is buyer-centric and involves the usual three parties: a buyer, suppliers and one or more FSPs. The FSP has a contract with the buyer. RF may improve a buyer’s liquidity position as the company is able to stretch its DPO while the supplier gets its invoices paid early reducing its DSO. Supplier loyalty may be strengthened. Approved invoices or payables can actually be funded by one or more FSPs. Reasons for choosing a multi-FSP solution are to not be dependent on one single financial institution (Zakai, 2015: 2) or to gain access to a broader range of financing opportunities that might otherwise be limited by geographical scope or some specific product features. (See also the box ‘Funding options’.) Figure 6.6 illustrates RF with one or more FSPs. The starting point is the transaction between the buyer and the supplier (1). The supplier invoices the buyer via the platform, as in this example, or directly to the buyer (2). In either case the buyer receives invoices into its ERP system (3). As the buyer approves the payable, this is communicated via the SCF platform (4), allowing the suppliers to see it. The supplier can usually either choose to wait until the payment term expires and the buyer pays the invoice, or decide to request the early payment (5). If early payment is requested, the FSP accepts the request via the platform (6) and pays the invoice, withholding the discount (7). When the agreed payment term between the FSP and the buyer expires, the buyer makes the payment to the FSP for invoices that have been financed (8).

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Figure 6.6  Reverse factoring

Suppliers

(5) Request to sell entitlement to payment

(1) Place order and send goods

Buyer

(2) Submit invoice

(3) Receive invoice into ERP (4) system Communicate approved invoices SCF Platform

(6) Supplier’s request communication (7) Advances cash, withholding discount

One or more FSPs

(8) Pay invoice at maturity

Funding models The first choice is between self-funding or from a third party, where the options are one-funder, multi-funder or funder-pooling solutions (EBA, 2014). With self-funding the finance requirement is part of the overall WC and cash needs, which in turn may be funded externally through equity, bonds or debt. So, the funding may still be external, but we can describe this as indirect external funding as far as SCF is concerned. The cost will be the average cost of the overall funding, generally the WACC. Generally, DD is self-funded while other SCF solutions use one of the following options. The one-funder model has a single FSP. For international programmes, the FSP may operate through a network of assisting, or ‘correspondent’, banks to support elements of the transaction, particularly payment. The cost is set by the specific arrangements that, in the case where it is not the buyer’s usual bank, may be based solely on the risk associated with payment of the relevant invoices. In a multi-funder model, the buyer generally opts for a service or platform provider that is set up to access multiple FSPs. The buyer chooses from among the participating funders based on geography, costs, etc and

The value proposition

can vary these over time as required. This approach can be described as a ‘hub and spoke’ model where the platform interconnects the systems of the various constituents, increasingly in a ‘plug-and-play’ fashion. Finally, the funder-pool model can be described as an ‘intermediation’ approach, where the service provider acts as an intermediary or broker with access to primary and secondary financial markets. Funding can come from banks, insurance companies, other corporates or alternative finance sources, such as crowd funding. By doing so, the buyer may benefit from a wider pool of available funders without having to choose one specifically and can automatically access the most competitive rate available. In practice, suppliers upload or mark their invoices electronically on a platform that are associated with information regarding the buyer’s credit rating, the early payment amount and payment maturity terms. Funders or investors can then bid for a bundle of invoices (see ‘Securitization’).

Securitization With a securitization approach, funding comes via the finance markets. This allows businesses to avoid the use of bank loans, capital increases or the direct issue of bonds as part of their general funding but allows for credit to be provided by equity- or bond-like market processes based on a single BS asset type (Jobst, 2008). Although securitization was initially used to finance simple self-liquidating assets such as mortgages, it rapidly became a common financing technique using all types of assets with stable cash flows, such as corporate and sovereign loans, consumer credit, project finance, trade receivables and individualized lending agreements, which fall under the name of asset-backed securities (ABS). In the world of SCF, securitization has come to invoices, or receivables, and more generally to all working capital. The mechanism used is an irrevocable payment undertaking (IPU), an obligation by a known corporate to pay a known amount of money on a known future date. In financial terms it is a single-name senior unsecured corporate credit risk (Greensill, 2020). According to Katz (2011: 26), given that receivables are typically the largest single asset category on companies’ balance sheets, they are a natural choice for securitization. The assets to be financed are often sold to a special purpose vehicle (SPV), which is a separate fund set up to hold the invoices as assets. The SPV then sells them to private and institutional investors on the capital market, usually bundled into common maturities, common risk

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profiles and with/without insurance. The pricing, transparency and structuring discipline of the capital markets should result in the best possible funding option for companies. Further, it is assumed that securitizing reduces the specific capital exposure for the involved parties, lowers risks and creates more efficient prices with benefits for the entire trade community involved (Miller, 2007). With the rise of specialist FSPs with associated technology platforms, securitization financing can challenge a domain that has traditionally been ruled by specialized banks and offer a simpler and more flexible solution more suited to all, including SMEs. Figure 6.7 illustrates a technology platform-driven buyer-led securitization approach. We pick up the process from the point when the supplier decides to request early payment. The issuing and paying agent receive the issuing information (registration criteria) from the service provider (that can be the arranger) (4) and issue a new commercial paper or note via a central security Figure 6.7  Reverse securitization Buyer (as the originator)

(1) Send invoice

Suppliers (as creditors)

(3)

(6) Receivable purchase & true sale

Req

ues

t ea

rly

t

en

ce

i vo

pay

me

nt

m ay

p

Technology platform service provider and arranger

In

) (7

(2) Payable approved & invoice upload

SPV

(4 Trustee

)I

ss

Legal adviser

ui

ng

Investors

in

fo

Auditors

rm

(8) Note redemption SPV’s custodian

at

io

n

(8) Note redemption

CSD (5) Cash settlement (8) Redemption

SOURCE Hofmann et al (2017: 33)

(5) Note settlement

Investor’s custodian

The value proposition

depository (CSD) (5). If securities are successfully settled (which typically occurs in two or three business days after trade), the SPV will instruct payments, with the discounted invoice amount, to the supplier (originator). The successful securities settlement is the condition precedent for the assignment of the receivable from the supplier to the SPV (6). When the agreed payment term between the supplier and the buyer expires, the buyer makes the payment to the owner of the invoice (ie SPV) (7). At the securities’ maturity, the SPV redeems the principal and interest on the issued securities (8).

Know your customer (KYC) To protect the global financial system from being used for illegal activities by money launderers, criminals or terrorists, FSPs have to perform ‘know your customer’ (KYC) processes for every new customer, for example the suppliers in RF. Identifying each likely user and collecting the relevant information is a particularly time-consuming and costly task for multinational corporations that have suppliers from all over the world. A survey from ICC Global Trade Finance (2014) points out that the principal reason for rejecting trade financing proposals is the burden of KYC procedures, particularly when dealing with foreign suppliers (APEC, 2015: 35). Compliance requirements could thus be identified as one of the principal barriers in delivering SCF by institutions covered by banking regulations and for the rise of alternative finance providers and multi-pool or securitized models described earlier where such processes are less stringent.

AP based buyer leasing AP based buyer leasing aims to reduce the initial investment required for larger capital items, often production machinery, and can in some cases help facilitate ‘pay by use’ arrangements. AP leasing is a buyer-centric SCF approach in which a buyer, supplier and the leasing company (sometimes a bank) are involved. The advantage is that the buyer can start to use the asset, hopefully earning a return to pay for it. The payment may be delayed in time and split into tranches, which enables an optimization of liquidity and cash flow. In the past and in some financial jurisdictions, depending on the form of the leasing agreement (operating or financing), the solution enabled the buyer to reduce its BS related capital commitment, as the capital good did not have to be declared fully as a fixed asset. However, recent IASB rules,

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The current practice

eg IFRS 16 effective 1 January 2019, require nearly all leases to be recognized on the BS. Accounting treatment of leasing is discussed in more detail in Chapter 7. On the suppliers’ side, the financing may lead to increased and earlier sales as well as the timely payment of AR by the FSP and therefore reducing DSO. The downside of this approach is the leasing fees that materially impact income, and as with the other leasing solutions discussed later, the net impact on the IS depends on the accounting treatment and the difference between costs and the depreciation that would be charged if the asset were owned directly. Figure 6.8  Accounts payable based buyer leasing (1) Deliver capital goods on credit Buyer

Suppliers

(4) Pay invoice

(2) Sell capital good to the leasing company (5) Pay leasing fees Financial service provider

(3) Lease capital good back to the buyer

Figure 6.8 illustrates AP based buyer leasing. The supplier delivers the capital goods to the buyer (1), who then transfers the title to a leasing company, an FSP (2). The buyer leases the capital goods from the FSP (3). The FSP now has a payment obligation towards the suppliers and pays their invoices (4). Finally, the buyer pays leasing fees to the FSP (5) and when these are complete gains full title and ownership of the asset.

Accounts receivable solutions Collective invoices If goods are delivered regularly to a customer, collective invoicing can be used to reduce the number of invoices and financial transactions and thus the related administrative costs and external transaction fees. Both buyer

The value proposition

and supplier have to agree and are involved in altering the processes of ordering and then summarizing the purchases and paying the invoices of all the deliveries in a certain period. The same requirements as for individual invoices are usually required; the same item or line-level information for each item or service needs to be provided. There may be movements in the inventory and AR for the supplier compared with individual order and invoice. Invoices will effectively be delayed by up to 30 days, if the agreement is for monthly invoicing, for items which would have normally been delivered and invoiced nearer the start of the period. The value will remain as inventory on the seller’s BS, only becoming AR when the invoice is issued. There will be matching/timing impacts on the buyer’s BS and AP. Finally, the supplier’s risk of buyer insolvency may increase due to fewer dates of payments. For the above reasons, this approach is usually adopted for lower value items and between organizations with an established trading history.

Sales offer financing SOF solutions support suppliers to achieve two main goals: promote sales of their products and create financial flexibility for their customers so they can more easily afford the purchase. A supplier may simply grant a longer repayment period or split the amount due into tranches. SOF is a supplier-centric SCF solution and takes place between three main actors: supplier, one or more buyers and potentially an FSP. In an internal solution the supplier itself provides the financing; in the external solution the company relies on an FSP with the FSP mainly using the supplier as a known/trusted facilitator for the loan that will be with the buyer. The longer payment period may have another advantage for suppliers, as offering an SOF may lead to an increase in the net price compared to having to offer a sales discount to secure the sale. Using an FSP helps the supplier to optimize their WCM vs internally funded SFO. There are associated costs based on the rates that FSPs charge the buyer as well as the costs incurred to set up the SOF solution. These may be covered by the seller or buyer depending on the sales strategy. The risk profile of the sale changes as default could occur over a longer period. For the buyer, SOF solutions enable a more stable cash flow, as outflows can be distributed throughout a longer time interval. Overall for the buyer, the average DPO may be extended, which leads to a better WCM.

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Figure 6.9  Sales offer financing (1) Deliver goods Buyers

Supplier (3) Use loan to pay goods upfront (4) Repay loan incl. any interest payments due Financial service provider

(2) Provide loan

Figure 6.9 illustrates the externally funded SOF process in which the supplier delivers goods to a buyer (1) in a transaction that the supplier offers to facilitate by a loan/delayed payments from an FSP. This helps the buyer to (partly) finance the transaction (2). The buyer may therefore settle their obligations with the supplier as agreed (3). The seller repays the FSP (4).

Invoice discounting The most common form of ID is when the supplier offers the customer a discount for early payment. For example, payment is normally due in 30 days, the customer can pay within 10 days for a 2 per cent discount. This is a case of self-funded SCF. Alternatively, suppliers can obtain early funds by selling rights to unpaid receivables, AR, to an FSP. Unlike traditional factoring, receivables are not transferred to the FSP but are used solely as collateral for obtaining liquidity. The FSP obtains rights to the outstanding obligation and provides financing as a proportion of the face value in advance, which includes a security margin that is pre-agreed by the seller and FSP (EBA, 2014: 57; GSCFF, 2016: 28). It is important to note that control of the AR remains with the supplier (Grath, 2014: 154–55). The contract is a supplier-orientated SCF solution and includes just the supplier and the FSP. The buyer is not part of the transaction and may not be informed about the arrangement as the use of factoring might be considered to show that the supplier is in some form of financial distress. However, some purchase arrangements include conditions that stipulate that the buyer must be briefed.

The value proposition

The ID is usually used for financing an element of a company’s receivables, rather than individual invoices. The maximum amount agreed in advance depends on a variety of risk criteria and gets fixed for the duration of the mandate, all based on the FSP’s assessment of overall creditworthiness. The agreement usually includes a recourse claim on the supplier’s other assets. The supplier hence still bears the credit risk and must repay the FSP independent of the buyer being able to pay its debt (Grath, 2014: 155). ID enables a company to optimize its WC as receivables are paid early and the DSO of the supplier can be reduced. As the FSP usually has recourse rights on the supplier, this tool is not useful for reducing a company’s risk exposure. The use of software platforms provides companies with flexible access to liquidity and simplifies the payment process while also reducing the risk for FSP through increased transparency. Illustrated in Figure 6.10 in an ID transaction. A supplier delivers goods and an invoice, generating AR on its BS (1). The FSP has sight of the invoices, usually via an online platform (2). The FSP pays the agreed percentage of total receivables (say 70–90 per cent) to the supplier (3). As the buyer settles its outstanding invoices with the supplier (4), the supplier uses that money to repay the prepayment of the FSP including all interest and fees. Figure 6.10  Invoice discounting (4) Pay invoices Buyers

Supplier (1) Deliver goods on credit (receivables) (2) Upload invoices (5) Pay back prepayment incl. interest & fees

(3) Cash prepayment of receivables

Financial service provider

Invoice factoring In IF, a supplier sells invoice(s) to an FSP, transferring ownership completely unlike ID, as above. It is supplier-centric SCF and usually involves a contractual agreement between a supplier and an FSP, often called a factor, much

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like for ID, for whole segments of the supplier’s AR. The buyer is usually not part of the contract but for the most part is informed about the factoring agreement as they will usually pay the FSP rather than the supplier when payment is due (GSCFF, 2016: 41). The supplier receives a discounted early payment (outstanding amount minus factoring fee). With the sale, the FSP obtains ownership of the claims and is responsible for managing and collecting the balance outstanding from the customer. Hence, factors are usually specialized organizations that explicitly target the receivables collection market and serve a broad client base (GSCFF, 2016: 41). Factoring generally offers three main advantages to suppliers: WC optimization, insurance against buyer default and outsourcing of receivables collection: ●●

●●

●●

Factoring increases liquidity and enables an optimization of WC. At the cost of the discount, outstanding invoices are paid early by the financial institution, which reduces DSO and the CCC. Clearly the supplier only engages in IF if the cost, the discount to the invoice or sale price, is less than the cost of its other sources of finance. In practice, the risk of default by the customer base, which is often larger and more financially secure, is evaluated by the FSP and, on this basis, the discount rate can be better priced than the supplier’s WACC. Furthermore, in its usual form, the FSP does not have any recourse claims on the supplier. Therefore, the factoring solution provides risk mitigation as it is protected against payment default or delay of its customers (Grath, 2014: 157). Finally, companies who use factoring for a significant proportion of their invoices are able to reduce selling, general and administrative (SG&A) costs as they are effectively outsourcing cash collection activities. The FSP may even take care of supplier accounting and evaluation of creditworthiness (USAID, 2010: 4).

IF is illustrated in Figure 6.11. The supplier delivers goods and an invoice to the customer (1) (2). As goods are not yet paid, the outstanding money owed results in AR on the suppliers’ BS. The supplier now sells the ownership of those receivables to an FSP (3) in exchange for a cash payment. The amount of the payment depends on the value of receivables sold as well as the factoring fee, which is deducted from the amount outstanding (4). The FSP takes on ownership of the receivables and is in charge of administering and collecting the invoices outstanding (5). The payment obligation hence is between the FSP and the buyer, who in a final step repays the outstanding balance (6).

The value proposition

Figure 6.11  Invoice factoring (1) Purchase order Buyers

Supplier (2) Deliver goods on credit (receivables) (3) Sell ownership of receivables for a factoring discount

(4) Cash advancement of accounts receivable

(6) Pay outstanding balance

Financial service provider

(5) Collect outstanding invoices

Invoice securitization Supplier- or seller-led invoice securitization is very similar to that described above for buyer-led RF solutions. The overall process of securitization is also described above in the AP solutions. Supplier-led IS adds additional liquidity to supplier-led IF by bundling and selling AR on the capital market, rather than to a single FSP. However, to make the opportunity significant and attractive to external investors, the amounts purchased usually exceed US$ 100 million requiring a large critical mass of invoices from a single supplier.

Supplier-led leasing In supplier-led or ‘vendor’ leasing, suppliers of investment-intensive goods aim at stimulating sales by offering their customers a lease financing solution instead of a single payment. The end result is similar to buyer-led l­ easing with the key difference being that the arrangement is proposed and facilitated by the supplier. The financing may be both provided by the supplier itself or via a leasing company, an FSP. Many large multinational machinery companies have groups or departments to manage such leasing services.

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Inventory financing Inventory challenges in supply chains As outlined in Chapter 1, optimization of financial flows in the SC is one of the key elements for the economic success of a company. And in Chapter 2 we discussed how, in addition to AP and AR, inventories are a lever in WCM. Inventory financing is an SCF solution for this area and can be divided into three different approaches reflecting the BS priorities of the buyer company: ●●

●●

●●

First, inventory could be financed in a collaborative way among the members of an SC. In such an ‘inside network internal financing’ approach, the financially strongest party – the so-called focal company – with the lowest WACC provides financing of the inventory for its SC partners. Such a collaborative inventory management is possible with suppliers in the inbound SC or with customers in the outbound SC. Second, it is possible for a company to finance inventory by means of a secured credit transaction without transferring the economic ownership to third parties (on-balance sheet inventory financing). In such an ‘inside network external financing’ approach, this can be applied to its own inventory or to that of customers or suppliers. Third, by means of off-balance sheet inventory financing, the financing can take place via a third institution that acts as the interim owner. In such an ‘outside network external financing’ approach, LSPs can be that party. The accounting treatment is an important issue for off-balance sheet solutions and is discussed in the box ‘Implications of accounting standards for inventory financing’.

Collaborative inventory management SC members aim to reduce the total chain’s inventory and capital ‘tied-up’ costs by optimizing inventory and shifting WC to the entity with the lowest financing costs. The solution may be supplier or customer orientated with no additional FSB or other third party. The analysis is based on Hofmann and Kotzab’s (2010) conceptual idea of a collaborative WCM approach that may bring benefits to the various entities in an SC. The theory recognizes that evaluation of CCC and its

The value proposition

c­ omponents in time format, usually counted in days, is not sufficient as the time spans also need to be valued. WACC is proposed as a proper metric for the valuation of these spans. Valuation of the time tied up in inventory implies that for a company with a higher cost of capital, an equally long cashto-cash cycle (C2C) is more costly than to a company with a lower cost of capital. Figure 6.12 illustrates this in a specific example. Figure 6.12  Collaborative inventory management in supply chains Supplier capital lockup

Focal company capital lockup

WACC supplier >

WACC focal company

Buyer capital lockup

Usual situation Collaborative approach

WACC

Usual situation (self-centric)

< WACC buyer

Collaborative approach

WACC

‘Collaborativegain’

The starting point is the difference in WACC between the three participants: FC, supplier and buyer. It might make sense for a company with a lower WACC (focal company in our example) to stretch its CCC cycle and reduce the more costly capital lockup of its SC partners. The figure shows that by extending the capital lockup of the FC, companies may unlock a so-called ‘collaborative-gain’ (marked in grey). The FC has voluntarily stretched its capital lockup period and therewith associated costs for the benefit of the chain. Needless to say, it must be reimbursed for the additional cost it has encumbered itself with. This does not have to take place with a cash settlement but may benefit the FC in various other ways such as increasing delivery and order volumes, any add-on services provided by supplier and buyer, or other preferential treatment by both buyers and suppliers.

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On-balance sheet inventory financing The aim is to generate cash by utilizing a collateralized loan based on the company’s inventory. In contrast to the off-balance sheet solution, inventories remain on the buyer’s BS and serve only as a guarantee (collateral) for a credit agreement. It is usually applied for either marketable commodities or finished goods, for which a buyer has already been identified. The main actors in the transaction include the borrower, an FSP as well as a third-party warehouse or logistics provider or a collateral management company that acts as the custodian entity to confirm the value of goods and provide storage facilities (EBA, 2014: 3). The main advantage for the supplier here is readily visible, as the company is able to enhance its liquidity position against collateral on its BS. Key risks are the ability to sell inventory in due time in order to be able to repay the loan outstanding, and quality or damage issues regarding the inventory that would decrease its value and hence lower collateral amount. However, these risks may be mitigated using inventory insurance. For the FSP, it is important to be able to dispose of the inventory (collateral) and at estimated market value in case of illiquidity or insolvency of the borrower (GSCFF, 2016). Figure 6.13  On-balance sheet inventory financing (4) Purchase order (7) Payment at due date Buyers

Supplier (5) Send invoice (1) Send inventories

(6) Send goods

Custodian/ Warehouse

(8) Repayment of loan

(2) Information regarding collateral

Financial service provider (3) Extend loan

The value proposition

Illustrated in Figure 6.13 in a general (supplier-orientated) inventory financing process, the supplier delivers the inventory to the custodian or warehousing company, which stores the goods (1). The custodian then informs and frequently updates the FSP on the condition and estimated value of the collateral (2), on the basis of which the FSP extends a loan to the supplier (3). In the case of a PO of the buyer (4), the supplier sends the invoice (5) at the same time as the goods to the buyer (6) and uses the liquidity from the buyer’s invoice payment (7) to repay part of the loan to the FSP (8). The outflow of goods from the warehouse lowers the collateral value for the FSP. This implies that the supplier may either send additional goods to the warehouse or repay part of the loan to match the contractually agreed-upon loan/collateral balance.

Off-balance sheet inventory financing Off-balance sheet inventory financing refers to the financing of inventories where operational goods, logistics and ownership are transferred to an external third party. In most off-balance sheet inventory financing solutions, the three main parties are a buyer, a supplier as well as an LSP and, depending on the contractual structure, also an FSP. Most commonly, the solution is applied for either marketable commodities, for which a value is readily available, or finished goods, where a buyer has already been identified (EBA, 2014). Lack of marketability makes work-in-progress (WIP) inventory an unlikely candidate for off-balance sheet solutions. Off-balance sheet inventory solutions bring benefits to all actors participating in the transaction. The LSP is able to present itself to potential clients as a full-service provider and increase its product range as a one-stop shop for all inventory-related services. Additionally, customer relationships are strengthened, and it may profit from follow-up orders. Suppliers, on the other hand, are able to optimize their liquidity as the inflow of cash usually takes place earlier, the DSO is shortened and hence the CCC as well. Furthermore, the commitment to purchase, which is usually an integral part of the agreement, has a risk mitigating impact on the supplier (Hartmut, 2017: 292–93). The buyer may have the biggest benefits from this transaction with a reduction in costs due to lower storage and logistics costs and an even more important increase in liquidity through a reduction in the capital tied up in the inventory. The DIO values decrease, which in turn leads to a decrease in C2C and therefore optimization in WC.

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An exemplary process of an off-balance sheet inventory transaction is provided in Figure 6.14 and is based on the illustration of Hartmut (2017: 291).

Figure 6.14  Off-balance sheet inventory financing (1) Agree on contract Buyer

Suppliers

(3) Sell inventories

(6) Cash payment

(5) Cash payment

Logistics service provider

(4) Sell inventories

(2) Provide additional capital FSP

First of all, the supplier and the buyer agree on the contractual framework and conditions, which usually comprise amounts, prices, as well as an acceptance guarantee for the inventory (1). The LSP may now co-­operate with an investor or FSP to obtain additional funding (2), which they use to purchase the inventory from the supplier and assume ownership (3). It is ­possible that the LSP undertakes additional effort such as refinement or labelling. In a next step, the supplier sells the inventories to the buyer (4) who in turn provides the cash payment to the LSP (5). Finally, the LSP reimburses the supplier for the inventories sold according to the initially agreed-upon contractual conditions (6). Additionally, in another variation illustrated in Figure 6.15, the transaction may also involve a custodian service provider that is employed with a service contract to deliver information regarding the inventory to all parties involved and acts as a mediator (7).

The value proposition

Figure 6.15  Off-balance sheet inventory financing (custodian alternative) (1) Agree on contract Buyer

Suppliers (7) Custodian service provider (3) Sell inventories

(6) Cash payment

(5) Cash payment

Logistics service provider

(4) Sell inventories

(2) Provide additional capital FSP

Implications of accounting standards for inventory financing Whether the inventory is ‘on-balance sheet’ or ‘off-balance sheet’ depends largely on the accounting standards in the country or region. In practice, legal advisers and accountants or auditors have to interpret these and so variation of what can be classified as off-balance sheet can vary even within a country. Despite this uncertainty, we can outline the key issues to be considered. IAS and IFRS frameworks: International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS) regulate the fundamentals of global accounting and financial reporting. They comprise definitions, accounting approaches and valuation principles of assets, liabilities and reporting items. On-balance sheet solutions are typically credit transactions that are addressed in IFRS 9, among other Standards. This Standard deals with the treatment of financial instruments, which also includes financial liabilities. Since this is purely a matter of financing the inventories by taking out a loan, only the liabilities in a BS are increased. This SCF solution is not

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subject to any special accounting requirements and has become an established practice. An off-balance sheet solution pursues the goal of derecognizing inventories from the BS. These are to be transferred to the BS of a third party. The principle of substance over form plays a particularly important role here. In addition, the question of control within the meaning of IFRS 15 must always be clarified and when exactly the assets are transferred to the customer or buyer. An important factor for classification is also the adoption of the associated benefits. In addition, the aspects of IFRS 10 must also be considered, whereby it must be determined whether a possible third party is to be included in the scope of consolidation or not. Here the issue of control or control over portfolios plays an important role as well. In conclusion, from an accounting perspective, there are no difficulties with on-balance sheet solutions. For off-balance sheet inventory financing, on the other hand, certain aspects have to be taken into consideration in order to achieve the intended goal of outsourcing inventories and thus to profit from an optimization of WC.

Structuring approaches for off-balance sheet inventory financing solutions In order to meet the challenge of aligning off-balance sheet solutions with local or IFRS Standards, a company may consider various structuring approaches. However, many sale and buy-back, sale and re-sale arrangements no longer meet accounting standards as ownership allocation is no longer a decisive criterion. Practical requirements for off-balance sheet financing solutions: Here we use the example of an LSP providing the finance. However, the implications also apply to other inventory solutions. Three aspects can be outlined as most relevant in this context: ●●

●●

The material or physical risk associated with inventories must largely lie with the LSP. This includes the risks associated with obsolete, damaged or lost inventories. This applies in particular to the period during which the assets are in its warehouse. The material risk during transport is not necessarily carried by the LSP. The relevance of control over inventories represents an extremely important prerequisite. The LSP must be entitled to dispose freely, without the influence

The value proposition

of third parties, of the use of inventories. It has to decide autonomously and independently of the supplier to which customers it wants to resell the inventories. In addition, it alone must be able to benefit from the associated advantages in terms of economic improvement. ●●

The final and most important criterion is the performance risk. If, at the time of resale to the customer, the goods do not correspond to the agreed performance, the LSP must be fully liable and may not assert any claims against the original supplier. As soon as the supplier is held accountable, this criterion is no longer fulfilled.

Other solutions Fixed assets in a supply chain (sale-and-lease back) In the sections above, we described buyer-led and supplier-led lease finance approaches as an option to help facilitate purchases and sales, respectively, of larger, usually ‘capital’ items. However, sale and lease back of an asset can take place independently of a new purchase or sale by the organization. The approach, benefits, costs and accounting issues are all described above.

Business case A number of comprehensive studies have been undertaken to evaluate the cost side of implemented SCF programmes, mostly RF, but there are very few studies that assess the benefit side and hence the return or payback from i­ nvestment in SCF. The benefit side is often described empirically from academic-based research. In our experience, networking and access to organizations that have implemented SCF are the most effective methods of understanding the actual costs and benefits. Taking time to establish personal contacts with organizations further along the journey is a good investment. Despite the lack of robust benchmarks, we present below a summary of the main factors found in the typical SCF business case and an example calculation. Generally, benefits and costs are described as tangible or intangible: ●●

Tangible: those that can be measured – time, money: {{

{{

one-off: received or paid once, typically during the start-up of the SCF programme; recurring: the ones that occur regularly or frequently.

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●●

These tangible items are measured in cash or resource terms: {{ {{

●●

monetized: easy to express in terms of cash; full-time equivalent (FTE): used for elements that are best compared by how people will be affected, and so definable as time spent by someone doing such activity.

Intangible: the ones not easily measurable – trust, satisfaction, improved supplier performance, reduced supplier risks.

Total cost of ownership (TCO) is considered the most comprehensive ­approach for evaluating the real financial implications of a project as the approach aims to capture all set-up, operating, periodic upgrading and endof-life costs. TCO requires a somewhat more complex treatment of time than is typically considered for an upfront investment payback or internal rate of return (IRR) analysis. Usually TCO is accompanied by a discounted cash flow (DCF). Organizations will typically have established standards for business cases and investments in programmes, such as SCF, and the corporate reader should adopt these while other readers can investigate best practice business case approaches. To develop the contents of the business case, let’s start with the benefits, then later look at costs and risks.

Benefits Despite the lack of comprehensive studies on benefits, authors like Tanrisever et al (2012) and van Laere (2012) have presented mathematical models to quantify the benefits for each party, concluding that SCF could improve the SC value by between 2 and 10 per cent of the price paid or the cost of goods. So, this is the theoretical target, but where do the actual b ­ enefits come from? The sources of the benefits of SCF are multiple and are depicted in Table 6.1 using the example cases of four SCF RF implementations. WC and cash flow management are the common tangible benefits. However, all the participants mentioned the financial support offered to key suppliers and the strengthened supplier relationships as great intangible benefits, contributing to the reliability and sustainability of their SC. Having established the source of benefits, we then need to look at the impact for each participant. The typical assumption is that bigger companies are better funded and at a lower cost of funds than smaller, apparently

Table 6.1  SCF cross-case benefits

Intangible

Tangible

Tel Co Pharma Co Chem Co Auto Co Literature Review Working capital improvement







Cash flow management







Value added in the balance sheet



Potential investment opportunity



Lower cost of goods sold





Reduced processing costs





Limited factoring of receivables



Builds goodwill with suppliers



Strengthened relationship with key suppliers











Financial support for strategic suppliers











Discipline and visibility in transactions









Negotiation tool (when the payment terms are long)







Clean settlement process



 

 











Risk awareness in the SC



Improved purchaser’s financial knowledge



Review of the supply base: harmonization of doing business





SOURCE  Cosse (2011) 253

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The current practice

riskier parties further up the chain. Clearly this is a very general assumption and is in many cases not true. However, to follow through this argument, the funds are passed along the chain so that those further up benefit in some way from the lower costs of funds available to the focal company. This is often called interest rate arbitrage, a term that implies taking a benefit from the differences between rates available to different parties or at different times. These general models need to be considered carefully – they are averages and may not be specific to individual situations in the SC. In one study undertaken as part of an MSc from the Cranfield School of Management in the aerospace industry fairly soon after the financial crisis, the surviving very small suppliers were the ones with no debt and high internal cash balances, which allowed them to take a long-term view of new business and get buyers’ commitments to long-term supply arrangements. For them invoicebased SCF was not relevant – capital, particularly bespoke tooling finance, was more critical as it tied into and reinforced the longer-term customer relationships. So, combining the change in cash amounts, the different costs of funds or capital and the time the cash is required leads to the following equation, which calculates the costs to the party providing the SCF and the benefit to the party receiving the funding: Benefit or Cost = Volume × Duration × Capital cost rate % Typically, business cases start with this calculation for the buyer and the suppliers and then add on the other elements. Note for some participants, this may be a negative amount to be offset by a supplier price discount or other payment. Finally, in this section on benefits, let’s look at the overall purpose of the SC – towards meeting customer demand. One of the major rationales for a company from a supplier-centric perspective to offer financing to its customers or buyers, is the upside potential in sales. A business expansion requires substantial investment, particularly for financing sales for industries with capital-intensive goods such as machinery or heavy equipment. Without financing, a cash restriction may impede growth in sales: although demand may be ample, low credit availability hinders the buyer from purchasing more goods or the supplier from providing them because the buyer or supplier simply cannot obtain further funds to finance the purchase or production. So SCF can give a competitive edge.

The value proposition

Costs As outlined earlier, SCF programmes incur tangible and intangible costs: ●●

●●

Tangible costs: such as IT implementation or update of an ERP system. The tangible investments and costs, which need to be met once at the beginning of the implementation, are generally easier to estimate with sound project planning approaches. Intangible costs: project management costs (resource allocation, internal and external training) and monitoring costs. In many cases, the intangible costs have been underestimated and keep occurring as the project rolls out. This applied to three of the four case examples. It is therefore essential to target the right supplier cluster to ensure that the benefits will be sufficiently significant to offset these costs.

As an example of the tangible costs involved, even in 2012 PrimeRevenue estimated the technology implementation costs to be approximately between US $50,000 and US $200,000. Obviously, this depends on factors such as the number of geographies involved and the number of ERP systems that feed data to the SCF platform. The same report identifies ongoing costs such as programme management resources. Then there is also the need to provide advice and assistance to the supplier organizations that want to utilize the SCF platform. This entails expert input regarding accounting structures, inter-operability and tax implications. A more complete table of costs is included in Table 6.2. These are all the costs ever mentioned in many case studies – some may not be relevant; some may be trivial.

Risks SCF can reduce overall business risk by increasing funding and financing options available through the SC. However, in some ways, risk increases by tying the parties closer together and extending the time at which settlement is still open, so making the impact of failure by one participant in the chain more extreme. (See discussion earlier in the chapter on irrevocable payment undertaking.) First, here are the arguments for reduced risk. SCF can impact demand uncertainty, buyer base solvency, process quality and internal controls, and also, potentially, FX management:

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Table 6.2  Cost categories Software implementation and upgrades costs: Technology development costs Purchasing price IT staff for installation and maintenance IT maintenance cost Hardware and equipment cost to access the platform

Operating activities costs: Contract term negotiation Processing and tracking data and events Document verification and confirmation Errors and disputes management Due diligence activities cost On-boarding and recruitment cost

Legal procedures cost (to formalize Late payment penalties the agreement): Discount on invoice Staff of legal department Information asymmetries cost Missing information management cost Assistance cost Limits and thresholds cost Lack of understanding of concept, Private information sharing cost cost, benefits, fees and limitations Risk management cost of SCF solution Risk mitigation actions cost Training and education costs Provisions Fee structures: Opportunity cost Software implementation and Other financial charges (eg loan success fee) integration fee Behaviour not fully rational cost SCF platform software licence Cultural barriers cost or opportunistic Software service behaviour Transaction fees Credit rating possible deterioration Membership and administration Marketing efforts fee Insurance against insolvency and Fee on amount lent bankruptcy Fee on profit earned Control and fraud measures costs Additional services’ fees Arrears and default fees Switching cost: Upsets from system’s change Suppliers’ resistance to embark on programme imposed by buyers Loss of investment in prior system Lack of experience in using new system Incompatibility with other systems SOURCE  Molon (2015)

The value proposition

●●

●●

●●

●●

To mitigate the risk of demand uncertainty, SCF is a stabilizer in SC relations. Including the buyers in the financing network ensures a higher commitment to the SC. Although the entire market may experience economic downturns, the risk of buyer flight and the risk of a sales halt due to financial burdens are reduced. Along the same lines, the buyer and seller base solvency can be monitored more efficiently and use of a third-party funder releases pressure from the buyers and sellers, which, in turn, goes hand-in-hand with a more solid buyer and seller base. Furthermore, the integration fosters information quality and information sharing among participants of, for instance, their financial performance history and payment behaviour. Efficient reporting and monitoring are also imperative, considering the relevance to internal controls. Reports on exposure to funders, preferably on a daily basis and down to the item level, are stated as essential for risk management and mitigation. An FX management option can leverage the value-added of SCF solutions, if many buyers or sellers are operating in distant markets with nontradeable currencies. An option is for local clearing or netting of foreign currencies by the bank, SCF platform or alternative FSP.

As mentioned, however, risks can increase. Take, for example, a supplier whose WC is now supported by an SCF RF solution. If the customer’s financing costs rise, which might happen for many reasons, then the cost of the early payment may also rise – adding costs to the supplier or forcing use of other, possibly more expensive, financing sources. In an extreme case, we have seen an example where one customer withdrew its early payment model, in this case payment on order introduced in the last financial crisis to secure supply, which pushed the supplier into insolvency and so had a major impact on the supplier’s other customers. So risk is a key element of the decision process and will require analysis to confirm the impact of the SCF solution on the overall risk profile of the business and its SC. Chapter 7 contains a more detailed analysis of the risk situation, but for the purposes of defining the value proposition, a high-level risk assessment, as above, is appropriate. Next, we need to consider all the elements of the benefits, costs and risk, linking all this to shareholder value (SV). The framework given in Figure 6.16 presents the six most frequently cited characteristics of SCF solutions from the literature, positioned above the three major flows (goods, information

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The current practice

and cash) that operate within a typical supply chain relationship (SCR) between the FC and its suppliers and buyers. The framework also incorporates liquidity providers, therefore establishing a conduit to improved WCM, providing improved returns, and the link to improved SV related to improvements in cash management.

Figure 6.16  A shareholder value framework for SCF Dematerialization IT, automation

Visibility, transparency

Control

Cash management

Collaboration

Risk management

Focal company

Supplier

Goods Buyer Information

sh

Ca

Ca

sh

Liquidity providers DIO DPO

DSO

WCM ROR

Finance liquidities cash-flow

SCM stability reliability

Shareholder value SOURCE  Cosse (2011)

Examples net benefit derivation We will now show how to calculate the net benefits of a traditional factoring approach, RF and DD.

The value proposition

Factoring Factoring, described above, allows a seller to borrow in anticipation of payment by their customer. This example from Wetzel (2019), shows the impact that can have on reducing the time waiting for payment; see Table 6.3.

Reverse factoring The example calculations – taken from Hofmann and Belin (2011) – are carried out with the inputs provided in Tables 6.4 and 6.5 as well as the formulas provided to calculate the components of the cost-benefit and benefit analysis. In the analysis for the buyer or importer, the net benefit of the FC is calculated by adding the unlocked WC with the administration benefit and then subtracting the funding fee as well as any servicing fee. The result is the tangible net benefit to the buyer by implementing an SCF solution. To obtain the tangible net benefit to the supplier by implementing an SCF solution, the financing costs of the supplier are deducted from the unlocked WC. In the AR solution (supplier-led SCF), the net benefit analysis for the seller calculates the net benefit as the risk benefit plus the unlocked WC plus the administration benefit plus the savings in loss deduction minus the funding, risk and servicing fees. This results in the tangible net benefit to the seller (FC) when they implement an SCF solution. To compute the benefit analysis of the buyers in the SCF model, the buyers’ financing costs are subtracted from the unlocked WC. This results in the tangible net benefit to the buyer by implementing an SCF solution. As we can see from these exemplary calculations, all the involved parties are able to gain a positive net benefit. Even the FSPs profit from the assumed funding and risk fees, and the SCF platform participates from the servicing fees. In these two specific SCF examples, real multi-win situations occur.

Dynamic discounting The following fictitious example, from Supply Chain Management Accounting (Templar, 2019), shows typical costs and benefits for DD. Ultra Co Ltd, a supplier to Mega PLC, has been onboarded onto the buyer’s DD solution. Based on Mega’s standard terms and conditions, the company will be paid in 90 days once the invoice has been approved for payment. However, if Ultra decides that it wants to take up the offer of an early payment of an invoice after it has been approved, then the company can take advantage of Mega’s DD programme. They are able to decide to take an early payment of any of

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260

Table 6.3  Example costs and benefit for traditional factoring CHF Revenue Payment term (days) Financing costs Receipt of payment (days) Financing cost per year

Status quo

Status quo, with factoring

Extended payment by customer, without factoring

Extended payment by customer, with factoring

50,000,000

50,000,000

50,000,000

50,000,000

30

30

90

90

6% (1)

2% (2)

6%

2%

30

3

30

3

246,575

Factoring cost per year Total costs Reduction

24,658

739,726

73,973 246,575

98,630 −147,945

NOTE  (1) WACC for an SME (2) Factoring charge – invoices approved for payment by a reputable customer

24,658 238,356

739,726

263,014 −476,712

The value proposition

Table 6.4a  Inputs to RF/AP net benefit calculation Inputs AP solution (inbound supply chain) Description Annual AP DPO of focal company (buyer) without SCF solution DPO of focal company (buyer) with SCF solution DSO of suppliers without SCF solution DSO of suppliers with SCF solution

Value

Unit

713,716,000

dollar

50.4

days

70

days

50.4

days

15

days

Funding fee

7.31

%

Risk fee

1.80

%

Servicing fee

0.12

%

WACC of focal company (OECD)

7.82

%

15.00

%

Administrative costs without SCF programme ($13.71 per invoice)

0.69

%

Administrative costs with SCF solution ($8.52 per invoice)

0.43

%

2,000

dollar

Process cost per invoice payable without SCF solution

13

dollar

Process cost per invoice payable with SCF solution

7.8

dollar

WACC of supplier (non-OECD)

Average invoice value

their invoices minus a discount or let the invoice carry on to its due payment date. Table 6.6 illustrates the DD offer: if Ultra requires an invoice to be paid immediately then they will receive 95 per cent of its face value; however, if they require the invoice to be paid after 40 days the invoice will be 97.22 per cent of its original value. The cost of this early payment needs to be compared to Ultra’s alternative sources of cash, often bank borrowing. Ultra can use the curve to establish the percentage discounted value of an invoice for a given early payment (Figure 6.17). Currently Ultra has five invoices that have been approved for payment. Table 6.7 illustrates for Ultra the value of their discounting invoices on the system at this moment in time. If Ultra decides to opt for earlier payment of all five invoices, they will receive £112,583.34 and Mega has a saving of £2,416.66 on their COGS. The system is dynamic as the discount value of the invoices will change on a daily basis.

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262

Table 6.4b  RF net benefit calculation Net benefit analysis to the buyer (focal company) Unlocked WC

Importer’s WACC * ((DPO of importer without SCF solution less DPO of importer with SCF solution) / 365) * AP

2,997,059.69

+ Administration benefit

Total administration costs without SCF solution less total administration costs with SCF solution = saving per invoice payable * (AP / average invoice value)

1,855,661.60

– Funding fee

Funding fee * ((DPO of buyer without SCF solution less DPO of buyer with SCF solution) / 365) * AP

2,801,599.28

– Servicing fee

Servicing fee * ((DPO of buyer without SCF solution less DPO of buyer with SCF solution) / 365) * AP

= Net benefit

Tangible net benefit to the buyer by implementing an SCF solution

45,990.69 2,005,131.33

Benefit analysis of the suppliers in the SCF importer model Unlocked WC

Supplier’s WACC * (granted credit period to supplier / 365) * AP

10,383,101.26

– Financing costs

FSP’s funding fee * (granted credit period to supplier / 365) * AP

5,060,031.35

= Tangible net benefit Tangible net benefit to the supplier by implementing an SCF solution

5,323,069.91

The value proposition

Table 6.5a  Inputs to an AR net benefit calculation Inputs AR solution (out-bound supply chain) Description Annual AR

Value

Unit

554,164,000

dollar

49.5

days

15

days

49.5

days

70

days

DSO of focal company (seller) without SCF solution DSO of focal company (seller) with SCF solution DPO of the buyers without SCF solution DPO of buyers with SCF solution Funding fee

7.31

%

Risk fee

1.80

%

Servicing fee

0.12

%

Dilution rate (loss ratio)

0.30

%

Savings in loss deduction

0.10

%

WACC of focal company (OECD)

7.81

%

15.00

%

Administrative costs without SCF solution ($4.69 per invoice)

0.23

%

Administrative costs with SCF solution ($0.68 per invoice)

0.03

%

2,000

dollar

14

dollar

7

dollar

WACC of buyer (non-OECD)

Average invoice value Process cost per invoice receivable without SCF solution Process cost per invoice receivable with SCF solution

Table 6.5b  AR net benefit calculation Net benefit analysis to the seller (focal company) Risk benefit

Loss ratio * AR

1,662,492.00

+ Unlocked WC

Exporter’s WACC * (DSO reduction / 365) * AR

4,090,869.01

+ Administration benefit

Administration costs without SCF solution less administration costs with SCF solution = saving per invoice receivable * (AP / average invoice value)

1,939,574.00

(continued )

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The current practice

Table 6.5b  (Continued) + Savings in loss Savings in loss deduction rate * AR deduction

554,164.00

- Funding fee

Funding fee * (DSO reduction / 365) * AR

3,828,969.59

- Risk fee

Annual risk fee * ((credit period to buyers / 365) * AR)

560,237.03

- Servicing fee

Servicing fee * (DSO reduction / 365) * AR

62,855.86

= Net benefit

Tangible net benefit to the seller by implementing an SCF solution

3,795,036.53

Benefit analysis of the buyers in the SCF seller model Unlocked WC

Buyer’s WACC * (granted credit period to buyer / 365) * AP

4,668,641.92

- Financing costs FSP’s funding fee * (granted credit period to buyer / 365) * AP

2,275,184.83

= Tangible net benefit

2,393,457.09

Tangible net benefit to the buyer by implementing an SCF solution

Table 6.6  Mega PLC dynamic discounting rates Discount %

Payment days

Net invoice value %

 0

95.00

5.00

10

95.56

4.44

20

96.11

3.89

30

96.67

3.33

40

97.22

2.78

50

97.78

2.22

60

98.33

1.67

70

98.89

1.11

80

99.44

0.56

90

100.00

0.00

The value proposition

Figure 6.17  Mega PLC’s dynamic discounting curve Discount

6% 5% 4% 3% 2% 1% 0%

0

10

20

30

40

50

60

70

80

90

Table 6.7  Ultra Co Ltd discounting invoices on the system Invoice no.

PO number

Payment due date

125

47500

10 days’ time

£20,000

£19,888.89

154

47578

20 days’ time

£25,000

£24,722.22

169

46001

40 days’ time

£15,000

£14,666.67

179

46234

50 days’ time

£25,000

£24,305.56

201

46645

60 days’ time

£30,000

£29,000.00

£115,000

£112,583.34

Total

Invoice value

Net invoice value

The advantages for Ultra are that should they require cash at short notice, they are able to receive earlier payment at a cost that may be more attractive than general bank borrowing. Mega is able to generate savings on their accounts payables, which will have a positive impact on their profitability.

Selection and decision trees A comparison table showing the solutions and their key characteristics is included in the Summary at the end of the chapter. In this section, we outline a set of questions that help narrow down the options for an individual organization. The solutions don’t, in practice, always fit into the neat definitions we have given them, as providers adapt and evolve their offerings and there are many mixed and emerging forms existing on the market. Nevertheless, this section illustrates at a high level what the main considerations are in selecting a solution. These are set out in the form of a ­decision tree. The first decision level shows the distinction between AP, AR and

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266

The current practice

i­ nventory (Figure 6.18). This decision level is likely to be set by the organization’s overall business strategy with respect to customers, operations and suppliers, and the resulting financial priorities.

Figure 6.18  Decision tree overall

WCM focus?

Buyer orientated

AP solutions

Inventory orientated Seller orientated

Inventory

AR solutions

Decision tree for AP solutions When looking for an SCF tool that supports the AP, or buyer, side of an SC transaction, the next level decision tree is illustrated in Figure 6.19, ie the AP decision tree. First, we distinguish transactions that are concerned with capital assets where buyer leasing is the most likely solution for high value items. For non-capital items, the key is to segment purchases between high and low procurement v­ olumes, as P-Cards are the main tool to implement SCF in the case of low purchasing amounts, infrequently recurring transactions and occasional suppliers. For medium to high non-capital items and for medium to low capital items, the next factor that must be taken into account is a true sale, or not, of the debt/obligation to pay. If a true sale is planned and an organization intends to sell ‘title’, there is the option to structure the deal with an FSP or with capital market investors via securitization. If the FSP solution is chosen, the decision is between a classical RF solution and a PO finance approach. If there is no true sale planned, the entities involved in a transaction must decide their ability and willingness to finance transactions within the SC, or, if external funding is needed, use PO finance. As already highlighted, there are no clear dividing lines between the solutions. As an example, DD solutions exist in forms where some external financing is provided by an FSP.

The value proposition

Figure 6.19  Decision tree: accounts payable solutions

Fixed asset?

No

Yes

Invoice values

Low

Invoice values

Medium to high

Medium to Low High

True sale of AP planned? Yes

No

Supply chain internal financing?

FSP or capital market? Capital market

P-cards

Reverse securitization

FSP

Reverse factoring

No

Purchase order financing

Yes

Dynamic discounting

Buyer leasing

Decision tree for AR solutions For the AR solutions decision tree illustrated in Figure 6.20, the same decisions as for AP tools are undertaken. A corporation must first identify if it is dealing with a fixed asset. In the case of the fixed asset or capital good, vendor leasing is the only AR focused option for high value items. In the procurement value differentiation, low value amounts and high frequency of transactions both point towards the implementation of a collective invoices approach. If a true sale of the debt is planned and a capital market solution chosen, invoice securitization is the

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268

The current practice

Figure 6.20  Decision tree: accounts receivable solutions

Capital asset? No

Yes

Invoice values

Item values? Low

Medium to Low

Medium to high

High

True sale of invoice planned? Yes

Bank or capital market? Capital market

Collective invoices

Invoice securitization

Bank

Factoring

No

Supply chain internal financing? No

Sales offer financing

Yes

Invoice discounting

Vendor leasing

tool that should be used and factoring if the banking structure is preferred. In the case of no true sale, companies may finance a transaction bilaterally by using an invoice discounting tool or use external financing via a sales offer financing approach. Also, on the AR side, the solutions introduced exist in a variety of forms. In the case of a cash rich company, sales offering financing might not need external liquidity sources and can extend financing to SC partners using its own funds.

The value proposition

Decision tree for inventory financing solutions The final tree illustrated in Figure 6.21 portrays the focal company-centric inventory financing solutions. The main decision to take here is whether to include an FSP or take an SC internal collaborative WCM approach to reduce the financing costs of the total chain’s inventory. If the transaction involves the transfer of a fixed asset, an SLB solution is one of the many possibilities for corporates to finance long-term assets. For current assets, the consideration is whether to keep the inventories on the corporate BS or sell ownership to an external service provider, which would result in an off-balance sheet inventory finance solution.

Figure 6.21  Decision tree: inventory financing solutions

Include external FSP? Yes

No

Fixed or current asset? Current

Fixed

Keep control of inventories or sell? Keep

On-balance sheet inventory finance

Sell

Off-balance sheet inventory finance

Sale and lease back

Collaborative inventory management

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270

The current practice

Supply chain programmes with an SCF impact This section covers typical SC operational approaches that impact buyer– supplier arrangements, including timings of payments, so they can often achieve some or all of the benefits of SCF. Most could be implemented alongside the SCF solutions described above.

Consignment stock In CS, the seller maintains stock at the buyer’s site, reducing that in its own warehouse and stores. The approach can help availability as the transport phase takes place further ahead of use and so is not usually a limiting factor. Also, shortages tend to reduce as the seller has better visibility of actual use, rather than just seeing discrete orders for replacement stock. The connection with SCF is that the buyer typically is invoiced when the stock is used, rather than when it is delivered to site, so reducing their WC. However, unless the seller is able to reduce their inventory substantially through better deployment, they will face an increase in WC and so potentially an increased demand for SCF.

Vendor-managed inventory VMI takes consignment stock one stage further and allows the supplier to manage inventories on the buyer’s site and replenish them when needed, often to agreed levels and taking into account forecast use. This can increase the benefits to the seller who, having full visibility on customer’s stocks and maybe even future demand, can make decisions on delivery volumes, transport and so on. The impact on SCF is similar to consignment stock.

Drop-shipping This is a business model epitomized by pure internet retailers, although there were examples before internet businesses became ubiquitous. In drop-­ shipping, the retailers don’t own any inventory, neither do they usually deliver to the buyer. Instead the suppliers own and hold the inventory of products until they are dispatched to the ultimate buyer. In some cases, particularly retail sales with next day settlement of the consumer’s credit or debit card transaction to the retailer by the card provider, and where the retailer settles

The value proposition

in 30–60–90 days with the supplier, the retailer can have a significant cash cycle benefit. Again, the link with SCF is in the potential need for additional financing from the supplier to bridge the gap between production cost and eventual payment.

Supply chain visibility With increasingly integrated electronic tracking of activities and items, many SCs now link this information together to allow parts, components or products in transit to be tracked from the original manufacturer to their final use. The primary purpose is collaborative synchronization by making data readily available to improve and strengthen the physical SC. This can reduce the overall level of inventory in the SC and reduce the costs of unplanned production through better understanding of demand. For SCF purposes, this visibility can help with funding the SC by better knowledge of actual location, ownership and risk at each point.

Collaborative planning, forecasting and replenishment CPFR builds on better visibility and allows members of an SC to jointly develop demand forecasts, production schedules and purchasing plans. This can increase customer service levels and reduce inventory, so achieving a better WC position.

Just in time JIT focuses on delivery of goods in the right quantities at the right time so reducing inventories and their associated costs. This should, in turn, reduce the funding requirements for both the buyer and the seller and may limit the SCF to those supply categories where the complexity of JIT is not justified.

Summary To conclude, the chapter includes many different approaches that are adopted to modify the normal buyer or supplier payment terms. The user has to develop a cost-benefit-risk analysis for the SC situation that they are faced with and choose the best SCF fit. The summary Table 6.8 shows a comparison of the approaches using some key selection criteria to help with this initial selection.

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272

Table 6.8  Section One: AP or buyer focus SCF solution

WCM optimization WCM focus potential

Definition

Goal

P-Cards

Corporate credit card used for small value and/or one-off items and suppliers

Simpler, faster AP and less costly than processing individual invoices. Reduce administrative costs by having only one ‘supplier’ – the card co.

Purchase order financing

Pre-shipment Enable financing of financing of large manufacturing purchase orders operations in pre-shipment phase based on purchase orders

Dynamic discounting

Granting of buyer discount on a dynamic basis – declining proportionally in time needed to settle an invoice

Collaboratively adjust standard payment terms in dynamic setting and therewith enabling realization of discounts

Level Other opportu- Challenges & of sophisnities risks Collateral tication Parties

Not the focus ‘Imbed’ card in here, However, procurement tool DPO for supplier More granular may be stretched expense reporting by bundling ad hoc payments into monthly transactions

Limited (lack of control and monitoring of usage); difficulties in categorizing spend

None

AP

Collect liquid Enable issuance of funds needed for large purchase manufacturing orders operation in pre-shipment phase but repay only in postshipment phase

Limited Purchase High implementation order of the up to date and buyer difficulty for FSP in credit assessment based on merely a purchase order

AP

The buyer in this transaction accepts a stretch of the cash conversion cycle

Realization of Complex None discounts on integration of IT invoices outstanding and increase in supplier loyalty by paying early

Low

Medium

Buyer, supplier(s), FSP

Buyer, supplier(s), (customers), FSP

Buyer, supplier(s) SCF platform

SCF solution

WCM optimization WCM focus potential

Level Other opportu- Challenges & of sophisnities risks Collateral tication Parties

Definition

Goal

FSP agrees to pre-finance liabilities of a buyer towards its suppliers

FSP purchases payables and therewith unlocks liquidity for all trade parties involved

AP

Stretch cash conversion cycle by realizing a longer DPO

Increase supplier loyalty as invoice payment is received early

Expensive platform on-boarding

Title to Medium payables is transferred to FSP

Buyer, suppliers, FSP(s),SCF platform

Reverse Capital market securitization investors pre-finance liabilities of a buyer towards its suppliers

Selling approved invoices on capital markets unlocks liquidity for all trade parties involved

AP

Stretch cash conversion cycle by realizing a longer DPO

Increase supplier loyalty as invoice payment is received early

Expensive platform on-boarding and high regulatory barriers associated with

Title to High payables is transferred to SPV

Buyer, supplier(s), SPV investors, CSD

Title to High fixed asset is transferred to leasing company

Buyer, supplier(s), FSP

Reverse factoring

capital market investments Buyer leasing A financial service provider purchases ownership to a buyer’s capex investment and transfers good back through a lease agreement

Reduce the investment-related capital commitment and repayment burden of purchasing companies

AP

Increase liquidity by splitting payment into tranches and delaying transaction through means of a leasing agreement

Increase supplier commitment as invoice payment is received early

Is the procedure permitted for tax purposes (eg IFRS 16)?

273

(continued )

274

Table 6.8  Section Two: AR or seller focus SCF solution

Definition

Goal

WCM optimization WCM focus potential

Collective

Supplier bundles

Reduce

AR

invoices

sales and sends administrative and consolidated external transaction invoice to buyer costs. on a periodic basis Generally used for regular purchases from longer-term suppliers

Sales offer financing

Supplier offers alternative payment conditions. eg longer payment terms to buyers through internal financing or via an FSP

Promote sales of the products and create financial flexibility for the customers

AR

Level Other opportu- Challenges & of sophisnities risks Collateral tication Parties

Primary goal is not

May need to

the optimization of WCM position DSO may be stretched slightly for seller vs invoicing immediately

set up and manage new processes between buyer and supplier to ensure control and reporting

Supplier can decrease DSO and thus decrease CCC, if external FSP is used

Can improve chances of making a sale if seller offers buyer financing Increase potential to bundle after-sales services, such as maintenance

Increases risk to supplier of non- or only partial payments if buyer not able to make repayments when due

None

Low

Supplier, buyer

None

Medium

Supplier, buyer(s), FSP

SCF solution

Definition

Goal

Invoice discounting

Supplier offers Encourage prompt buyer a discount payment for early payment Pre-finance some of Optionally supplier a company’s raises funds from receivables FSP who has visibility but not ownership of the AR

Factoring

Supplier transfers invoices to the FSP and receives a prepayment by FSP. The supplier must repay it as they receive the payment from the buyer

WCM optimization WCM focus potential

Level Other opportu- Challenges & of sophisnities risks Collateral tication Parties

AR

Simplify payment process, increase transparency May be hidden from buyer so not being a visible sign of needing the cash

Optimize working AR capital, outsource receivables collection and insure against buyer default

Reduce DSO and thus decrease CCC Costs need to be less than alternative financing of WC to justify its use

Decrease DSO Factoring and thus company may decrease CCC collect payments Factoring cost and so reduce needs to be less admin cost for than alternative buyer financing of WC to justify its use

Does not reduce a company’s balance sheet credit risk exposure

None

Medium

Supplier, buyer(s), FSP

Uncollectible invoices; recourse and non-recourse approach (factoring company assumes all the responsibility for collecting the debt)

Title to Medium receivables is transferred to FSP

Supplier, buyer(s), FSP

(continued )

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276

Table 6.8  (Continued) SCF solution

Definition

Goal

WCM optimization WCM focus potential

Level Other opportu- Challenges & of sophisnities risks Collateral tication Parties

Invoice Supplier sells securitization accounts receivable on the capital market via an SPV Securitization is based on commercial paper conduits

Lower interest payments Increase willingness of banks to commit larger amounts in securitization Supplier receives cash immediately

AR

Decrease DSO FSP may collect and thus payments and so decrease reduce admin cost CCC for buyer Overall cost needs to be less than alternative financing of WC to justify its use, particularly given increased complexity and cost of operating SPV

Amounts purchased usually exceed US $100m

Title to High receivables is transferred to FSP and held for benefit of investors

Supplier, buyer(s), SPV, investor(s), investors’ custodian, CP conduit

Vendor leasing

Place capital intensive products with customer as a package with a financing solution to increase sales

AR

Decrease DSO Leasing costs need to be less than alternative financing to justify its use and thus decrease CCC

Is the procedure permitted for tax purposes (eg IFRS 16)?

Title to Medium fixed asset is transferred to leasing company

Buyer(s), supplier, FSP

Capital good is sold to the leasing institution, which leases the object to the buyer

Minimize receivables default and delay risk

Table 6.8  Section Three: Inventory or asset focus SCF solution

Definition

Collaborative Manage inventory inventory across whole management chain and shift ownership, where possible, to entity with the lowest financing costs

Goal

WCM optimization WCM focus potential

Level Other opportu- Challenges & of sophisnities risks Collateral tication Parties

Reduce the total chain’s inventory and capital tied-up costs and thus companies may unlock a so-called ‘collaborative gain’

Inventory financing

Focus on CCC in Other collaboration Supply chain None combination with with supply chain partners are not WACC partners willing to participate

Medium

Supplier’s supplier, supplier, focal company, buyer, buyer’s buyer

On-balance sheet

Generate Secure financing investable cash by from an FSP against

Inventory financing

Generate investable cash

Application processes for

Ability for the supplier to sell

High

Supplier, buyer(s), FSP,

inventory financing

utilizing a a collateral, which is collateralized loan the inventory based on the company’s balance sheet inventory

by utilizing a collateralized loan and thus reduce WACC

financing may be sped up, and financing cost may be reduced through the integration of a custodian entity in the process

inventory in due time to repay the loan outstanding and quality or damage issues that would decrease the value

None

third-party warehouse/ custodian

(continued )

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278

Table 6.8  (Continued) SCF solution Off-balance sheet inventory financing

WCM optimization WCM focus potential

Definition

Goal

Transfer operational goods, logistics and ownership to an external third party The FSP may be engaged in the transaction to provide capital investment for the

Pursuit of a Inventory streamlined balance financing sheet by freeing it up from currently unused inventory

Level Other opportu- Challenges & of sophisnities risks Collateral tication Parties

Decrease DSO A reduction in and DIH and thus costs and an decrease CCC increase in liquidity for buyer An increase in stability through increased inventory consolidation and visibility

Is the procedure permitted for tax purposes (eg IFRS 16)?

Asset High transferred

Buyer, supplier(s), LSP, (CSP)

Decrease DIH and thus CCC

Bears risks for the focal company Is the procedure permitted for tax purposes (eg IFRS 16)?

Asset High transferred

Buyer, leasing company, (supplier), (SCF operator), (investors)

LSP Sale and lease back

A company may Optimization of sell the fixed longer-term cash assets it uses for flows and liquidity operations, such as real estate, to an FSP The FSP then leases them back to the company

Other solutions

A reduction of liquidity burden for a focal company

The value proposition

References Aite Group (2014) [accessed 24 January 2020] A study of the business case for supply chain finance [Online] www.accaglobal.com/ab111 (archived at https:// perma.cc/WV6V-C6JV) APEC (2015) [accessed 24 January 2020] Regulatory issues affecting trade and supply chain finance [Online] http://mddb.apec.org/Documents/2015/SMEWG/ SMEWG40/15_smewg40_007.pdf (archived at https://perma.cc/44LA-GZ2T) Cosse, M (2011) An investigation into the current supply chain finance practices in business: A case study approach, unpublished MSc Thesis, Cranfield School of Management EBA (2014) [accessed 24 January 2020] Supply Chain Finance: EBA European market guide, Version 2.0 [Online] www.abe-eba.eu/media/azure/production/1348/ eba-market-guide-on-supply-chain-finance-version-20.pdf (archived at https:// perma.cc/YSC6-6PJM) Grath, A (2014) The Handbook of International Trade and Finance: The complete guide for international sales, finance, shipping and administration, 3rd edn, Kogan Page, London Graves, ET (1998) The advantages and disadvantages of procurement cards, Journal of State Taxation, 17, p 79 Greensill [accessed 24 January 2020] Working capital finance as an asset class [Online] www.greensill.com/whitepapers/working-capital-finance-as-an-assetclass/ (archived at https://perma.cc/L57B-74AX) GSCFF (2016) [accessed 24 January 2020] Standard definitions for techniques of supply chain finance [Online] https://iccwbo.org/publication/standarddefinitions-­techniques-supply-chain-finance/ (archived at https://perma.cc/ N4HM-PRS4) Hartmut, W (2017) Supply Chain Management: Grundlagen, Strategien, Instrumente und Controlling, 6th edn, Springer Gabler, Wiesbaden Hofmann, E and Belin, O (2011) Supply Chain Finance Solutions: Relevance – Propositions – Market value, Springer Verlag, Berlin/Heidelberg Hofmann, E and Kotzab, H (2010) A supply chain-oriented approach of working capital management, Journal of Business Logistics, 31 (2), pp 305–30 Hofmann, E, Strewe UM and Bosia, N (2017) Supply Chain Finance and Blockchain Technology: The case of reverse securitisation, Springer Verlag, Berlin/Heidelberg ICC (2014) [accessed 24 January 2020] Global survey on trade finance [Online] https://iccwbo.org/publication/global-survey-2014-rethinking-trade-and-finance/ (archived at https://perma.cc/R6FA-RATN) Jobst, A (2008) [accessed 24 January 2020] What is securitisation? [Online] www. imf.org/external/pubs/ft/fandd/2008/09/pdf/basics.pdf (archived at https:// perma.cc/8YEL-FXRJ)

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The current practice Katz, A (2011) Accounts receivable securitization, Journal of Structured Finance, 17 (2), pp 23–27 Kischporski, M (2015) Elektronischer Rechnungsaustausch mit E-Invoicing, Springer Gabler, Wiesbaden Miller, A (2008) [accessed 24 January 2020] Trade services: Pooled payables securitisation [Online] www.gtreview.com/news/global/trade-services-pooledpayables-­securitisation/ (archived at https://perma.cc/X3GY-VSJR) Molon, C (2015) Analysis of supply chain finance solutions from a total cost perspective, unpublished MSc Thesis, Politecnico di Milano, July Tanrisever, F, Cetinay, H, Reindorp, M and Fransoo, JC (2012) Value of reverse factoring in multistage supply chains, SSRN 2183991 Templar, S (2019) Supply Chain Management Accounting, Kogan Page, London USAID (2010) Asset-Based Finance, White Paper no. 1, U.S. Agency for International Development, Washington, DC van Laere, M (2012) Modelling international reverse factoring and the future of supply chain finance, University of Eindhoven, February 2012 Wetzel, P (2019) Philipp Wetzel unpublished model Zakai, H (2015) [accessed 24 January 2020] Platform power: Eeny, meeny, miny, moe – with which provider shall I go? [Online] www.txfnews.com/News/ Article/5238/Platform-power-Eeny-meeny-miny-moe-with-which-provider-shallI-go (archived at https://perma.cc/JL9U-T93E)

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07 The implementation Bringing supply chain finance programmes to life

O U TCO M E S The intended outcomes of this chapter are to: ●●

share the enablers and inhibitors to implementing SCF;

●●

describe guidelines to follow, based on prior experience;

●●

propose a risk management approach for implementing SCF.

By the end of this chapter you should be able to: ●●

understand the typical implementation challenges;

●●

focus planning efforts around the important factors;

●●

educate your organization and external partners to help enable successful implementation.

Activities We recommend the following: Work to understand what already exists to plan and manage change programmes within your organization so that this can be built on and adapted for SCF.

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Introduction The aim of this chapter is to explore the enablers and inhibitors to SCF programmes and establish guidelines for successful implementation. As described in earlier chapters there are many forms of SCF and, as in other chapters, we will focus on reverse factoring (RF) and dynamic discounting (DD), the most common forms. However, we will describe approaches that apply to all forms, including customer-focused applications, and make points about specific approaches where necessary. The objective is to prepare the reader to implement an SCF programme by describing the process and providing checklists and guidelines taken from both the successful – and the less successful – initiatives.

Agenda This chapter starts with a reminder of the context and challenge, followed by an outline of typical SCF pitfalls or ‘what can possibly go wrong’. We then cover 10 implementation guidelines developed from research into SCF programmes. Next, we give a general overview of risk management for SCF.

A reminder of the context and challenge World-class supply chain management (SCM) is possible when the participants in the chain exchange information such as forecasts, orders, tracking data and goods receipt notes – information to allow them individually or collectively to optimize the chain. SCF adds the flows of cash or funding to this end-to-end thinking. The objectives are to lower the net working capital (WC) or cost of financing the supply chain (SC), to reduce the finance risk in the SC and, even, to increase access to finance for customers or suppliers for new products or increased demand. Achieving one or more of these objectives can lead to a more profitable product or service in the end market than competing SCs can deliver. With these objectives in mind, we can summarize the key areas to focus on: ●●

●●

The scope typically covers the operations within and across multiple organizations, hence there is a need for internal and external commonality of direction, approach, language and definitions. SCF supports SCM, hence poor underlying SCM is a poor foundation to deploy SCF.

The implementation

●●

●●

The models of financing are more complex than the individual funding of each link, or organization, in the chain – hence a need for more sophisticated financial understanding and expertise, particularly taking a ‘total cost’ perspective. The goal of better end-to-end financing of the SC requires more extensive measures and, possibly, different goals and rewards than used for traditional, single organizational or functional-focused cash management and funding.

Typical pitfalls Without wanting to dissuade anyone from embarking on an SCF implementation, experience from past projects demonstrates the common pitfalls and challenges. Projects can take longer and cost more. Projects may not attract or appeal to the target suppliers or customers. They may appear publicly as one-sided or commercially aggressive. Or they may not deliver the expected benefits to the different parties. We have also seen that projects can be too successful and have to be slowed down or constrained to fit within agreed limits, particularly to the total amount of cash or credit committed. However, specific examples of failed or less than entirely successful projects are difficult to research and write up as organizations and individual executives are obviously wary of the resulting bad publicity. There are many more examples of corporates looking to share good news of successful ­implementations. Solution providers, financial institutions and advisers generally only publicize their client lists and credential case studies where they are proud of the results. So to maintain balance, this chapter is based on research by many teams and individuals and, when undertaken with ­commitments of confidentiality, case examples have been anonymized. There are three main types of failure: adoption, complication and ­reputation.

Adoption Adoption is often cited as the biggest challenge, getting target customers or suppliers to adopt the organization’s chosen SCF solution and take advantage of the apparent benefits. Too often, general assumptions have been made about the attractiveness of a solution to external parties without

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c­ onfirming this and establishing a proper understanding of the barriers from their perspective to taking it up. For example: ●●

the external party might have previously been involved in other SCF programmes that have not worked to their benefit;

●●

the complication and effort may appear to outweigh the benefits;

●●

their existing FSPs might insist on an exclusive funding model.

Whatever the reason, the result is the same – fewer sign up, there is less take up than expected by those who do sign up, and the returns fall while the costs rise in an attempt to deliver the targets and meet the financial goals.

Complication Complication can stifle the solution, particularly where existing underlying processes or systems are ineffective (don’t work well) or inefficient (require excessive resources). In these situations, when SCF is implemented, the additional processes lead to chaos. The evidence usually presents itself with increasing and unmanageable delays in reconciliation of invoices and payments, followed by complaints from internal users and external suppliers or customers. In some cases, the SCF solution is implemented to replace, automate and finesse these poor existing situations and this can work as a way of modernizing while gaining sufficient benefits from SCF to fund the update. However, in most cases when implementation of SCF is challenged from a process or systems direction, it is usually the unstable starting point that is the p ­ roblem.

Reputation As enterprises alter payment terms for their suppliers, maybe to improve their WC position and enhance their financial performance, reputations can be damaged. Extended payment terms are sometimes introduced with offers of early payment SCF to mitigate the impact. In some instances changes in supplier terms have drawn widespread negative reaction from the media, especially about the impact on the liquidity and even survival of SMEs. This adverse media reaction can, in turn, have a negative impact on the perceptions of the instigator by their stakeholders (eg investors, customers, p ­ artners and analysts) with implications for reputation and brand value. An organization’s shareholder value can also be affected if investors believe the ­reputational impact will negatively affect the business’s ability to achieve

The implementation

profitable pricing for its products or services or will create a riskier supply situation. So, having looked at what can go wrong, here are some guidelines to minimize the risks involved in implementing an SCF programme.

Implementation guidelines As described in earlier chapters, there are a range of SCF possibilities (Chapter 6) and associated stakeholders (Chapter 5), but we believe the following points apply to all forms of SCF and are written for customer- as well as supplier-focused initiatives. The 10 guidelines, outlined in Figure 7.1, cover the setting up, delivery and operation of SCF programmes: 1 Ensure that SCF is an appropriate solution for your business. 2 Define your SCF strategy and objectives. 3 Analyse your business partner base and listen to your suppliers and customers. 4 Build awareness and knowledge in SCF. 5 Design the implementation approach appropriate for you and your target audience. 6 Develop the business case. 7 Establish a project management framework: planning, budgets, resource allocations. 8 Create a multifunctional dedicated team led by a fully committed leader and ensure support from the top management. 9 Foster collaborative teamwork across functions, the users and the SCF solution provider. 10 Monitor the effectiveness of the programme and adjust as necessary.

Guideline 1 – Ensure that SCF is an appropriate solution for your business SCF is, in effect, about lending to or borrowing in collaboration with your SC partners. This is in contrast with direct funding of a single organization through banks, investors or other sources of finance. Does your business really benefit from this approach to changing the typical or traditional individual organization-focused funding models?

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Figure 7.1  The supply chain finance implementation wheel Monitor effectiveness of the programme Foster collaboration

Ensure SCF is appropriate

Create implementation team

Define strategy and objectives

The Supply Chain Implementation Wheel Analyse your supplier base

Establish project plan

Build awareness and knowledge

Develop the business case Design the appropriate solution SOURCE  Adapted from Templar et al (2012)

Close integration in the SC is evidenced in a number of situations, but in others there is much more of an arm’s length relationship, particularly where there is an open or commodity market in the product or service that is being bought or sold. Looking at the existing relationships in the SC is a good starting point for a strategic view of the fit with SCF. Given the nature of SCF relationships and the longer-term commitment required to justify the increased complication and costs, it is likely that a level of operational mutual dependency is in evidence that can be extended to increased financial interdependency. However, an alternative model is to focus on customers or suppliers where there may be limited SC integration and so a simpler trade-off for each party, such as an early payment for a sales invoice discount, as part of a ‘transactional’ relationship. In this section, we explore three high level criteria to help give an initial view of the potential value in SCF: industry fit, scale and priorities.

The implementation

Criterion one – industry fit Industry-based analysis has led a number of researchers to rank the attractiveness of SCF given the different buyer–supplier relationships in each. Where there is sharing of plans, forecasts, technology or new product plans, there is a level of mutual dependence. At the other end of the spectrum, some commodities can be bought from one of many suppliers and the decision made on an order-by-order basis. One view of comparative SCF attractiveness, ranking those industries with the most integration up or down the chain, is shown in Table 7.1. Table 7.1  Industry SCF ranking Rank

Industry

1

Automotive

2

Food and drink

3

Retail multiples

4

Hi-tech

5

Manufacturing industry

6

Logistics

7

Heavy plant

8

Electronics

9

Pharmaceuticals

SOURCE  Cosse (2011)

Another view is one based on the competitiveness of the market and the C2C cycle (Hofmann and Belin, 2011). Table 7.2 shows the focus on industries under the most WC pressure and so an incentive to extend payment terms with suppliers (see Chapter 2, ‘The cash-to-cash cycle’). A third view of likely industries (Figure 7.2), is based on survey responses from users. As this gives a similar order of industries to the research mentioned above, it confirms the reasoning developed in the research that SCF fits best within certain industry structures and where supplier payment terms are under pressure.

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Table 7.2  SCF potential by industry SCF potential (%)

Product category (Industry segment)

Less than 5

●●

Mineral, fuels, lubricants and related material

●●

Animal and vegetable oils, fats and waxes

●●

Commodities and transactions not classified elsewhere

Up to10

●●

Crude materials (except fuels)

Up to 60

●●

Food, beverage and tobacco

●●

Chemicals and related products

●●

Up to 90

●●

Machinery and transport equipment (including telecommunication) Manufactured goods and miscellaneous articles

SOURCE  Adapted from Hofmann and Belin (2011)

Figure 7.2  Likely industries for SCF Retailers Automotive Manufacturing Industry Electronics Food and drink Pharmaceuticals Distribution Heavy equipment Technology 0

10

20

30

40

50

60

70

80

90

100

% of respondents

SOURCE  Cosse (2011)

Criterion two – scale Having looked at the industry dynamics, does it make economic sense to change standard payment or credit terms with suppliers or customers? The next question most organizations ask is one of specific fit with the scale and scope required to justify implementing a programme. Note, here we are talking about the decision of the focal company or initiating organization. Once the programme is in place, the decision to take part, by a customer or supplier, is a separate decision and is based on what is being offered in the context of that organization’s financial situation and level of business with the focal company.

The implementation

A first cut view is that an organization has to have sufficient volume and value of transactions to implement an SCF programme. Clearly joining in or linking with a standardized consortia model, possibly government led, may reduce the barriers to entry, but a specific solution has one-off initial set-up costs that have to be justified by the potential benefit. Koch (2009), cited in Hofmann and Belin (2011), estimated the implementation cost of an SCF programme at US $100,000 (depreciated over five years), to which must be added US $10,000 annual operational costs. A minimum annual volume of SCF benefits in order to offset US $30,000 would therefore be a prerequisite to enrolling in an SCF programme: ●●

●●

A purchasing focal company offering SCF to its suppliers would get benefits from SCF provided that their purchase volume is greater than US $3 million. A selling focal company offering SCF to its customers would get benefits from SCF if turnover volume is greater than US $1.9 million.

Criterion three – priorities The third criterion is the financial position of the organization, particularly its cash situation and its cost of capital or borrowing. In cases of constrained or expensive funding, an organization should be looking at its customers and suppliers to supplement its own cash sources through SCF. On the other hand, if there are excess funds or access to relatively low cost finance, the organization’s competitive position could be enhanced by lending to customers or suppliers through some other form of SCF initiative, such as DD or financing the supplier’s inventory. In periods of low interest rates, this may also generate a better return than short- to mid-term bank deposits or money market bonds. This section has sought to provide some high level criteria to help organizations decide if they should explore SCF opportunities in general. The results of this thinking can be recorded and agreed by the key internal stakeholders in a short positioning brief. The next step is to come up with a ­specific strategy and associated objectives – where, how and why should we implement SCF?

Guideline 2 – Define your SCF strategy and objectives Getting clarity on the ‘is there opportunity?’ question, above, leads on to then developing a specific SCF strategy for the organization; one that recognizes that the best approach depends on the situation and objectives. For discussion on the different SCF approaches, see Chapter 6.

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As an example, many organizations start out on SCF programmes from a WC objective where improving liquidity and cash flow in the business can reduce the level of external borrowing, improve Return on Capital Employed (ROCE) and allow investment in other areas. From this starting point, ­delaying payment to suppliers seems to be an obvious benefit. Sometimes, SCF approaches, such as RF or externally funded DD, are implemented to mitigate the impact on suppliers. However, in the long term, suppliers have to build in their financing costs into the prices they charge their customers. For the purchaser delaying payment, therefore, this may be counter-­productive from an overall profitability perspective. In addition, there are risks to the organization if suppliers put less priority on serving the organization than serving others with better payment performance. These a­ rguments are well rehearsed and often debated and show the importance of the organization developing, agreeing and communicating a consistent strategy for its supply base, or each segment of the supply base.

SCF strategy examples As part of a research project, we looked at four examples on the AP side. In each case, the organization developed a strategy for SCF implementation, which we have summarized in Table 7.3. The case companies are global corporate businesses, each with sales revenue above $20 billion, headquartered in Europe and are named TelCo, PharmaCo, ChemCo and AutoCo for reasons of confidentiality. TelCo is a major telecommunication company delivering services to large and small customers, including retail customers, and its SC includes consumer and network equipment and services from providers across the world. PharmaCo is a global R&D-based manufacturer of pharmaceutical products, which it markets and sells internationally. Its SC includes research services, raw materials, manufacturing equipment, transport, marketing and business services support in many countries. ChemCo is a multinational chemicals manufacturer with operations in many locations serving industrial customers. In addition to manufacturing

The implementation

Table 7.3  SCF cross-case strategies Cases

TelCo

PharmaCo

ChemCo

AutoCo

SCF strategy Cash Supplier Global working Supply chain management relationship capital initiative risk management (payables strategy) management Ownership

Finance Corporate (procurement finance group) working capital team

Procurement operations

Procurement

SOURCE  Cosse (2011)

and distribution categories, the SC includes commodity materials as well as many intermediate chemicals. AutoCo is a typical large, global manufacturer of cars, vans and trucks, with operations in developed and emerging markets. These examples demonstrate two apparently distinct motivations: 1 Cash management/WC. These strategies suggest a financial orientation of the business model for SCF. 2 Supplier (or customer) relationship management and SC risk management through financial support for the SC. Interestingly, as can been seen in the second row, the strategic priority was also evidenced by the ‘ownership’ of the initiative within each company. Executives in all four cases strongly recommended that the case for SCF be developed, which links up to the organization’s supply, procurement and finance strategies, and balances, respectively, the needs for responsiveness, competitiveness and WC efficiency. Clearly, this case will vary for different categories of spend and different areas of the business and so, typically, a segmented model will evolve with different approaches appropriate in d ­ ifferent areas. As mentioned in the introduction to this chapter, examples of less effective or failed SCF initiatives are not widely published, but we suspect that many can be traced back to misalignment at this early stage – where the evidence points to some operational issue,

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such as ‘supplier o ­ n-boarding’, it may be that the root cause is that the strategy did not really fit with, or appeal to, the supplier segment in the first place. Looking at other research, Figure 7.3 shows how financial benefits fit within a much wider supplier relationship picture. Figure 7.3  Benefits of SCF collaboration ECONOMIC Increase in revenues Purchasing costs SUPPLY CHAIN Improvement in sustainability Relationships with banks Enhancement of relationships OPERATIONAL

Supplier

Process efficiency

Buyer

Better access to credit FINANCIAL Lower default risk Cost of debt Credit rating ROI ROE C2C WC Strongly disagree

Strongly agree

SOURCE  Adapted from BIS (2012)

Generally, there are a number of criteria to weight the final choice of s­ trategy. Going back to our comparative study of four corporates, as per Table 7.4, we can look at the individual criteria used in each case to select the appropriate strategy. An important aspect increasingly on the board agenda is the publicity impact of changing terms of payment. Programmes implemented by bigger companies that impact smaller companies can be reported or described with a focus on the negative aspects, particularly for SMEs. To help prepare for and manage this risk, SCF strategy and objectives need to be agreed at the board level. Getting agreement to the SCF strategy from senior stakeholders also sets the foundations for the right choices of internal team and leadership, external

Table 7.4  SCF strategy selection criteria TelCo

PharmaCo

ChemCo

AutoCo

Literature

Supplier demand (eg high cost of funding)



Reduce factoring of receivables by suppliers



Standardization of payment terms or harmonization of contracts







Supply base financial health and economic sustainability











Working capital improvement and cash management











Value for money procurement tool



Simplification of transaction processes





 



Create a competitive advantage for the supplier





Risk management of the supply base





Expend the financial relationship as a new collaborative area to support the suppliers



SOURCE  Cosse (2011)

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partners and advisers, tools and incentives. It is also important to ­identify and appoint an SCF champion who has the passion and the organization’s authority to make or influence executive board level decisions over the whole implementation period. One decision that can be made now is choosing external advisers, consultants and solution providers. The advantage of early decisions here is that they can support the early phases; the disadvantage is that they can overly influence a decision to proceed. Table 7.5 shows an example of an external solution provider selection matrix from our four cases. It is interesting that the reasons overlap with those that might be more appropriate for the selection of advisers and consultants. The output from the strategy phase is usually an overall positioning statement and supporting analyses setting out the high level justification for the chosen SCF approach to gain internal consensus to the strategy. While this seems a simple statement, the best programmes have a formal step to confirm internal consensus to the aims, objectives, approach, timetable and expected benefits. This can be incorporated into stakeholder sign-off of the project charter covering the executive and functional (see Guideline 8 below) leadership.

Guideline 3 – Analyse your business partner base and listen to your suppliers and customers Suppliers and customers may have very different financial situations and constraints from annual or seasonal fluctuations to large capital commitments. Knowing what drives their funding costs helps devise and ‘sell’ appropriate funding solutions to the SC partners. Maybe tooling finance is a more appropriate offer to suppliers than RF? Some suppliers or customers will have cheaper, more flexible sources of finance and won’t be attracted by simple cost of borrowing ‘arbitrage’ benefit. Therefore, it is important to segment the supply base and clearly establish criteria for including and ­excluding each group. This analysis may appear to repeat the thinking outlined in earlier sections, but here we are looking outside the organization. Very specifically, we seek to understand how our customers and suppliers fund themselves. Typically, the procurement functions (or sales department) within the focal ­organization undertake an ABC analysis of suppliers (or customers) in order to focus efforts on the larger or more important ones and, at the other end of the spectrum, have very ‘light touch’ approaches to the smaller or less

Table 7.5  External SCF support criteria TelCo No prejudice to other agreed payment terms



Options to invest



Implementation and ongoing management should be third-party driven



Simplicity and speed to market or adaptability to IT system



Scalability or coverage or lifespan of the programme



Management of the accounting impact



Former experience with the SCF provider



PharmaCo

ChemCo

AutoCo









  

Financial strength and stability of the provider





SCF provider brand recognition or experience





Willingness to support







SOURCE  Cosse (2011)

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i­mportant ones – the ‘tail’. However, this may not recognize the financial position of the other party. Irrespective of their importance to the organization, you might, for example, be buying relatively little from one supplier who is a large, well-funded multinational and relatively a lot from a second who is a small, local struggling company. In this case, the offer of a supplier finance solution might be ignored by the first supplier but it might be a life saver for the second – and bring reputational rewards. Figure 7.4 shows the result of a survey of which s­ uppliers segments fit closest with SCF. Figure 7.4  Supplier-oriented SCF fit SUPPPLIERS WITH Long-term alliances and cooperative relationships Significant spend Key impact on quality of final product Key impact on cost of final product Key impact on differentiation of final product Poor access to credit Financial issues/challenges Limited spend Limited importance

Very important

SOURCE Extra et al (2018)

So the enlightened organization will seek to understand their customers and suppliers and seek to educate them on appropriate approaches, offering SCF as the circumstances warrant. Refer to Chapter 6 for the range of financing available. Having added an understanding of the financial situation to the normal intelligence on customers or suppliers, it is good practice to test the planned strategy with some friendly partners in the SC to unearth the likely reactions and to develop the best approach to selling the strategy. Small changes can make a difference to the programme’s appeal. For example, looking at RF in the four company examples in the earlier sub-section ‘SCF strategy examples’ shows: ●●

All the programmes offer automatic discounting but some additionally offer an optional or selective model.

The implementation

●●

●●

Three process their invoices directly to their bank partner platform, whereas one chose an SCF independent technology provider to channel the different requests between buyer, supplier and bank. One has the option to pay invoices earlier at a discounted rate to manage its own cash flows.

Industry experience shows that customers and suppliers do react very differently to what would appear to be a win–win financial proposition. So, in order to make the most positive impression and gain support, it is important to prepare the story, the responses to likely questions and to agree on the engagement approach. Is it an open offer; is it a requirement of doing business; is it only for one group and not another? SCF platform providers can bring their experience to bear in this analysis: ‘With the experience of bringing 1.6 million suppliers on board, we can predict who will use the service and at what rate, depending on their situation’ (Mitchell, 2019). One key constituency are those customers or suppliers who are already involved in different SCF programmes as part of different SCs, often each with different costs and benefits, different approaches, and different process and systems requirements. Here the other party is likely to be more aware of the solution being offered but will have specific views on the advantages and disadvantages. In these situations it may be easier to tie into a third-party hub or exchange to link with these organizations and so avoid duplication of process and technology investment. In summary, having looked inside the organization in the first two sections, this section recommends a good look outside the organization to see if the intended audience for the SCF initiative is likely to be receptive to it and how to make it the best solution for them.

Guideline 4 – Build awareness and knowledge in SCF Given the multi-party nature of SCF, there are many internal and external stakeholders who can help or hinder a programme. Misunderstandings and ignorance can be real barriers, which can and should be planned for and mitigated by learning from research on best practices or lessons from other implementations and by sharing experience from consultants, advisers and solution providers. There are published case examples demonstrating the common implementation enablers and inhibitors. By understanding these and sharing the opportunities and challenges, it is more likely that all those involved will be better prepared. Table 7.6 shows the number of issues raised by different stakeholders to SCF and groups them by factor.

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Table 7.6  Example stakeholder issues (AP solution) Group Internal

Focus

Accounting / Controlling Internal

Legal

IT

Terms Real interest rates Work load Inflexible internal processes

External

Accounting classification Country-specific regulation Risks of outsourcing supplier payments

Local

Legal boundaries Suppliers’ receivables already pledged or assigned Sustainability standards Reputational risk

International

Industry regulations Contracts required in each country Legal boundaries complicate a global programme State-affiliated companies limited payment flexibility

Inflexible

Changes… need to be done manually… a very high implementation effort Inter-operability of computer and software systems Inflexible standard processes Want a single standard solution No SCF provider is able to provide a single standard

Adaptable

Unclear who is responsible for the extra costs Banks get too much confidential information High number of ERP systems… high processing complexity

Procurement

Collaborative Supplier’s contact person is not authorized to make decisions Attractive suppliers in terms of volume have the longest decision-making processes and are difficult to on-board Relationship with our suppliers may suffer, resulting in significant ‘hidden costs’ in the future Do not know the right contact person from our suppliers Suppliers and external stakeholders have a different understanding and knowledge Receivables are already pledged or assigned as collateral No constant interest from suppliers Suppliers talk to each other Lacks solid arguments to convince their supervisors Increase the price or demand pre-payment Never given their customers such extended payment terms Suppliers are not interested Antagonistic

Different supplier structures per division and business segments Risk of losing our strategic key suppliers, putting our production at risk Complicated contracting deters suppliers Too much additional time and resources Lose our regular discount claims for early payment No operationalized incentive Lack the financial know-how to negotiate the specifics We and our suppliers are not familiar with the financial elements Suppliers shift the transactional costs, including the discounts, of the SCF programme back to us via higher purchasing prices resulting in hidden costs (continued)

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Table 7.6 (Continued) Group

Focus

Treasury / Finance

Support

Lack the coordination to organize the communication Banks charge too high fees including hidden costs SCF provider offers an inefficient reporting SCF provider is not operating with our principal bank and/or prioritized financial institutions Additional costs for working capital improvements Increased complexity when involving multiple banks Balance overall risks and benefits Difficult to estimate the standard financing costs of suppliers Cost-benefit ratio is not given when on-boarding small suppliers Currency risk exposure will be further increased EBIT effect of cash discounts outweighs the effect Overall volumes diminish in the event of the bankruptcies Benefits… are too small in the current low interest rate environment Use our credit rating for ourselves Lack of ownership between us and Procurement Who needs to cover the losses or pay the charges in case one of our suppliers’ defaults

External Suppliers

Lead

Auditors set boundaries too tight Due to varying interest rates and margins, banks are unwilling to finance the SCF programme globally Depends on a single department Our market position does not allow us [to use SCF], our internal / external stakeholders lack commitment and do not support Division of key functions and relocation into different countries Scale and complexity of the back end and operations processes Business units are reluctant Only have a few selected suppliers eligible Internal stakeholders do not understand, IT department is overwhelmed Procurement questions the potential benefit Not enough top management support

Large

Our logistics or finance department do not support the SCF programme Banks do not offer acceptable fee structures Financing cost rates are not suitable and too unattractive Do not agree to your payment terms Have a lot of cash flow and do not want to accelerate our receivables Want to have an add opt-out clause… in case the programme is not attractive for us anymore We will have to increase price and/or pre-payment We will just bill you 60 days before (continued)

301

302

Table 7.6 (Continued) Group

Bank or Platform Provider

SOURCE  Lebreton (2019)

Focus SME

Not compatible with our internal SAP/ERP Lack the financial and internal resources Lack the legal resources Not willing to cover the additional costs of the on-boarding process Forced to deal with multiple banks increasing the complexity Negative press about banks IT department is concerned about the complexity and scale of integration Not been informed about changes of the payment terms Do not want to deal with an additional intermediary Cannot control if our invoices are going to be paid Afraid that the time to get paid is going to be longer due to the complexity of our payment processes

Margins

Expenses of on-boarding new suppliers Margins (maybe) too low Know-your-customer requirements

Creditworthiness

Creditworthiness of the buying company is inadequate Buying company is unable to provide a sufficient risk history SCF market in this country is too small Clients close relationship with their main bank Do not want to provide ‘unlimited’ credit lines

The implementation

It is clear that the majority of issues identified can be traced back to poor understanding of, and preparation for, the requirements and challenges, not just in the implementing organization but also in the customer or suppliers who are offered the programme. There are a number of sources of information available to help inform and educate: SCF Community (SCFC): SCFC is a not-for-profit association of all those involved in SCs, with members in more than 30 countries around the world. It is a community for promoting SCF and for its development and change. The SCFC aims to: ●●

●●

●●

create linkages across existing organizations and associations to collate and consolidate common reference models, specifications, standards and best practices; refine and build cross-functional metrics, baselines, benchmarks and relative perspectives; contribute to research, conferences, consultations and publications. (SCFC, 2019)

Case studies: Many of the suppliers of SCF solutions, tools and finance publish short write-ups of their successful implementations. Clearly these are a selected set biased towards the specific solution and only focused on the good news, but extracting the key learning points from each can deliver a good checklist. In addition, the names of the organizations implementing SCF and willing to publicly associate their name and brand with the implementation should give your organization confidence that the SCF solution is a developed approach. Using industry networks, it should be possible to follow up on individual situations and understand the full ‘inside’ stories. Experience from conferences: There are an increasing number of conferences dedicated to SCF but there are also others, such as those on working capital and trade finance, which include SCF as topics. We have also seen professional or functional conferences, such as those for treasurers or procurement, include SCF as strands or special areas of focus. The goal is that executives, functional teams, SC partners and the project team are well informed and so prepared.

Guideline 5 – Design the appropriate SCF implementation approach for you and your target audience While the title of this section might seem to apply narrowly to the specific SCF process, sources of funding and the platform or tool, the full approach

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The current practice

needs to be taken into account, particularly the test, trial and scale plans; the priority implementation segmentation of suppliers or customers; and changes to internal processes, policies and systems as well as the organization to implement (and then deliver) the operational solution. SCF solutions depend on the situation of the buyer and supplier but also on the physical, data and financial flows. Different industries and markets require different information and different commercial arrangements. These affect the solution best fitted to the requirements. For example, if RF has been chosen as the organization’s SCF programme, it could be offered through a third party for smaller, less critical purchases while an in-house approach could be used for strategic suppliers. Similarly, the costs versus benefits for different segments should lead to different implementation ­approaches. For some, this will be part of comprehensive supply negotiations and agreements; for others it may be a simple self-service sign-up if they are interested. One area that seems to be often overlooked is the internal situation, ­specifically in terms of the processes and organization in which an SCF programme will fit. Walk through, document and review the existing purchaseto-pay processes to ensure they are ‘finely tuned’ and identify any potential issues that may cause disruption or delay, before implementing an SCF ­programme. Figure 7.5 is an overall approach for developing the right solution, including the implementation approach. As can been seen, there is a formal selection of SCF solution or FSP, but it also shows the importance of the internal and external activities required. Figure 7.6 (Enablers) and Figure 7.7 (Inhibitors) are included here, to demonstrate some common themes. As the situation differs for each ­organization, these will lead to different selection criteria for a solution provider. One significant design topic for buyer-led SCF is supplier on-boarding. In Chapter 8 there is a box on ‘How to on-board SME suppliers efficiently’. In summary, this section has outlined the process and some of the factors that should be taken into account when selecting an appropriate approach to implementing an SCF solution. We have included it at this stage, number 5, because decisions here lead to the costs of implementation, the scope of ­implementation and the timetable – all of which feed into the business case. However, it is usual that once the business case is developed and the benefit stream clarified, the approach may be revisited to adjust some of the dimensions such as the rollout timetable.

The implementation

Figure 7.5  SCF implementation approach Objectives and Strategy

Selection criteria for the solution

Shortlist of suppliers (RFQ)

Supplier selection and contract

Supplier on-boarding strategy

Process, data and report definitions

Pilot plan (size, volume, geography, business entity)

IT, Supply Contract and Organization change

Pilot

Full deployment SOURCE  Adapted from Camerinelli (2014)

Guideline 6 – Develop the business case The business case provides visibility of the expected benefits and costs, including the intangible benefits, eg the impact on SC relationships. The bottom line is usually a payback calculation and net present value (NPV) analysis. The business case is generally required by the Board to agree to implement an SCF solution as well as to be a baseline to measure progress and results.

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The current practice

Figure 7.6  Enablers of SCF implementation MARKET DRIVERS Buyer-supplier cooperation Change of trade finance instruments New enabling technology Increased competition Globalization and trade growth FINANCIAL DRIVERS External pressure for WC optimization Lower access capability to credit Intensified compliance regulations Strongly disagree

Strongly agree

SOURCE Extra et al (2018)

Figure 7.7  Inhibitors of SCF implementation ECONOMIC-FINANCIAL Lack of enough transaction volume Low supplier's interest rate Cost of adoption Resistance to information sharing Lack of enabling technology SUPPLY CHAIN Poor collaboration within firm Poor collaboration between (other) firms Uncertainty about supplier/buyer operations Lack of top management commitment CULTURAL Different buyer-supplier objectives Lack of training Strongly disagree

Strongly agree

SOURCE Extra et al (2018)

The overall case for SCF was discussed in Chapters 4 and 6 and there we outlined the economic, organizational and reputational costs and benefits. We now look at how this can be narrowed down to a specific analysis for a specific situation. However, we do not repeat the overall case for SCF and the reader should refer to these earlier chapters. As a starting list of the items to be included in the financial analysis, Table 7.7 shows the top line areas covered by each of our four case study

Intangible

Tangible

Table 7.7  Costs and benefits of SCF implementation TelCo

PharmaCo

ChemCo

AutoCo

LR

WC improvement











Cash flow management







Value added in the balance sheet



Potential investment opportunity for cash



Lower cost of goods sold





Reduced processing costs





Limited external factoring of receivables



Builds goodwill with suppliers



Strengthened relationship with key suppliers











Financial support for strategic suppliers











Discipline and visibility in transactions









Negotiation tool (when payment terms are long)







Clean settlement process



 











Risk awareness in the supply chain



Improved purchasers’ financial knowledge



Review of the supply base: harmonization in the ways of doing business





SOURCE  Cosse (2011) 307

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The current practice

examples. Given the strategy developed above in Guideline 2, the goal is to develop a more detailed model of the situation: number of transactions, value of transactions, likely change in actual payments, cost of financing each payment and differences by country. With the above checklist adapted for the situation, the financial case can be summarized in the following categories. Chapter 6 shows an example calculation. All of our four case examples showed agreement on the different costs of their respective SCF programme: ●●

●●

Tangible costs: IT implementation and update of the ERP system. TelCo also added the cost of the legal documentation as a significant one. Intangible costs: project management costs (resource allocation, internal and external trainings) and monitoring costs.

The tangible costs, which need to be met once at the beginning of the implementation process, need to be rapidly offset when the solution achieves scale. In many cases, the intangible costs have been underestimated and keep occurring as the project rolls out. It is therefore essential to target the right supplier cluster to ensure that the benefits will be significant enough to offset these costs. Overall, the SCF business case will likely follow the organization’s own standards and templates for investment proposals.

Guideline 7 – Establish a project management framework: planning, budgets, resource allocation There is an old saying, ‘If you fail to plan, you plan to fail’. The SCF implementation process is crucial as the project cuts across several internal functions and departments, but the degree of complexity increases significantly as the project involves external stakeholders, hence this guideline is 1 of the 10 key areas to focus on for SCF implementation. There are many project management methodologies and supporting tools and often organizations have established approaches, so this chapter will not go into depth in this area but instead focus on some of the important SCF-specific points. Experience shows that the fundamentals for good project and programme management (vital for any change initiative) are just as important as the specifics associated with SCF. SCF implementation can be

Table 7.8  Typical characteristics of SCF implementation process TelCo

PharmaCo

ChemCo

AutoCo

Definition and on-boarding of the pilot

A few large key suppliers Automatic process

One large collaborative supplier Manual process

One business division A handful of long-term steady suppliers with good volumes One country Automatic process

A small group of large purchase volume suppliers, with the shortest payment terms Automatic platform

Time required for implementation

6 months of IT implementation

18 months from the concept to the contract 6 months of IT implementation

3 months from concept to 6 months of IT pilot implementation

SOURCE  Cosse (2011)

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The current practice

divided up into a set of discrete projects and these should be all part of a coordinated programme of activity. Differences in the SCF implementation process are described in Table 7.8 for the four case examples. From the examples in Table 7.8, the approaches adopted are clearly different. The reasons why are less important here than the evidence of the differences in the scope and speed of change required in internal and external groups. A programme management budget of 10 per cent, possibly distributed through the sub-projects, is not unusual to cover the direct costs of management, reporting and administration. These costs are included in all the business case examples discussed above, but the categorization is often different and it is difficult to compare and give a universal ratio or amount for planning purposes. Involvement by the whole organization is important, but some is more important than others. We have already discussed using a RACI (Responsible, Accountable, Consulted, Informed) model to help understand and align the stakeholders (Chapter 5). Here, we will simply include feedback from the SCF Community Barometer on the importance of each function; see Figure 7.8.

Figure 7.8  Typical functional involvement in SCF Legal ICT Purchase Sales Logistics Finance Administrative No contribution SOURCE Extra et al (2018 )

Key contribution

The implementation

Guideline 8 – Create a multifunctional dedicated team led by a fully committed leader and ensure the support of top management With many stakeholders and different areas of expertise required, the SCF team will need good resources and support. Multifunctional teams include representation from operations, procurement, sales, finance, treasury or cash management, AP, IT, legal and auditors. Table 7.9 documents the different functional inputs in the four case studies described previously. Some of the differences between the individual cases are a consequence of the different organizational structures in each company and the language or terms used to describe them. However, the table should be a starting point for identifying the who, why and when of the different skills and responsibilities needed. The responsibilities of each functional input needs to be defined for each stage of the programme as these will change over the course of the initiative. Knowing when awareness is the goal, or when a formal sign-off is required, Table 7.9  Typical ownership of SCF implementation TelCo

PharmaCo ChemCo

AutoCo

Initiation

Finance and Treasury

Sourcing Group

Ownership

Finance Corporate Procurement Procurement (Procurement Finance WC Operations Group) team

Finance and Purchasing Treasury

Working Treasury or  team cash management





Procurement 





Accounting (AP)







Legal and auditors









IT













Finance Sponsorship SOURCE  Cosse (2011)

CFO

Treasury Treasury and Finance



CFO

311

312

The current practice

will impact the nature and seniority of the engagement. As mentioned before, organizations adopt a RACI model to define who is responsible, accountable, communicated to and otherwise involved in each decision and activity or process. (See also Chapter 5.) Alongside the scale of the management challenge, discussed in the previous guideline, is the impact of the timetable on choice of resources, assuming an end point when the SCF is adopted as part of normal, day-to-day activities without a separate and focused structure. Where shorter-term implementations are planned it would be reasonable to move people in on a temporary basis and hire external resources from a consulting organization with experience of SCF projects. However, with longer-term and multiphase deployments, transferring a core team, hiring specialists and taking on interim resources to build a complete team with some stability in personnel and structure may be more appropriate. In summary, experience shows that involving the right resources at the right time is most important but that having too many involved all the time leads to frustration and wasted energies.

Guideline 9 – Foster collaborative team work involving working across functions, the users and the SCF solution provider This is about putting in place the right mechanisms for collaborative working and setting the right environment to establish the working practices – preferably before any problems and issues arise. In most aspects, this is no different from any other programme of change. However, with SCF initiatives, the number of stakeholders can be large and cross internal and external boundaries. Typically a structure of executive sponsorship, programme steering group, project executive and focused working groups is established in the initiating company or organization. Experience from many SCF programmes has shown a number of specific challenges for collaboration and team working, including hierarchy, time and functional silos. Each is described below: ●●

There is often a major hierarchical gap between those in executive roles who agree and approve the idea and those in the operational or transactional detail who have to implement the changes to day-to-day activities. This gap arises as the principal or strategic impact of SCF

The implementation

requires commitment at the highest level, eg CFO, Treasurer, CPO, but in practice it does not change these executives’ activities – it is a change of policy and process for the CFO, an additional use or source of cash for the Treasurer and only one part of the supplier negotiation for the CPO. However, for the AP or AR teams it may change a financial transaction’s approval, routing, timing and error resolution completely. Taking these two ends of the organizational hierarchy, we can see the need for the right approach to engage each level and extrapolate the different needs in between. ●●

●●

As there can often be a considerable time between the initial commitment and the actual implementation, it is good practice to keep a visible record at each stage and include formal sign-offs. Being clear about the beginning and end of each stage and what triggers the next stage can help trigger changes to resource and management reporting arrangements and keep teams working together at the appropriate pace. For SCF, alignment between stakeholders should also be documented to reduce the lack of awareness of commitments and changes between functional silos, particularly finance and procurement or sales.

In summary, experience shows that the need for collaboration is critical to success and requires an integrated and consistent communication and training strategy, including external stakeholders as well as internal ones.

Guideline 10 – Monitor the effectiveness of the SCF programme Timely reporting against agreed milestones is essential to ensure that any plan is achieved. It is important to communicate and celebrate success when key milestones are achieved. It will allow corrective actions to be put in place when things start to go wrong, hopefully before it is too late. As described previously, typical SCF initiatives impact many stakeholders both internal and external to the organization. A number of the usual functional­-specific metrics can influence behaviours in directions that do not support SCF. For example, reduction in WC through extending payment terms may impact the commitments made during supplier negotiations and contracting. So it is essential that individual stakeholder KPIs are adjusted to align with the SCF strategy and generate behaviours that are congruent. What are some appropriate metrics to measure and report? After the obvious milestone reporting, typical metrics focus on the take-up and use of

313

314

The current practice

the SCF services. How many of each segment of customer or supplier has signed the necessary agreements, connected their transaction systems and started using the service? Next, users focus on the metrics outlined in the business case, the value of transactions, the change in settlement times, early or late payment discounts or charges, the cost of financing and so forth. In a number of cases, we have seen take-up of SCF credit exceed expectations and a programme having to be throttled back to meet available finance and risk levels. The number of exceptions, errors and reworks are important to track as these indicate areas for improvement – and areas of frustration in the wider business. In these measures, it is important to have a good baseline of performance before and after – what was the reality against which to measure the change. Cross-functional metrics are useful to steer the SCF programme and to demonstrate successes and challenges particularly as operational control of the main levers may be spread between Procurement (who establish the supplier terms and conditions), Operations and/or Logistics (who order and register receipt of the goods and services), Finance (who settle payment) and Treasury (who provide the funding). One measure that is likely to be required is overall payment performance. For example, the UK government mandates reporting on supplier payment performance. This was initially required of public bodies in the UK to demonstrate commitment to their suppliers and to encourage suppliers to bid for work knowing they will be paid without requiring expensive working capital financing and to prioritize the associated delivery as it would be rewarded rapidly. It is now required from all larger commercial organizations.

Risk reduction approaches In this section, we explore the typical challenges met in SCF initiatives. As with all major projects or programmes of change, a risk management approach should be adopted to identify, mitigate, track, manage and resolve problems. This typically follows the corporate risk approach and should also fit with the risk approaches in each functional area impacted by the changes. As the implementation transitions into operation and ‘business as usual’, so the risk approach should transition from a separate process into one imbedded in the appropriate places within the organization. Table 7.10 is a list of issues/risks/challenges raised in the four case examples discussed earlier in this chapter. This is a good starting point to develop the

The implementation

Table 7.10  Risks of implementing SCF 1

Accounting classification of SCF (payables, receivables or other debts)

2

Legal implication under different laws

3

Lack of knowledge and guidance for accounting risk

4

Existing financing agreement preventing the supplier from further factoring. Suppliers’ situations with other banks and SCF programmes

5

Suppliers having direct access to capital markets with apparently more favourable conditions

6

Unique and relatively inflexible programme or lack of customization

7

Specific regulatory framework (for example, food and drug regulations)

8

Time for implementation is too short

9

Lack of clear definition of SCF strategy, processes and responsibilities

10

Lack of internal education and communication

11

Suppliers’ lack of understanding of SCF

12

Lack of understanding from procurement, if a finance-led programme, and lack of understanding from finance if a supply chain or procurementled programme. Lack of consensus

13

Resource allocation (internal and supplier training) or lack of focus of the project team

14

Complex and inefficient invoice matching process (late invoices, duplicate invoices)

15

Resistance to change

16

Process perceived as additional complexity by the supplier

17

Ability of procurement to introduce the programme

18

Complex IT environment

19

Confidentiality of the suppliers

20

High cost of funding in emerging markets

21

Suppliers’ understanding of the accounting treatment

SOURCE  Cosse (2011)

first cut of risks faced by any SCF programme. This list is not MICE (Mutually Inclusive and Collectively Exhaustive): in other words, it does not cover all the issues and a number overlap or duplicate each other. However, it is the list created from the research of the four SCF cases and uses the language and focus of the interviewee comments. We found a risk of over-s­implification on

315

316

The current practice

this list was high. For example, using one summary term ‘communication’ was not specific enough to capture the very different issues around: ●●

●●

the internal strategy communication on deciding if SCF was a valuable approach in the first place; the phased introductory briefings and more detailed guidance for customers or suppliers during deployment.

So the advice is that a longer and specific list be used, possibly grouped under the main areas of mitigation or contingency response. As mentioned in Guideline 2 above, organizational reputation is a particular risk – the potential for the SCF programme to be, or to be seen to be, aggressive and abusive. Taking this risk as an example, the initial step is to review the experience of others in the area and so understand the potential impact. This helps qualify how seriously this particular risk has to be taken and the level of effort put in to mitigate it, ie avoid the risk becoming a problem, and to manage it, should the problem happen. We use this example to demonstrate that different areas of the business need to be involved. In this example public relations (PR) is impacted and so, in larger organizations, those responsible for corporate communications, PR and branding will need to be part of the solution. This section is not intended to be a comprehensive approach to risk management as most organizations have established risk processes. It does describe the appropriate areas to focus on and the user should also review the enablers and inhibitors included earlier in the chapter.

Summary Some will have read this chapter and concluded that it is just the typical disciplines of good project and change management, while others may see a level of complication much higher than they expected. For the first group, the content should act as a checklist to ensure they cover all the common enablers and inhibitors. For the second group, the content is a starting point to develop a structured approach to an SCF initiative. As the essence of most SCF programmes involves changing the relationship with customers or suppliers, and these relationships often have many points of connection into the organization, particularly bigger organizations,

The implementation

it should not be unexpected that the change will impact many areas of the business. Therefore there are opportunities to make the change easier through good planning, communication or resourcing. The main challenges should be avoidable, or at worst mitigated, by adopting the lessons from cases, suppliers and peers to help manage the risk and support successful implementations. In addition, as has been mentioned, the change may put pressure on internal processes and systems when the implementation may require connection to external third-party tools and processes that expect, perhaps naively, clean, accurate and timely information and response. So some reluctance and reticence to support the SCF programme from internal stakeholders may stem from this concern – the fear of being discovered to be responsible for, or part of, a less than efficient operation. A realistic internal assessment of readiness for SCF is therefore a prerequisite to sound planning but also to understanding some of the softer, more emotive, barriers to change.

References BIS (2012) [accessed 24 January 2020] Large Businesses and SMEs: Exploring how SMEs interact with large businesses, UK Department for Business, Innovations and Skills [Online] www.gov.uk/government/publications/large-businesses-andsmes-exploring-how-smes-interact-with-large-businesses (archived at https://perma.cc/W9Y3-K5B6) Camerinelli, E (2014) [accessed 24 January 2020] Supply Chain Finance: EBA European Market Guide, Version 2.0 [Online] www.abe-eba.eu/media/azure/­ production/1348/eba-market-guide-on-supply-chain-finance-version-20.pdf (archived at https://perma.cc/TG5H-9PQB) Cosse, M (2011) An investigation into the current supply chain finance practices in business: A case study approach, unpublished MSc Thesis, Cranfield School of Management Extra, W, Kortman, R, Siemes, D, Caniato, F, Moretto, A and Gelsomino, LM (2018) [accessed 24 January 2020] SCF Barometer 2018/2019, Supply Chain Finance Academy [Online] http://scfacademy.org/wp-content/uploads/2019/01/20181218SCF-Barometer-2018_2019-final-report.pdf (archived at https://perma.cc/ YY4V-SG7M) Hofmann, E and Belin, O (2011) Supply Chain Finance Solutions: Relevance – propositions – market value, Springer Verlag, Berlin/Heidelberg

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The current practice Lebreton, C (2019) Supply Chain Finance and Stakeholder Theory: Examining challenges and value-creation programs for stakeholders in approved payables supply chain finance programs, unpublished Master’s Thesis, University of St. Gallen, School of Management, Economics, Law, Social Sciences and International Affairs Mitchell, L (2019) Lewis Mitchell, Senior Director, Taulia interviewed on 5 July 2019 SCFC (2019) [accessed 24 January 2020] Website, www.scfcommunity.org/ (archived at https://perma.cc/B3P2-KF4B) Templar, S, Cosse, M, Camerinelli, E and Findlay, C (2012) [accessed 24 January 2020] An investigation into the current supply chain finance practices in business: A case study research, Proceedings of the 17th Logistics Research Network Conference, September, Cranfield, UK [Online] https://ciltuk.org.uk/About-Us/ Professional-Sectors-Forums/Forums/LRN-Forum (archived at https://perma.cc/ WU2D-X2CE)

Study question Put the 10 guidelines into order: Analyse your business partner base and listen to your suppliers and customers. Build awareness and knowledge in SCF. Create a multifunctional dedicated team led by a fully committed leader and ensure support of top management. Define your SCF strategy and objectives. Design the appropriate SCF approach for you and your target audience. Develop the business case. Ensure that SCF is an appropriate solution for your business. Establish a project management framework: planning, budgets, resource allocation. Foster collaborative team work involving working across functions, the users and the SCF solution provider. Monitor the effectiveness of the programme.

Next steps Research the project management methodology in your organization and compare it to what will be required for SCF.

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PART THREE The future

320

THIS PAGE IS INTENTIONALLY LEFT BLANK

321

The global setting

08

Supply chain finance in the context of cultural and geographical dispersion

O U TCO M E S The intended outcomes of this chapter are to: ●●

●●

●●

show opportunities and challenges of supply chain finance (SCF) in China’s financial system; introduce the reader to Islamic financing and its opportunities within SCF; explain how SCF solutions impact small- and medium-sized enterprises (SMEs) and the efforts that governments and international organizations make to support SMEs with SCF.

By the end of this chapter you should be able to: ●●

●●

●●

●●

realize the importance of the analysis of other countries (especially China and Islam-orientated regions); analyse the Chinese and Islamic banking systems and their developments in the context of your situation; understand the characteristics of SCF in China and in Muslim-dominated markets; identify diverse opportunities and challenges of financing SMEs and how SCF can help, including in developing countries.

322

The future

Introduction Since the early 2000s, companies have tried to optimize the flow of information and goods or services in more and more cross-border supply chains (SCs) due to increasing competition driven by the megatrend of globalization. The world is becoming a smaller place, information is more easily accessible and, therefore, transparency is higher. Moreover, market barriers have been lowered resulting in a higher level of worldwide competition. Companies have continued to focus on their core competencies, outsourcing more and more, working closer together. These developments are not without consequences. Hence, SCs must work in an international setting, while building global standards, on the one hand, and considering domestic constraints, on the other. Facing the tremendous impacts of the financial crisis of 2008/09, the World Bank highlights the importance of SMEs because they play a crucial role in economic development. There are 365 million to 445 million SMEs worldwide, of which fewer than 10 per cent are formal enterprises. The formal companies – as opposed to ‘informal sectors’ – are fully registered enterprises and make up approximately 33 per cent of the world’s GDP. Up to 45 per cent of all employees worldwide work for a formal SME. The net job creation is higher in SMEs than in large companies. Therefore, providing SMEs with assistance can result in higher innovation and healthy competition in the economy. Supporting their growth would have positive effects on prosperity and economic growth (World Bank, 2010). On the other hand, many SME firms fail – especially start-ups – in the first years (Tewari et al, 2013), in particular for liquidity reasons. SCF seems to be a good fit to overcome these liquidity failures and quicken the financial stability of these firms. Although a clear analysis of the present SCF market is essential and is covered in the first seven chapters of this book, it is just as important to look at the global development – especially against the background of cultural and geographical dispersion. Other markets, settings and business cultures are still waiting in the wings. For example, China and Islamic countries are rising and will play a crucial role in world business. Looking at China, the importance is significant. China’s economy is the second largest economy in terms of GDP at US $13.6 trillion in 2018 and, by 2030, its GDP will have grown to more than twice today’s size. Besides that, China is the most important trading partner worldwide and the largest exporter. Low product costs, a huge labour pool and a vast talent base are some of the many factors that have made China a manufacturing hub – ‘the

The global setting

world’s factory’. This is now being evolved to the world’s biggest market with a huge base of innovation and development. In comparison with Buddhism in China, the Western world has its religious roots in Christianity. Christianity is still the main religion in the world, but by 2010 some 49 of 194 countries had a population with over 50 per cent Muslims (PewResearchCenter, 2011), which amounts to 23 per cent of the world’s population or 1.6 billion people. Compared to that, 32 per cent of the world’s population were Christians (PewResearchCenter, 2012). In the future this gap will shrink and studies predict that in 2050 Christianity and Islam will have the same number of followers and by 2070 Islam will be the world’s largest religion (Shammas, 2014). We believe that China and the Islamic states will play a dominant role in the foreseeable future. Thus, it is necessary to look at their financial systems to understand the opportunities and barriers of SCF. Each of the three sections in this chapter are structured in a similar manner. After an introduction and background information, opportunities and challenges for corporates are drawn out. Finally, selected aspects from the view of the network financing philosophy – more precisely, inside network internal financing, inside network external financing and outside network external financing – are presented.

Chinese financing and supply chain finance Introduction to Chinese financing The Chinese market has made a remarkable transformation from a centrally planned economy to an open economy in the last decades. Deng Xiaoping started the transformation process with his statement: ‘It doesn’t matter whether a cat is black or white as long as it catches mice’. As part of this development, providing capital played a crucial role. In 1979 the Chinese banking system consisted of only one bank. The People’s Bank of China existed with the acronym PBC or PBoC and is nowadays the Central Bank of China. In the 1980s four banks, which were also state-owned, were defined to finance key areas to promote economic development (Garrcia-Herrero and Santabarbara, 2013). These four state-owned commercial banks (SOCB) were the Bank of China (BOC), the China Construction Bank (CCB), the Agricultural Bank of China (ABC) and the Industrial and Commercial Bank of China (ICBC). As the names indicate, these institutions each financed particular industries.

323

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During the crisis in 2008 and 2009 exports dropped. At the same time prices for raw materials, labour and inventory went up. As a result, industries, which had a big impact on the economy of China, were selected and given the chance to profit from a stimulus plan. In 2009, the Chinese government defined 10 key industries to promote further growth and prosperity: automobile, iron and steel, textiles, equipment manufacturing, ship-­building, electronics and information technology, petrochemicals, light industries, non-ferrous metals and logistics (Lui and Margaritis, 2009). When looking at the Chinese economy, it is essential to differentiate between state-owned enterprises (SOEs) and privately owned companies. As may be obvious, SOEs have a closer relationship with the Communist Party and therefore profit more from political support. The biggest financial institutions are also closely held by the state, which enables them to refinance themselves with cheap capital. Besides, these financial institutions have a bias for lending to SOEs. Even high-risk SOEs are able to borrow more than low-risk SOEs and non-SOEs. This is due to two facts. First, the government makes interventions ex ante for direct bank lending in favour of high-risk SOEs. As a result banks that are owned by the state have to follow the orders. Second, it is only rational for banks to grant these loans if there is an implicit government guarantee for loans to the SOE. So the credit rating of the SOE no longer matters. Chinese banks can trust that there will be government bailouts for non-profit loans (Lu et al, 2007). These lending practices have consequences. They result in non-performing loans, which accumulate and cause systematic risks. Estimations even say that onequarter of all loans in China are non-performing loans (Lu et al, 2007). Strikingly, if loans are granted due to political reasons, banks have no incentive to secure information about their customers. Quite the contrary and this might be an unintended incentive causing excessive bank loans. In the past, implementing risk management tools and consequently evaluating and pricing risks was not first priority. Even today, these banks are still struggling to operate on a commercial basis (Lui and Margaritis, 2009). Besides domestic bank loans, the most important financing sources for firms in China are self-financing, state budgets and foreign direct investments. Self-fundraising grew at an average annual rate of 14 per cent from 1994 to 2002. Privately owned companies have self-fundraising as 90 per cent of total financing. Even for SOEs it can be up to 60 per cent of their financing (Allen et al, 2005). Chinese people have a long tradition of lending money from family and peer groups (Wei, 2013). This has been possible mainly because China has

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one of the highest savings rates in the world. Nearly 70 per cent of savings end up in bank deposits. The government caps the interest rate for bank deposits. So there is enough supply, and cheap money pushes economic growth and maintains the stability of the banking system (Lui and Margaritis, 2009). Given the low and capped interest rates, depositors have a strong incentive to find alternatives to their savings. Consequently, ‘shadow ­banking’ has arisen to exploit the interest difference between low interest rates for deposits and high interest rates for loans representing the market equilibrium.

The rise of peer-to-peer lending in China In the past, SMEs in China often had limited access to the formal banking sector. Nowadays, new technologies offer additional sources of finance. A new form is the peer-to-peer (P2P) lending sector, which has grown dramatically since its start in 2007 tapping into the tradition of family and peer group lending (Wei, 2013). Nevertheless, not all is rosy in the Chinese P2P lending sector. Trouble started brewing in China back in 2016, when statistics released by the Chinese Banking Regulatory Commission showed that about 40 per cent of P2P lending platforms were in fact Ponzi schemes (a form of fraud that lures investors by paying attractive profits to earlier investors with funds from more recent investors, which in turn attracts more investors). Consequently, this has forced authorities to tighten regulations with the introduction of over 100 new rules that are gradually being implemented. This has triggered the shutdown of P2P lending platforms; over 900 had closed by the end of 2016 (Liu, 2019). P2P lending in China can be distinguished as follows (ACCA, 2020): Direct vs indirect lending: direct financial contracting between individual borrowers and individual lenders. Under indirect P2P lending the providers assign credit to borrowers from pooled investor funds, which may have also undergone some form of further asset transformation. The risks entailed are less transparent than in direct lending models. Technology-based providers vs wealth management companies: Another distinction in China is whether the providers are financial technologydriven or whether their ‘financial technology’ is based on conventional credit allocation processes with an online ‘shop-front’ only. Paipaidai, Jimubox and Dianrong are examples of such financial technology-based P2P providers.

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Online vs offline processes: P2P lending providers in China tend to rely much more on offline processes (eg www.CreditEase.cn). On the borrower side, this difference is explained by the relative lack of comprehensive credit information, which means there is a greater role for providers in offline credit investigations. Providers in China also tend to use offline processes to educate and consult with individual investors. P2P lending in China is not subject to bank-like regulations and providers can procure fundraising and originate loans without being subject to securities law (Xusheng, 2014). In contrast, we should not forget that the Chinese government puts stability first. So, the government will not tighten loopholes in the regulatory system that would force companies into bankruptcy.

C A S E S TU DY CreditEase’s P2P lending platform based on Tradeshift Tradeshift (https://tradeshiftchina.cn/en), a business commerce platform provider, partnered with CreditEase to deliver a trade financing app that will bring low-cost financing to corporates in China. CreditEase, a P2P lender in China, now delivers AR financing to small and medium enterprises (SMEs). The goal of the partnership is to help solve the financing difficulties that many SMEs face in China through the digitalization of trade financing. As a first step, CreditEase has integrated and delivered an app on the Tradeshift platform. The app connects to CreditEase’s FinTech solution, which combines an expansive database containing information such as historical transaction and buyer payment data along with the company’s risk control and financial management expertise. The app allows SMEs to apply for credit based on the invoice approval and buying power of their cross-border enterprise buyers. Through the company’s venture fund – the CreditEase New Financial Industry Investment Fund – CreditEase will work with Tradeshift to jointly develop solutions that enhance traditional SCF services. The aim is to improve the success rate and efficiency for suppliers and buyers.

Even though China’s ‘unregulated banking’ has some positive effects on the Chinese economy, it might be a ticking time bomb. Its market volume can only be estimated roughly. If a wave of defaults occurred, there could be a domino effect. A borrower’s failure to repay may open Pandora’s box. Reassuringly, one good aspect is that Chinese households and companies

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have big savings and this could work as a buffer (Doug, 2014). The differences between conventional and Chinese banking are highlighted in Table 8.1. Table 8.1  Comparison between conventional (Western) and Chinese banking Conventional banking

Chinese banking

A lot of private and state-owned banks. The number of financial institutions is not limited.

Small number of state-owned banks. The number of financial institutions is limited.

Interest rates are regulated by the banks.

Interest rates are regulated by the government.

Bank deposits and other financial instruments are based on risks.

Interest rate controls on bank deposits.

There is just indirect political influence. If at all central banks have some impact.

Political influence on state-owned banks has led to a bias in credit allocation towards state-owned enterprises.

Firms with a better performance are more likely to receive bank loans.

Firms with a poorer performance are more likely to receive bank loans.

Goal of the central bank is to fight inflation.

Goal of the central bank is to maintain the stability of the domestic currency Renminbi, provide capital to the economy and support certain key industries – promote economic growth.

Political legitimation by voting.

Legitimation by hard economic facts.

Credit rating of the SOE does matter. Credit rating of the SOE does not matter. Professionalization of the capital market with diverse opportunities to get financial resources (eg ‘crowd funding’).

Huge shadow market and underground lending.

Opportunities and challenges for corporates C A S E S TU DY  Buyer financing in the consumer goods industry – A Chinese case The Standard Chartered Bank describes in GT News how multinational corporations (MNC) in China manage their receivables risks. The article, written by David Leong who is head of Standard Chartered Bank’s trade finance solutions department, focuses on mitigating and controlling the accounts

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receivable (AR) risk of MNCs. What makes it relevant in the context of SCF? Leong notes that many of the MNCs that are currently developing the Chinese market grant their Chinese customers payment terms as generous as 180 days. This is a way for them to capture market share, as their customers, who are often distributors, are in need of additional working capital that they find difficult and expensive to acquire. Not providing these distributors with such extended payment terms would mean bottlenecks in working capital for the distributors and thus potentially lost sales for the MNCs.

As the MNCs in China demonstrate, under particular circumstances extended payment terms may be an effective way to provide customers (as buyers) with working capital. MNCs (as suppliers) that are entering new markets and are able to achieve substantially lower weighted average capital cost (WACC) or tax rates than their new buyers may provide these with working capital at lower cost. Intelligent payment terms setting can lead to additional business and better business relations with the customers (­buyers). In this case, the cost for expanded days of AR (DSO) for the MNC is compensated by higher turnover. This SCF approach is equivalent to a ‘cash injection’ to the sales market.

SCF opportunities in China An advantage of SCF solutions is that the capital burden is shifted towards companies with lower capital costs. For instance, considering a Chinese supplier and a Swiss buyer, the latter will have easier and cheaper access to capital because of higher accounting standards and so on, reducing asymmetric information. Gained profit can be shared according to the risk ­profile. Another advantage of SCF, especially in the case of China, is founded in the characteristics of cross-border SCs. China has a huge trade surplus and therefore many companies trade with international partners. SCF can be used to receive liquidity from abroad and profit from interest rate differences between countries. However, a hurdle is the legal system. A question arises as to whether contracts can be enforced in China if a company defaults (Xingjian and Shimming, 2014).

Government support for SCF in China On the one hand, it is questionable whether the government would support alternative financing methods such as SCF. However, this government support is needed. Bankruptcy regulations and collateral r­egistration, among

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others, improve the application of SCF methods. On the other hand, P2P lending is now accepted as an essential part of the Chinese financial system by the government. It became too important for the stability of the economic system. Obviously, this acceptance by the government also allows for ­regulation of the P2P service providers. Nevertheless, it is conceivable that state-owned banks, instead of using these new financial opportunities, will fight them and they are very well connected with the government. An additional point is that the use of SCF concepts and methods demands a change in organizational thinking. The perspective must change from a stand-alone to a collaborative and interorganizational perspective. This also means differences in stockholding or capital cost within an SC can be exploited. However, companies must have know-how about supply chain management (SCM), they must understand it, and there must be the will and possibility to implement it. For example, logistics service providers (LSPs) in China often do not have appropriate know-how to implement SCF solutions (Xingjian and Shimming, 2014).

Challenges to SCF in China Given insufficient assets and credit, it is difficult for SMEs to borrow funds secured by fixed or credit-based financing. Especially in China, they suffer from a shortage of fixed assets, limited capacity of credit rating and an underdeveloped SMEs’ credit guarantee system. The provided SCF solution in China is quite different from a classical Western solution. The traditional approach in China is regarded as a collaborative entity consisting of multiple organizations (Figure 8.1). Primarily, it is composed of three participants: borrowing companies, commercial banks and LSPs. Borrowing companies are often some SMEs that need funds to function and expand their businesses. By pledging their movable assets, such as raw materials and consumer products, to banks as security, SMEs are able to borrow funds from banks from which they could not borrow in the conventional lending system. These SMEs leave their liquid assets as security or collateral to banks. The c­ ollateral – as a main element in SCF solutions in China – is nevertheless different from traditional commercial loans that rely on fixed assets as security. Because of regulatory restrictions, banks are not allowed to engage in nonfinancial business, as mixed operations in the financial sector are banned in China. Therefore, banks do not have permission to access non-financial ­business and vice versa. This is the so-called ‘separated operation model’. Consequently, LSPs are entrusted by the banks and are responsible for monitoring the assets and providing other relative services. LSPs have therefore gained an advantage, by providing value-added services for SMEs with service

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Figure 8.1  A typical SCF set in China with collateral

Banks

Cre

dit

Ent

gua

rus

ran

tee

tme

nt

Repayment

ng

lli ro nt Co

Monitoring

Collateral

cs gisti

Lo

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Credit granting

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Serv

Supplier

Sale of asset

Logistics flow

LSPs

ision

prov

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Customer

Financial flow

compensation for conducting inventories and managing, on the one hand, and value appraising and monitoring banks, on the other (Liu et al, 2015).

Definition of collateral Collateral in China includes any assets that can be used to compensate investors for losses. This can range from personal guarantees to real estate and equipment owned by the enterprises, and can also include intangible assets such as intellectual property. Even ‘land and property’ are being handled as collaterals for loans, eg in the farming business (ACCA, 2011).

All in all, LSPs gain a lot from this SCF solution. Nevertheless, they are not the only ones who benefit. The resulting SMEs’ financing demand arising from SCF has led banks to a derivative deposit and intermediate business income, hence a new profit point of growth. Thus, by leveraging the SCF model, the affiliated partners in the Chinese SCF solution, ie SMEs, banks

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and LSPs, can obtain multiple-win situations. Additionally, the risk can be reduced because SCF deals with the capital management against liquid assets by integrating financial services and logistics services. SCF also requires cooperation and collaboration between multiple participating companies with different characteristics. Thus, the risk has been shifted from a single organization to the members within the SC.

Opportunities and challenges for inside network internal financing Generally, adjusted payment terms at the payment or receivable side are easy to implement. No additional IT is needed and it promises quick access to liquidity. In particular, customers’ goods ordered in China usually have to be paid for in advance. Many Chinese corporates are already applying this simple SCF method, although they often do it on a stand-alone approach. Another challenge for Chinese companies is to find ‘cash-rich’ customers who are willing to agree to such payment terms, and the potential disadvantages for the buyer and the supplier are serious obstacles for a national dissemination. In terms of upfront payments, the buyer faces a certain risk regarding the quality of the product, especially for a first order of an unknown supplier. On the other hand, the supplier only receives money at the end of the production process when the products are sold and shipped. Moreover, adjusted payment terms provide no standardization. The Chinese economy is booming but it is not immune to crises – as stock-­ market crashes from time to time show. As a consequence, demand will be volatile and, given an economic downturn, trading partners will have an incentive to renegotiate payment terms.

Opportunities and challenges for inside network external financing (current assets) An SCF platform would allow Chinese suppliers to profit from the credit rating of the buyer of their products, refinance themselves with cheaper ­capital than competitors, and alleviate capital rationing. SCF solution providers offer the opportunity to include a foreign financial service provider (FSP). Most likely a foreign FSP (compared to a Chinese bank) will be able to provide more and also cheaper capital, which will provide a competitive edge by lowering the weighted average cost of capital (WACC).

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Added to this an SCF platform promises a standardized process, which is a long-term solution affecting a long-term business relationship. This will enhance planning reliability for the Chinese SC partners. As buyers will prefer customers that are linked to their SCF programme, the product demand from this buyer will be less volatile, especially considering a potential recession. Moreover, SC partners linked to the SCF platform have an incentive to share information and know-how. Given that many Chinese companies still have to develop their products for an international market with sustainable quality standards, SCF platforms could help them as a service (a) to achieve this higher quality level and (b) to sell their products in other market ­segments. Setting up an SCF platform is not free for buyers as well as suppliers. Considering the costs, as well as the opportunity for strategic partnerships, suppliers might claim certain exclusivity regarding their business relationship. For a fast-growing Chinese supplier this approach causes some kind of a lock-in situation. As a consequence, a slowing in growth of the buyer will negatively influence the supplier. Moreover, suppliers must be able to fulfil IT requirements, train their staff accordingly and implement the principles of SCM within their company. As a Chinese company must have the production capacity to deliver a certain quantity of products and services to compensate the operating cost and depreciation of the SCF platform, investments will be necessary before the SCF platform comes into play.

Opportunities and challenges for external network external financing Trade receivable securitization (TRS) could offer Chinese companies a way to diversify funds. With a number of receivables (over US $50 million) such an instrument can be set up. The risk for the investors, therefore, is relying only on the trade receivables. This would allow Chinese companies to use the credit rating within their SC. Moreover, the instrument of TRS is flexible: it enables the originator to add other guarantees, such as insurance or over-collateralization, to build up trust and marketability. Moreover, several Chinese companies can work together to achieve the US $50 million in AR. So due to securitization the tranches can be sold to customers with diverse risk–return profiles. Besides TRS, freight receivable securitization is another valuable form of SCF instrument in China.

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Freight receivable securitization in China Securitization allows a company to monetize its receivables by legally isolating the assets from the company originating them. The company pledges its receivables to an independent special purpose vehicle (SPV), which then pledges its ownership interest in the receivables to the lender. In particular, freight receivable securitization involves using a so-called ‘future flow structure’ where the receivables sold are not only those existing at the time of entering into the sale contract but also all future receivables. For a period of time, the transaction is revolving, meaning no principal is paid on the securities and all surplus cash is returned to the originator to purchase more receivables. If the level of receivables generated reaches certain agreed levels and other conditions are satisfied, further issuances of securities may be made. At some point in the future, either at a fixed date or upon the occurrence of a trigger event (for example, if defaults exceed a specified level), all funds collected from the receivables will be trapped in the structure. After the SPV has paid all other liabilities, any excess, instead of being returned to the originator, will be used to pay down the asset-backed securities. This sequence of events is often called rapid amortization (Paul Hastings, 2020).

Firms face some hurdles to securitization in China. The approach is accompanied by several activities. It involves several parties like the issuer and arranger. Thus, Chinese corporates need sophisticated financial know-how. In addition to this, the collateral is crucial. Foreign investors in particular will probably only consider receivables that offer financial data, follow international standards of accounting and are rated by international rating agencies, limiting the scope to corporates with high transparency in terms of their financial statements. Currently, receivables from Chinese SMEs will in most cases not fulfil these requirements. Therefore, securitization would be an instrument for larger Chinese corporates listed on the stock exchange. Nevertheless, we have to consider that these firms in China are often state-owned. They usually have good connections to the government and therefore also to the banking sector providing cheap and sufficient capital.

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Islamic financing and supply chain finance Introduction to Islamic financing Islam is – in the broadest sense – not only a religion but more a social idea. Islam has a universal claim on nearly every aspect of life (Black, 2008). According to the Quran, this social idea was implemented in Medina by Prophet Muhammad – he called it Ummah, as a description for a collective community of Islamic people (Simader, 2013). An interface between Islam and economics is Islamic financing. In particular, services for Muslims who want to invest their funds according to shariah without interest are part of this banking system. In 2010 over 300 Islamic financial service providers were operating in more than 50 countries worldwide (Volk, 2010). The idea of banking services without interest is relatively new. It arose after the Second World War. Before then, in the Ottoman Empire, interest rates up to 20 per cent were customary and accepted by religious society as conforming to shariah. In those days, it was also normal to deposit collateral for loans (Khan, 2010).

Definition of important Islamic financing principles Quran: The Quran literally means ‘the recitation’ and is the central religious text of Islam. It is the last revealed word of God and is the primary source of every Muslim’s faith and practice. It deals with all subjects and provides guidelines and detailed teachings for society, proper human conduct and an equitable economic system. The Quran comprehends the complete code for Muslims to live a good, chaste, abundant and rewarding life in obedience to the commandments of Allah, in this life, and to gain salvation in the next. Halal: In Islamic-dominated economies the whole financial system and the underlying SCs must be halal. Halal is an Arabic word that means permissible or lawful. All objects or actions permissible to use or engage in (goods or acts) according to Islamic law are halal. The term covers not only food and drink but also all matters of daily life. Muslims are supposed to live their lives by this concept, with its connotations of cleanliness, integrity and self-restraint.

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Shariah: Shariah is the fundamental religious concept of Islam and derives from the religious precepts of Islam, particularly the Quran. At the most basic level, shariah is the Muslim universe of ideals. It is the result of the collective effort to understand and apply the Quran and supplementary teachings of the Prophet Muhammad. It is the basic Islamic legal system and provides the legal framework for the foundation and functioning of a society; it also details moral, ethical, social and political codes of conduct for Muslims at an individual and collective level, including many topics like crime, politics, marriage contracts, trade regulations, religious prescriptions and economics. It is a significant source of legislation in many Muslim countries.

Towards shariah-conforming SCF practices The starting point for the shariah-conforming banking system we know today was in India. This may be surprising, but it arose following the separation of the Muslim minority from the Hindus by the British colonial administration. On the one hand, ideas about geographical separation were emphasized, which ended in a split into the three states: India, Pakistan and Bangladesh. On the other, efforts regarding cultural and economic independence and respective segregation were deliberate. The system of Islamic banking was developed for these reasons. From then on Muslim countries were also able to differentiate themselves from the West in terms of banking services. Islamic banking must fulfil three elementary rules. It must be free from: ●●

interest (riba);

●●

uncertainty (gharar);

●●

gambling (maisir) or anything that is banned by the Quran or Sunna (non-halal).

This is set in the trade law as fiqh al-mu’amalat (Ariss, 2010). Further principles must be fulfilled for Islamic banking (El Hawary et al, 2004): ●● ●●

●●

The risk must be borne by both parties. Financial flows must be linked with a business transaction. Therefore, a good must be sold. Exploiting a contract partner is not allowed.

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The most important point regarding Islamic finance is the ban on interest (riba). Scholars see it as unfair that the lender receives a fixed amount of money without entrepreneurial risk, which is often the case with interestbearing loans. Added to this, many Muslim authors see money only as a means of exchange, not as an asset in its own right (Visser, 2013). Therefore it has a fixed value and cannot grow through added interest. However, a general deficiency is that riba is not defined universally in the Islamic world, which causes an ongoing debate. The orthodox interpretation, for instance, equates riba with all types of interest. In this direction, some modern scholars accept interest if it is not exorbitant and if the loan is used for investment and not consumption (Akram Khan, 2013). Islam has different schools of thought on riba as well on other economic principles (Simader, 2013). As a result, a range of opinions and methods of operating are possible. The result is a heterogeneity of configurations and established practices in Islamic ­financing. To conform to halal and replace interest in Islamic finance, methods using profit-loss-sharing (PLS) were developed. A differentiation is made between strong and weak forms of PLS products. An example of a strong PLS product is Mudaraba. Two partners found an enterprise together. One partner provides the capital and the other partner provides the labour force and runs the company. Profits are shared according to a split agreed at the outset. If the company makes a loss, the capital provider bears the risk alone (Figure 8.2). Strong PLS products may be the ideal of Islamic financing, but in practice they only play a secondary role (Visser, 2013).

Figure 8.2  Concept of Mudaraba financing with profit-loss-sharing Loss is borne by the capital provider alone Profit is shared according to a split

Capital provider

Capital

Labour provider

Knowhow

Business enterprise

Profit is shared according to a split

Profit or Loss

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In contrast, Murabaha is a weak PLS form. In Islamic finance it is the dominant form of financing. It can be described as a ‘cost-up transaction’. For example, a customer wants to buy a good from a supplier – for example, raw materials for his/her own production – but cannot afford the purchase price. Therefore the supplier and the customer go to a bank and make a property purchase contract. The bank buys the good from the supplier and immediately resells it to the customer. The customer has to repay the money including a mark-up in the future (Figure 8.3). The parallels to interest-based finance are obvious. Similar to conventional lending, the bank assesses the creditworthiness of the client, the underlying asset serves as collateral, and the bank and the client enter a debtor–creditor relationship. The bank bears the risk relating to the underlying good, but usually the bank owns it only for minutes, if not seconds. The contract for buying and the contract for selling the good are signed at the same time at the same place. Therefore, the Islamic bank carries a similar risk to a conventional bank, which provides a loan covered by collateral. As a result, Murabaha is a clear deviation from strict interpretation of the Islamic finance rules (Al-Bashir Muhammad Al-Amine, 2013). Sometimes, mark-ups for Murabaha products are even linked to LIBOR (Visser, 2013). Figure 8.3  Concept of Murabaha financing

Good supplier

Sale of asset

Payment of purchase price (P)

Bank

Sale of asset

Customer

Payment of purchase price plus mark-up (P+x)

A third popular form of Islamic finance is Salam financing. This is a kind of pre-paid forward sale. Mostly the supplier uses the money made available to buy raw materials, which they need to produce a good. While the supplier gets paid in advance, the bank or the customer will not get the good until a settled date in the future. Additionally, the seller need not be the manufacturer or producer. It is possible that they are just an agent who organizes the transaction. In this case the client requests a quotation for commodity prices on specified future dates and the commodity supplier makes a quotation and undertakes to provide the commodities on specified dates at specified prices (Figure 8.4). Indeed, a good must be sold to fulfil the principles of Islamic banking. But there is consensus among Muslim jurists on the permissibility of Salam because the object of the contract is that the goods are a recompense

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Figure 8.4  Concept of Salam financing Payment of purchase price

Client

Request

Payment of purchase price

Salam agreement

Bank

Salam agreement

Customer

Delivery of commodity

Bank

Delivery of commodity

Customer

Quotation

Commodity supplier

First supply chain

Second supply chain on a specified date in the future

for the price paid in advance, just as the price is recompense paid for getting the goods in advance. The idea of Salam is to provide a mechanism that ensures the seller has the liquidity they expected from entering into the transaction in the first place (Financial Islam, 2019). The Salam contract must conform to several conditions in order to be valid (United Nations Conference on Trade and Development, 2006): ●● ●●

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●●

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The commodity should not exist when the finance is provided. The full purchase price is paid at or near to the moment that the contract is signed. The underlying asset is standardizable, easily quantifiable and of determinate quality. Assets where quality or quantity cannot be determined by specification cannot be sold through the contract of Salam. Quantity, quality, maturity date and place of delivery must be specified clearly in the contract. It is necessary that the quality of the object of sale is fully specified leaving no ambiguity that may lead to a dispute. The buyer (the bank) is allowed to require security from the seller in the form of a guarantee or mortgage. In case of a default in delivery, the borrower or his/her guarantor may be asked to deliver the same commodity by purchasing it from the market, or to reimburse the sum advanced to him/her.

Besides the different formats of Islamic financing, it has to be noted that in most Muslim countries, there are a halal-conforming and a traditional

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(Western-shaped) banking system. Only banks in Pakistan, Sudan and Iran exclusively offer shariah-compatible products (Simader, 2013). This parallelism reflects customer behaviour. Most wealthy customers from Muslim countries have two accounts: one account is for Islamic banking and one account is for conventional banking. To sum up, conventional banking is largely debt-based and allows risk transfer, and Islamic intermediation is asset-based and centred on risk-­ sharing (Hasan and Dridi, 2011). In contrast, Islamic transactions often mimic the financial results of an interest rate comparable to conventional products (Hunt-Ahmed, 2013). A comparison can be found in Table 8.2. Table 8.2  Comparison between conventional (Western) and Islamic banking Conventional banking

Islamic banking

Money is a product. Besides medium of Real asset is a product and money is exchange it is a store of value. just a medium of exchange. Time value is the basis for charging interest on capital.

Profit on exchange of goods and services is the basis for earning profit.

The expanded money in the money Balanced budget is the outcome of market, without backing the real assets, no expansion of money. results in deficit financing. Interest is charged even in case the organization suffers losses. Thus no concept of sharing loss.

Loss is shared when the organization suffers loss.

While disbursing working capital finance, no agreement for exchange of goods or services is made.

The execution of agreements for the exchange of goods and services is a must, while disbursing funds under Murabaha and Salam.

Due to non-existence of goods or services behind the money while disbursing funds, the expansion of money takes place, which creates inflation.

Due to existence of goods or services no expansion of money takes place and thus no inflation is created.

Due to inflation the entrepreneur increases prices of his goods or services, due to incorporating the inflationary effect into the cost of the product.

Due to control over inflation, no extra price is charged by the entrepreneur.

Bridge financing and long-term loans lending is not made on the basis of existence of capital goods.

Agreements are made after making sure that the capital goods exist and before disbursing funds for a capital project. (continued)

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Table 8.2  (Continued) Conventional banking

Islamic banking

Government very easily obtains loans from central bank through money market operations without initiating capital development expenditure.

Government cannot obtain loans from the monetary agency without making sure that they deliver goods to the national investment fund.

Debts financing has the advantage of leverage for an enterprise, due to interest expense as deductible item from taxable profits. This causes huge burden of taxes on salaried persons. Thus the saving and disposable income of the people is badly affected. This decreases the real gross domestic product.

Sharing profits in case of Mudaraba provides extra tax to federal government. This leads to a minimization of the tax burden over salaried persons. This increases the savings and disposable income of the people, which increases the real gross domestic product.

Opportunities and challenges for corporates SCF can be in line with the principles of Islamic financing. The Islamic banking system offers an alternative chance for the design of specific SCFinstruments as borrowers can view a bank also as a trustee, as current shariah-compliant solutions show.

A shariah-compliant SCF solution The Bursa Suq Al-Sila’ platform (www.bursamalaysia.com) claims to be the world’s first end-to-end shariah-compliant commodity trading platform that facilitates commodity-based Islamic financing and investment transactions. The platform, according to Bursa Malaysia, operates as a hybrid market based on a fully electronic trading system coupled with the traditional voicebroking facility. It is an international platform that is able to facilitate cross-border, multi-currency, commodity-based Islamic financing and investment transactions under the shariah principles of Murabahah, Tawarruq and Musawwamah. Another example is Tawreeq Holdings (www.tawreeqholdings.com), an investment group based in Dubai and Luxembourg, launching an Islamic trade receivables financing platform catering to the Gulf region’s small businesses, with plans to tap into the capital markets to fund the venture (Vizcaino, 2015).

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SCF opportunities in the Islamic world As a constitutive characteristic, there is a shariah board in an Islamic bank that protects the interests of all stakeholders and sets boundaries according to halal. So an Islamic financial contract includes moral and ethical elements. Added to this, decision makers in Islamic financing are not measured by commercial success only (Alljifri and Khandelwal, 2013). As a result, a borrower can expect that Islamic banks will not exclusively follow a shareholder maximization approach but also act according to Islamic principles. For borrowers in a weak position, this might be an argument to apply for a loan at an Islamic bank. Also, entrepreneurial believers might prefer Islamic banking, although it might have some drawbacks. A further opportunity for any company is that Islamic financing does not distinguish between equity and debt. In conventional banking the capital lender, who provides the company’s debt, has an advantage over the equity holder. If the company defaults or is liquidated, the capital lender has the first draw. In Islamic banking, debt is abandoned, and this causes a specific principal–agent constellation. If the business is not running well, the capital provider is affected immediately even though there might be an information asymmetry to the disadvantage of the capital lender. As a logical consequence, the KYC (know your customer) costs for FSPs are much higher. In fact the company must be monitored and also expertise regarding the business area must be available for the FSP. As a result, companies have the advantage that they typically work more closely with their investors. Those investors will also be interested in providing business contacts and knowhow to the company, comparable to a venture capital fund. From an economic standpoint for an enterprise, depending on the customer base it might be an important differentiation that the company is financed according to Islamic principles. If one element in an SC is not halal, the whole SC is not halal. This is also true for SCF.

Challenges of SCF in the Islamic world Nevertheless, the Islamic world is not homogeneous. Muslim countries are spread around the globe and can differ widely in terms of cultural aspects. Currently, numerous Islamic countries have an emerging economy, with less developed financial infrastructures and non-Western-orientated legal systems. In such an environment it is hard for an investor to estimate credit risks and, in case of default, recover the debts. Consequently, investors will demand a premium for this risk. Depending on the specific situations the premium can be very high, so we usually see a credit spread between Western

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countries and emerging economies. These credit spreads might be exploited by SCF. If a company from an emerging economy can use an SCF solution in such a constellation, it has cheaper access to capital and usually a strategic business relationship with its SC partners. Furthermore, SCF in Islamic banking systems also faces some specific challenges. It can only provide a partial solution for the capital needs. A major challenge in Islamic financing is asymmetric information. Entrepreneurs know more about their companies and projects than banks do, and they know the markets better than an investor providing capital. Therefore, investors use signals to estimate the efforts and credibility of customers. Pledged collateral, debt guarantee and acceptance of financial covenants are all commonly used signals that help to overcome asymmetric information. For example, Mudaraba impedes an entrepreneur when giving such signals. The capital lender is not allowed to demand collateral or a stake from his or her partner. Added to this, motivation and efforts of the entrepreneur might change over time, which will have an impact on profit and earning. Unfortunately, the capital provider bears the losses alone. Also, there exists an immanent incentive for a partner to hide earnings from his or her capital provider. Tax issues might also be a hurdle for Islamic banking and SCF. In Islamic banking, financial flows depend on the flow of goods or services. This causes some fundamental drawbacks. First of all, the purchase and sale of goods may require value added taxes (VAT). Second, tax law often allows interest to be deductible, whereas mark-ups or cost-ups are not (Visser, 2013). To overcome these issues, countries such as the UK and the United States have defined criteria for Islamic financial products regarding tax law. The profit element of deferred purchase price, lease arrangements and investor arrangements are treated for tax purposes as payment and receipt of interest (Conway and Feese, 2007). In the UK, for instance, Islamic banks work closely with tax advisers and treasury to guarantee that new Islamic financial products fall under tax legislation. Murabaha transactions should have a zero rating for VAT. Therefore, Islamic banking depends heavily on the goodwill of the government and multilateral organizations. So if SCF and trade finance comes into play, all possible products must be negotiated with each country separately to provide an even playing field.

Opportunities and challenges for inside network internal financing In Islamic finance, companies can manage AR days (DSO) or AP days (DPO), meaning they can adapt payment terms, which allows companies with a

The global setting

lower WACC within the SC to improve cash-to-cash (C2C) days. All requirements for Islamic financing can be fulfilled. Interest must not be used to adapt the price for the goods or services. Furthermore, there is no gambling due to additional uncertainty or risk involved. At the same time, both parties still share risk due to their business transaction, while there is a connection between the flow of goods and services. A big challenge arises when payment terms are not met. First, penalties due to delayed payments are not in line with the principles of Islamic financing or should at least be given to charity. Second, the legal system comes into play to enforce payments. Most countries with Islam as a state religion have emerging economies with a less efficient legal system compared to developing countries. Third, the enforceability of an Islamic finance transaction is of pressing legal concern (Hunt-Ahmed, 2013). Borrowers might doubt the underlying legal contract due to questions arising in regard to the morality of the contract. The next big challenge is that trading partners with access to disposable liquidity are needed within the SC. Even if such a partner is available, one potential restriction is that, in the case of an economic downturn, the cash-rich partner may renegotiate the payment terms and cause a liquidity shortage for the other trading partner. Finally, a challenge arises due to the ban on interest. Due to the adaptation of payment terms both companies should be able to make a profit. The involved companies have to calculate the total gain without using the concept of interest. The concept of Mudaraba with its strong PLS approach seems to be a good starting point to solve this challenge in practice.

Opportunities and challenges for inside network external financing (current assets) To meet the regulations of Islamic banking the supplier sells the products or services via the SCF platform to the FSP, which immediately resells it to the buyer. The FSP can use the concept of a Mudaraba transaction and charge a mark-up instead of interest. Herewith, risk-sharing, the connection of flows of goods and money, and the ethical requirements like fairness, can be f­ ulfilled. Corporate entities that fully comply with Islamic financing could receive, via SCF platforms, an additional source of capital. Typically one partner has to provide the capital alone. Thus, reducing the needed capital with an SCF platform could enhance the number of newly founded companies. At the same time, using an SCF platform can help corporate entities to standardize their processes. This helps to improve reliability of financial flows and also efficiency. Islamic bankers should also apply moral values. This could help in case of disagreements between the trading partners.

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A challenge arises due to the fact that each component of an SC should be halal. As a result, conventional banks may have to set up a separate entity in order to fulfil these requirements. Taxes pose a threat to the implementation of SCF platforms within Islamic financing. In contrast to conventional banking, goods and services go through an additional sale. Consequently, taxes like VAT may have to be paid a second time, with a resulting negative impact on the margins. As a result, companies must find a way to solve this problem or this will be a competitive disadvantage. In terms of international trade, in particular, dealing with different tax and legal authorities to lift this handicap could be complex.

Opportunities and challenges for external network external financing As a result of the strict application of the principles of Islamic financing, any form of trade receivable securitization cannot be offered by any Islamic bank. Selling commercial paper on the financial market is a way to mitigate risk and stands in contrast to the idea of risk-sharing. As a result, it involves uncertainty and, in some cases, also gambling. Moreover, the flows of goods and money have no connection. There is no transaction of goods or services involved. Added to this, interest is involved. In conclusion, the opportunities for external network external financing in Islamic-dominated economies is rather limited.

Western SME financing and supply chain finance Introduction to SME financing The European Union defines SME on the basis of three facts: employees, turnover and total assets. To be regarded as an SME the number of employees must be fewer than 250 and the company should generate less than €50 million euros turnover each year. Furthermore, the total balance sheet should be less than approximately €40 million euros. The European Union also defines micro companies with the following characteristics: fewer than 10 employees, and turnover and total assets both below 2 million euros. Therefore, any company between these two defined boundaries is a smallor medium-sized enterprise (SME).

The global setting

SMEs are very heterogeneous. There are big differences regarding firm productivity and growth between them. In general, they can be divided into three groups: ●●

●●

●●

The first group is small companies. Usually they were founded to provide labour or services, and usually remain small in regard to staff strength and sales revenues. The second group has moderate growth. Usually they enter an existing market with an existing product. The third group is high-growth firms. They have tremendous expansion in the first years and they usually become medium- to large-sized enterprises.

All SME groups share some characteristics. Often SMEs do not have a good financial record – they have insufficient assets usable as collateral and need only small loans, so contract-making is labour intensive. Added to this, SMEs commonly have a less-professional management and are mostly ­family-owned (Munro, 2013). So, we have to consider that, for FSPs, giving loans to SMEs is more difficult. Even estimating credit risk is harder than for a big corporate and – typically – the cost-to-earnings ratio is higher. Added to this, most large companies have know-how about how to deal with capital markets or with FSPs. This might not be the case for SMEs: 43 per cent of small enterprises and 38 per cent of medium-sized companies report that access to finance is a major obstacle (World Bank, 2010). In contrast to large companies, SMEs are more affected by collateral requirements, bank bureaucracy and connection to legal and tax authorities. Financial obstacles have an impact on the operation and growth of SMEs (Beck et al, 2005). In contrast to size, age does not matter; firm age has no correlation to a financial constraint state (Kuntchev et al, 2013). Besides the similarities, we have to distinguish whether an SME operates in the formal or informal economy. The latter – also known as the black market – is hard to define. Typically, an informal economy produces goods and services deliberately concealed from public authorities to avoid paying taxes and social security contributions and legal obligations or requirements and market standards. In emerging countries around 40 to 50 per cent of the GDP is produced by informal companies (Martinez Peria and Singh, 2014). Formal companies are – in contrast – establishments and businesses that are formally registered, eg in the register of companies. Some 53 per cent of all informal firms have a bank account compared to 86 per cent of all firms in the formal sector, but only 12 per cent of all firms in the informal sector have bank loans. By contrast 47 per cent of all firms in the

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formal sector have them. If we look at financing of working capital, the situation is even more severe. Only 7 per cent of all informal enterprises have received external finance for their working capital; 47 per cent of all formal companies have access to bank finance for their working capital. This is due to the fact that informal companies often have no credit record (Tewari et al, 2013). The debt crisis that started in 2009/10 made the fragile banking sector more risk-averse and also discouraged bank lending (OECD, 2020). The resulting consequences were even more severe for SMEs. Turnover and profit of many companies dropped, which negatively affected creditworthiness. Therefore, most banks reduced the financial access available to SMEs and tightened credit conditions (World Bank, 2020). This had a deep impact. It is well recognized that SMEs are more dependent on debt financing than are larger enterprises (which can turn to other types of finance such as public offering for debts and equity). As a result, a larger number of SMEs had serious liquidity problems. The most vulnerable did not survive and went bankrupt. Even worse, the implementation of Basel III in 2014 had a significant impact on SME lending and credit conditions. Banks reduced their balance sheets accordingly instead of raising capital. A reduction of loans would again hit the SME segment (OECD, 2013). However, some SMEs are favourable candidates for bank loans compared to their peer group: they are competitive and fast growing and therefore contribute disproportionately more to the overall economic performance. Unfortunately, credit rationing affects them as well (Tewari et al, 2013).

National initiatives encouraging SME supplier financing Despite their relevance, SMEs were too often overlooked by policy makers in the past. Fortunately, more and more countries realize the value of SMEs. The Netherlands, the United States and the UK – beside other countries – have launched initiatives between them to strengthen SMEs by encouraging supplier financing solutions. Table 8.3 summarizes the key characteristics of the SCF initiatives (www.supplierfinancing.org). All of these initiatives aim to improve the financing options of smaller companies and give them access to the working capital they need for growth.

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C A S E S TU DY Betaalme.nu (‘pay me now’) initiative in the Netherlands Betaalme.nu (translation = ‘pay me now’) is a not-for-profit initiative that aims to ease SME suppliers’ access to reasonably priced liquidity. This can support their growth ambitions and their ability to create jobs and strengthen the stability of SCs, benefiting the Dutch economy as a whole. The initiative works together with a ‘pledge’ of large corporates to ensure that the Dutch SMEs receive payment on early terms and at attractive financing rates (Figure 8.5). These corporates decide if they want to pay their suppliers faster or to offer an SCF solution to their partners at the supply side. SCF is an appropriate solution to support suppliers with liquidity. The crucial point is that companies approve the invoices of their suppliers quickly. After that suppliers are able to get their invoices paid by an FSP. The financing depends on the credit rating of their business partners, which leads to low interest rates. This alleviates the need for suppliers to obtain outside financing, providing them with fast and easy access to cash – regardless of industry, size or financial strength. Figure 8.5  Faster payment with Betaalme.nu (Betaalme.nu, 2020) Before

Supplier

Sale of asset

Customer (large corporate)

Sale of asset

Customer with pledge

Payment within average 60 days and can be extended to 90 days or longer

Supplier

After

Supplier

Payment of 90% of the invoices within 30 days

Supplier

Shorter supply chain with betaalme.nu

The Dutch ‘pay me now’ initiative targets the following specific ­advantages: ●● ●●

better insight into the cash flows; possibility to harmonize the payment terms between the SME suppliers and the customers;

●●

easier growth for activated SME suppliers;

●●

strengthening of the SC’s stability;

●●

lower costs because of improved efficiency for all of the SC members;

●●

fewer mistakes because of electronic invoicing.

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Table 8.3  National initiatives to strengthen SMEs by encouraging supplier financing solutions Country & Initiative

Idea

Programme

Participation

United Kingdom SCF Scheme

Help companies secure financing and get paid earlier, to secure the supply chains of the UK’s biggest companies and to protect thousands of jobs.

The idea is to offer early payments to UK suppliers at attractive terms, based on the creditworthiness of their customers.

Since 2012 many companies have agreed to support by actively evaluating the implementation of supply chain finance such as: Atos, BAE Systems, Kingfisher, Sainsbury’s, Rolls-Royce, Tesco, etc.

United States of America SupplierPay

The main goal of the SupplierPay initiative is to support small businesses with a possibility that will make it much easier for them to raise money for their companies. Faster payments help small business owners reduce their need for external lending, grow their operations and create jobs.

The initiative supports US-based suppliers with early payment terms and offers them access to attractive financing solutions to improve their working capital.

As of October 2014, more than 50 US-based corporations including IBM, AT&T, Lockheed Martin, Coca Cola and Johnson & Johnson have signed the SupplierPay pledge and committed to provide an option to their suppliers to get paid earlier.

Netherlands Betaalme.nu (‘pay me now’)

The purpose of the programme is to support local, small businesses with solutions allowing them to receive payment on early terms and at attractive financing rates. This alleviates the need for suppliers to obtain outside financing, providing them with fast and easy access to cash – regardless of industry, size or financial strength.

The initiative allows corporates to improve their working capital or profitability while supporting their suppliers with early payment terms.

It was officially launched in November 2015. Leading Dutch corporates such as Heineken Nederland, Randstad, Jumbo and Friesland Campina have already signed to participate.

SOURCE  www.supplierfinancing.org

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Betaalme.nu seeks to unlock 2.5 billion euros in liquidity for Dutch SMEs by 2025. It aims to do this by mobilizing 50 per cent of the top 1,000 corporates to offer their suppliers the opportunity of faster payment, or fast financing of their invoices. These ambitious goals will financially strengthen the SMEs and give them more opportunity for investment (Betaalme.nu).

The Pharmacy Earlier Payment Scheme The PEPS, introduced in April 2013, is a privately financed, voluntary arrangement, as part of a broader initiative by the UK government, to allow community pharmacies early access to their monthly advance payment for the provision of NHS pharmaceutical services. Starting in mid-2018, Taulia (https://taulia.com/), an SCF platform provider managed by the NHS Business Services Authority (NHSBSA), a special health authority and an arm’s length body of the Department of Health and Social Care (DHSC), will take over from Citibank as the scheme provider. The funding is provided by Greensill Capital (www.greensill.com). Initially, the SCF platform provider will only be offering an automatic financing option but will work with NHSBSA to provide a manual financing option in the near future.

The U.S. SupplierPay Pledge Strengthening small business access to capital is a ‘win–win’ for small companies and us, their large customers. We recognize that we thrive when supply chains are healthy, when firms of all sizes are able to support our growth, investing in new ideas and new equipment, and creating new jobs. We do best when Main Street is strong, as small businesses are critical to our reaching our full economic potential as a company and a nation. Small firms are responsible for the majority of U.S. job creation and generate close to half of U.S. gross domestic product. While small firms have made momentous strides in recovering from the depths of the Great Recession, too many small businesses continue to struggle to access capital, including working capital, which creates a drag on growth and employment. We are committed to addressing this marketplace gap in small business lending. Our efforts are intended as a meaningful step in reinvigorating our supply chains, making them more resilient over time while supporting Main Street today. Accordingly, we resolve to:

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1 Provide a working capital solution to our SME suppliers: We will take

active steps to lower the working capital cost of small business suppliers through either: Paying our small suppliers faster than we do today in order to reduce their capital needs, or enabling a financing solution that helps small suppliers to access working capital at a lower cost. 2 Share best practices: Our pledge is a first step in a larger effort to

strengthen supply chains and support small firms with the goal of driving impactful follow-on action from the broader marketplace. To encourage wider support, we’ll highlight tangible outcomes for our own efforts, providing visibility into our actions and publicize key learnings in implementing this pledge. 3 Implement a ‘win–win’ solution: We will implement this pledge in a

manner that ensures our small suppliers are able to take advantage of our commitment while minimizing new administrative or operational burdens. We will define ‘small supplier’, and if we choose to offer these solutions to the entire supply chain, we will continue to focus our efforts on the small suppliers that will benefit most. We will not use our pledge to offer financing solutions as a means of extending payment terms with our current small business supplier base. SOURCE:  https://obamawhitehouse.archives.gov/sites/default/files/docs/supplierpay_pledge.pdf

Opportunities and challenges for corporates In the early stages, firms often depend on informal funding. If firms start to expand, formal sources become more and more important and their availability can terminate the growth rate. In the Western world it is banks that are the major providers of financing working capital. SMEs typically need a wide range of services that only banks are able to provide, but traditional banking models typically target the largest firms.

Opportunities for SME supplier financing A first big opportunity for companies is the fact that SCF solutions enable them to diversify their capital sources and therefore reduce their dependence on bank loans. Microfinance companies have developed specific skills and business models to provide small loans to the informal sector, but they

The global setting

have limited ability to accompany client firms as they grow. SMEs usually start with short-term lending until there is sufficient credit history (World Bank, 2010). A company’s growth-inhibiting starting position can be fundamentally changed by means of adequate measures for strengthening its financing power (Hofmann et al, 2011). With the approach of ‘self-financing growth rate’ (SFG-rate), companies are able to calculate which business expansion out of their own means is possible and suitable. Beyond that rate, a company runs the risk of running out of cash or even funding external financing. The key challenge is to strike the proper balance between consuming cash and generating it (Churchill and Mullins, 2011). How to elaborate the available internal financing capabilities is shown in the excursus.

Excursus: Elaborating the internal financing capability of a firm For the determination of the SFG-rate, three factors are essential: 1 A company’s operating cash cycle (OCC), which is the amount of time the

company’s money is tied up in inventory and other current assets before the company is paid for the goods and services it produces. 2 The amount of cash needed to finance each euro of sales, including

working capital and operating expenses. 3 The amount of cash generated by each euro of sales.

The length of the OCC depends on a lot of different factors. For example, a service firm with little inventory and quick payments in cash from its customers typically has a shorter OCC than a company that has to tie up funds, has a large inventory and has to wait a long time until it can collect its account receivables. Before the SFG-rate can be calculated, each of the three factors has to be determined (Figure 8.6). In the given example the annual SFG-rate is 18.58 per cent. If the firm grows more slowly than this, it will produce more cash than it needs to support its business expansion. But if it attempts to grow faster than 18.58 per cent per year, it must either free up more cash from its operations or find additional funding externally. Otherwise, it could unexpectedly find itself strapped for cash.

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Figure 8.6  Exemplary calculation of the annual SFG rate Duration cash is tied up (in days) Days of accounts receivable Days holding inventory Operating cash cycle (OCC) Days of accounts payable Days of cost of sales (cash-to-cash cycle) Days outstanding operating expenses

70 80 150 30 120 =(75)

Income statement 1.000€ 0.600€ 0.400€ 0.350€ 0.05€

Sales Cost of sales Gross profit Operating expenses Profit

Amount of cash tied up per sales euro 0.60€ x (120/150) = 0.480 € Cost of sales Operations expenses 0.350€ x (75/150) = 0.175 € 0.655 € Cash required for each OCC

30-day credit term shortens the time the cash is tied up to only 120 days. Operating expenses are paid from time to time throughout the circle, so they are outstanding for half the period, or 75 days. Normalization 1 euro equates to 100%. To simplify this example, we have included income taxes within operating expenses and ignore depreciation. The income statement shows that to produce 1 euro of sales incurs 0.60 euros in cost of sales. This is tied up for 120 days. The income statement also shows that 0.35 euros must invest per euro of sales to pay the operating expenses. This cash is tied up for 75 days.

Cash generated per sales euro Cash generated per sales Euro

0.05 €

SFG-rate calculations OCC SFG-rate OCCs per year Annual SFG rate

0.05€/0.655€ = 7.63% 365/150 = 2.433 7.63% × 2.433 = 18.58%

Adding the 0.05 euros to the 0.655 euros that already is invested would increase the investment by 7.63% each cycle. This can be directly translated into a 7.63% increase in sales volume in the next cycle.

It is possible to increase the SFG-rate by effecting any of the three levers that determine the SFG-rate: 1 Shortening the OCC, eg by lowering the period of inventory lock-up,

lowering the AR payment terms or increasing the AP payment terms. 2 Reducing cost of goods sold and other expenses, eg realization of

discounts. 3 Increasing net sales, eg through lower sales prices because of reduced

purchase prices.

Another aspect that favours an SCF solution for an SME is that some approaches are the equivalent to committing to a long-term business relationship. Thus, there will be more business between the two partners, more information will flow, and both will have an incentive to improve the traded goods and services in respect of the buyer’s need. For suppliers, SCF ­solutions also offer a higher planning reliability; volumes of sales can be better e­ stimated and planned, which will reduce waste in production time and ­materials.

The global setting

SCF challenges of SME supplier financing There are also challenges for SCF solutions as similar characteristics as applying for a bank loan come into play. Such small firms must find a trading partner; in most cases this would be a strong corporate that has a better WACC and is willing to enter into a strategic partnership. Implementing SCF solutions usually causes costs regarding IT, schooling staff and process re-engineering. Clearly, a big enterprise must see an advantage in doing so. In fact, large enterprises will run a back-up check and due diligence to pick the ‘best’ suppliers before implementing an SCF solution. Moreover, similar to small bank loans, small transaction volumes regarding traded goods or services are typically not interesting. A defined transaction volume and value is needed to achieve break-even for some SCF projects, especially including FSPs. If an SME supplier is willing to engage in an SCF programme and to provide the needed quantity, it can also represent a systematic risk for the entity due to dependence.

Opportunities and challenges for inside network internal financing Western SMEs can apply changes in days of AR (DSO) or days of AP (DPO) within their SC. As long as one partner within the SC has lower WACC, flows of goods or money can be adapted and gained profits can be shared according to the carried risk. But the implementation of changes regarding the payment terms also ­creates some challenges. For example, the trading partner with the lower WACC must be able to provide liquidity. In addition to this, trading partners within the SC must have the trust to share confidential information. Also, payment term adjustments should take place in a preconditioned, self-­ binding and well-communicated setting. In practice, there remains an incentive for one SC partner to try to renegotiate and alter terms afterwards. Especially during an economic crisis, these recurrences could be critical for weaker SMEs.

Opportunities and challenges for inside network external financing (current assets) The biggest opportunity for Western SMEs regarding SCF platforms is the prospect of overcoming capital constraints. SCF platforms offer an appropriate and additional source of financial resources. Regarding the credit risk,

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an FSP has to consider the buyer of the goods and services only. As long as a buyer with a good rating is involved, suppliers will usually have cheaper access to capital. Entering an SCF platform project helps create a strong bond between SC partners. For an SME in particular this has several advantages. The depreciation and operating costs are high but are taken from the initiating corporate. Furthermore, the buyer has an incentive to stay with the chosen suppliers. So, SMEs have a higher planning reliability and an advantage against competitors (positive lock-in effect). As a result, the supplier can also tackle projects with a longer time horizon regarding the demanded products or goods. In contrast, there are also challenges. SME suppliers must be able to provide a certain production capacity to achieve a certain turnover and frequency regarding deals with the supplier to offset the costs for the SCF platform. At the same time, these ties with the buyer will create a certain negative lock-in effect. The buyer will make sure that the supplier stays, which potentially blocks other business opportunities. At the same time an unpleasant development for the buyer will directly influence the supplier, which creates a dependency risk. An additional challenge is that the buyer carefully reflects which supplier will be picked for the SCF platform. While using an SCF platform, one of the major problems is the rapid and efficient on-boarding of suppliers – independently of their size and the ­corresponding trade volume. The success of this form of inside network external financing is directly tied to supplier willingness to use the system. Especially for small companies, such a procedure can be a major inconvenience, calling for change. But how can a corporate establish a successful AP solution with its SME suppliers? The answer lies in simple psychology – it has to be obvious to the supplier that it is more lucrative to be part of an SCF programme than not (prospect for a win–win situation).

How to on-board SME suppliers efficiently There are seven principles for on-boarding SME suppliers on an RF platform: 1 Be proactive: Corporates should address supplier on-boarding proactively

rather than reactively. They should make the process seamless from the beginning so that suppliers have no cause to push back. 2 Prioritize suppliers to on-board: Based on the Pareto principle, 20 per cent

of the suppliers will typically account for 80 per cent of the total spend. By

The global setting

focusing on that 20 per cent, the corporates will get more of their spend into the system even while on-boarding a smaller number of suppliers. Then, once the top vendors are on board, the focus can be expanded to the next tier. 3 Plan how the suppliers will connect: Corporates have to determine

whether the suppliers already use a defined EDI format, because SMEs would easily buy into a system that they are already using. Between these suppliers it is important to prioritize the on-boarding of those suppliers that use supported browsers – changing browsers is easier and more cost effective than developing support for a new browser. 4 Make registration of individual suppliers and users as easy as possible:

Automatic on-boarding of 80 per cent of the suppliers will allow corporates to focus on the 20 per cent that run into issues. It should be possible to send suppliers email invitations with a link, username and password, and to allow suppliers to submit various documents and required certificates online so they can be tracked efficiently. 5 Plan for future growth: A merger or acquisition can increase the number

of suppliers to be on-boarded. If a corporate is currently in an expansion phase, numerous connectivity and management options into the collaboration platform should be considered, in order to retain scalability. 6 Prioritize processes to implement: If the majority of time is spent

handling invoicing manually, starting an AP automation can be a success. If there is a significant need for this, suppliers are more likely to give it a try. Once the suppliers buy into this, depending upon the need, it is possible to roll out additional processes such as a joint purchase order collaboration. 7 Plan to provide supplier training: Training and online education (eg in the

form of an internet tutorial or webinar) help to form the initial perception of an SCF platform and can ensure a positive experience, especially for SME suppliers. SOURCE  Inspired by Take Supply Chain (2016)

While there may be initial reluctance from SME suppliers to trying this new approach, with these few simple steps it is possible to overcome that resistance more easily.

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SME support in developing countries by international organizations such as the IFC is covered in Chapter 5. In Chapter 4, we describe the Unilever example of supporting SMEs in a developing country.

Opportunities and challenges for external network external financing Trade receivable securitization (TRS) helps companies to turn their AR into quick cash. As long as the AR relates to a customer with a higher credit rating, ie lower cost of capital than the SME, an optimization opportunity ­exists. An opportunity can also arise due to the flexibility of TRS. In case a SME has not sufficient AR to achieve the necessary limit of US $50 million, an issuer could set up a pool with AR from other companies. An example might be that only AR are used from one buyer but from several suppliers, or AR from companies within a region, or within the same industry, are included. In addition, to increase marketability, over-collateralization or insurance can be included. Western SMEs wishing to conduct a TRS transaction will have a limited choice when considering the acting financial intermediary, ie investment bank, due to their size. Another challenge is that Western SMEs must have access to AR from companies with a good credit rating. Credit arbitrage is possible only if the customer of the suppliers has a higher credit rating. Added to this the SME  must have qualified staff who can support the issuer setting up the ­transaction.

Summary From the discussions in this chapter, we can take out some useful pointers when acting in China with Chinese firms or while making business in Islamic-orientated countries. Furthermore, some important issues for SCF regarding SMEs were tackled. To sum up, global socio-cultural aspects will become increasingly significant in the future. Corporates need to account for distinctive SCF features against this backdrop of ‘regional’ specialities (especially legislation), values and behaviour patterns. However, it is also clear that SCF has a positive contribution to make in all these areas.

The global setting

Recap on Chinese financing and SCF In the long run, the Chinese market (including currency) will play a dominant role in the world and will – possibly – replace some previously established businesses (if not the whole markets). But changes appear to be necessary to rebuild the Chinese banking system. SCF solutions might be a promising way to provide liquidity to the economy; the question is whether the Chinese government would allow SCF solutions at high volumes. Currently, the Chinese capital market is more or less isolated, something that tempered the effects of historical financial crises. Such isolation is also easier to monitor and regulate due to a lower degree of complexity. In China the government heavily influences lending behaviour and therefore promotes and subsidizes certain industries. SCF solutions, which probably would be offered by international and non-Chinese players, would increase independence from Chinese banks and consequently the Chinese g­ overnment. But, in contrast to loans, SCF solutions are more complex and they are ‘the new kid on the block’. In order to push SCF solutions into the Chinese market, there would be the need for a lobby promoting these concepts. In addition, general improvements in the financial infrastructure would enhance the chance of successful implementation of SCF solutions. For example, an approximation to or harmonization of international established standards like accounting and auditing standards, credit reporting systems, collateral and insolvency regimes as well as payment and settlement systems, would be beneficial (World Bank, 2010). Furthermore, the ‘shadow banking’ market in China has become too big to fail. A public example is the rapidly increasing popularity of P2P lending. The Chinese government recently started to regulate these P2P systems. This might be another reason to establish alternative sources of capital for the economy. Here, SCF could also play a role in fostering business growth in China. The key is having the right levels of support from the government (especially legal, tax and regulatory authorities as well as jurisdictions) to encourage the SCF approach. There are definitely signs that such support is increasing in China.

Recap on Islamic financing and SCF SCF provides some halal-conforming opportunities for policy makers in countries where Islam is the defining regulatory driver. It should be noted that Islamic banking is often a complement rather than a substitute in many

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countries. In most cases it will be an additional capital source, but it could also help to reduce risk. To date, Islamic banks appear more protected against risks than large conventional banks. One reason is that they are financed primarily from deposit accounts, which grants stability. Islamic banks also do not engage in the secondary market, for example in the sub-prime mortgage market. This means that Islamic financing can help to diversify systematic risks due to their different exposure (Imam and Kpodar, 2013). Unfortunately, as soon as the real economy was hit in 2008/09, Islamic banks performed as badly as their conventional competitors (Hasan and Dridi, 2011). Some SCF solutions could support the economic stability of a country due to the link between the flow of goods or services and money. As soon as demand increases, capital is available. Overall, promoting SCF solutions could benefit the reputations of politicians in a Muslim society, as SCF can provide several opportunities. In addition, it can be totally in line with the requirements of shariah and other Islamic principles. The heterogeneity of Islamic financing is – and will ­remain – one of the major challenges to introducing SCF in such regions and cultural contexts in the future.

Recap on Western SME financing and SCF If a government supports SCF for SMEs it can have a positive effect on its economy. First of all SCF offers constrained SMEs an additional source of capital, reducing cost of capital and fostering operational efficiency. For SMEs in particular, this could help to finance growth, create jobs and reduce operations expenses. Moreover, the diversification of capital sources for companies might even have a positive effect in financial or economic crises. Added to this, implementing SCF programmes is accompanied by entering into strategic partnerships. SMEs not only receive cheaper credit, they usually also receive know-how and technology support. Moreover, companies can plan on a longer time horizon. Governments already use partial credit guarantees (PCGs) – like the longrunning SBA Section 7a program in the United States, the Italian small loan guarantee scheme or the UK Small Firm Loan Guarantee (SFLG) scheme (Honohan, 2010). They are established for countercyclical purposes (World Bank, 2020). If states apply such PCG schemes, authorities still have to decide which companies receive access and profit from partial credit guarantees. Unfortunately, governments often fail to pick the winner (Tewari et al, 2013).

The global setting

Furthermore, if politicians support a winner, they can receive credit for it. In contrast, enabling SCF, which also could help fast-growing companies to get access to capital, is made on the free market. If a company succeeds, partly financed with SCF, it is hard to take the credit for it. Moreover, we have to consider that SCF is still the new kid on the block. Therefore, politicians, first of all, must have awareness of the meaning of SCF. Then they must understand it and, as a result, take the requirements of SCF into consideration when they decide on new regulations. It is common for banks to have a good connection to politicians. However, as long as SCF solutions for banks are just a niche market, they will not get sufficient political attention. On the other hand, if new and innovative competitors, for example from fintechs, enter the scene, building up hurdles by means of new regulations could be a rational strategy for FSP lobbyists. So, the key question is a strategic one: how will the financial industry push SCF solutions in the near future? But experience from the international community, especially the IFC, shows that some governmental agencies are seeing the opportunities for SCF.

References ACCA (2011) [accessed 24 January 2020] Website, www.accaglobal.com/gb/en. html (archived at https://perma.cc/52TM-4AZV) Akram Khan, M (2013) What is Wrong with Islamic Economics? Edward Elgar Publishing, Cheltenham Al-Bashir Muhammad Al-Amine, M (2013) Managing liquidity risk in Islamic finance, in Contemporary Islamic Finance, ed K Hunt-Ahmed, pp 121–47, Wiley, Hoboken, NJ Allen, F, Qian, J and Qian, M (2005) Law, finance and economic growth in China, Journal of Financial Economics, 77 (1), pp 57–116 Alljifri, K and Khandelwal, SK (2013) Financial contracts in conventional and Islamic financial institution: An agent theory perspective, Review of Business and Finance Studies, 4 (2), pp 79–88 Ariss, RT (2010) Competitive conditions in Islamic and conventional banking: A global perspective, Review of Financial Economics, 19 (3), pp 101–08 Beck, T, Demirgüc-Kunt, A and Maksimovic, V (2005) Financial and legal constraints to growth: Does firm size matter? The Journal of Finance, LX (1), pp 137–77 Betaalme.nu [accessed 24 January 2020] Pay Me Now [Online] www.betaalme.nu (archived at https://perma.cc/D89B-LUUF)

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The future Black, A (2008) The West and Islam, Oxford University Press, New York Churchill, NC and Mullins, JW (2011) How fast can your company afford to grow? Harvard Business Review, May, pp 135–4, 166 Conway, K and Feese, S (2007) The tax dilemma in Islamic finance, International Tax Review, 18, pp 20–22 Doug, T (2014) China shadow credit still a major worry, Investors Business Daily, p A01 El Hawary, D, Grais, W and Iqbal, Z (2004) [accessed 24 January 2020] Regulating Islamic financial institutions: The nature of the regulated, World Bank Policy Research Working Paper [Online] http://documents.worldbank.org/curated/ en/918931468761945251/Regulating-islamic-financial-institutions-The-natureof-the-regulated (archived at https://perma.cc/3T6Y-J7SG) Financial Islam (2019) [accessed 24 January 2020] Salam [Online] www. financialislam.com/salam.html (archived at https://perma.cc/PH99-YCLN) Garrcia-Herrero, A and Santabarbara, D (2013) An assessment of China’s banking, in Who Will Provide the Next Financial Model? ed S Kaji and E Ogawa, pp 147–82, Springer, Tokyo Hasan, M and Dridi, J (2011) The effects of the global crisis on Islamic and conventional banks: A comparative study, Journal of International Commerce, Economics and Policy, 2 (2), pp 163–200 Hofmann, E, Maucher, D, Piesker, S and Richter, P (2011) Ways Out of the Working Capital Trap, Springer, Heidelberg Honohan, P (2010) Partial credit guarantees: Principles and practice, Journal of Financial Stability, 6 (1), pp 1–9 Hunt-Ahmed, K (2013) Contemporary Islamic Finance, Wiley, Hoboken, NJ Imam, P and Kpodar, K (2013) Islamic banking: How has it expanded? Emerging Markets Finance & Trade, 49 (6), pp 112–37 Khan, F (2010) How Islamic is Islamic banking? Journal of Economic Behavior & Organization, 76 (3), pp 805–20 Kuntchev, V, Ramalho, R, Rodriguez-Meza, J and Yang, JS (2013) [accessed 24 January 2020] What have we learned from the enterprise surveys regarding access to credit by SMEs? [Online] https://openknowledge.worldbank.org/ bitstream/handle/10986/16885/WPS6670.pdf?sequence=1 (archived at https:// perma.cc/H9U3-7HY5) Liu, A (2019) [accessed 24 January 2020] China P2P lending crackdown may see 70% of firms close, Bloomberg, 2 January 2019 [Online] www.bloomberg.com/ news/articles/2019-01-02/china-s-online-lending-crackdown-may-see-70-ofbusinesses-close (archived at https://perma.cc/2234-NDD2) Liu, X, Zhou, L and Wu, YCJ (2015) Supply chain finance in China: Business innovation and theory development, Sustainability, 7 (11), 14689–709 Lu, D, Thangavelu, SM and Hu, Q (2007) Biased lending and non-performing loans in China’s banking sector, The Journal of Development Studies, 1 (6), pp 1071–91

The global setting Lui, M-H and Margaritis, D (2009) Monetary policy and interest rate rigidity in China, Applied Financial Economics, 19 (8), pp 647–57 Martinez Peria, M and Singh, S (2014) [accessed 24 January 2020] The impact of credit information sharing reforms on firm financing [Online] https:// openknowledge.worldbank.org/bitstream/handle/10986/20348/WPS7013. pdf?sequence=1 (archived at https://perma.cc/24DN-SF2X) Munro, D (2013) A Guide to SME Financing, Palgrave Macmillan, New York OECD (2013) [accessed 24 January 2020] Financing SMEs and entrepreneurs: An OECD scoreboard [Online] www.oecd.org/cfe/smes/Scoreboard_2013_extract_ chapter2.pdf (archived at https://perma.cc/3FDT-SGBF) Paul Hastings [accessed 24 January 2020] Securitizations and structured finance [Online] https://www.paulhastings.com/area/Asset-Securitization-andStructured-Finance (archived at https://perma.cc/P7R5-PYFG) PewResearchCenter (2011) [accessed 24 January 2020] Table: Muslim population by country [Online] www.pewforum.org/2011/01/27/table-muslim-populationby-country/ (archived at https://perma.cc/TWQ7-23QF) PewResearchCenter (2012) [accessed 24 January 2020] The global religious landscape [Online] www.pewforum.org/2012/12/18/global-religious-landscapeexec/ (archived at https://perma.cc/L2AN-FP27) Shammas, J (2014) [accessed 24 January 2020] Islam predicted to overtake Christianity as world’s largest religion by 2070 [Online] www.mirror.co.uk/ news/world-news/islam-predicted-overtake-christianity-worlds-5450794 (archived at https://perma.cc/NSC8-XHN6) Simader, E (2013) Die westliche Finanzkrise, Peter Lang GmbH, Frankfurt am Main Take Supply Chain (2016) [accessed 24 January 2020] 7 steps to easy supplier onboarding [Online] www.supplychainbrain.com/articles/18601-7-steps-toeasy-supplier-onboarding (archived at https://perma.cc/VF5D-XZEU) Tewari, PS, Skilling, D, Kumar, P and Wu, Z (2013) [accessed 24 January 2020] Competitive small and medium enterprises: A diagnostic to help design smart SME policy [Online] https://openknowledge.worldbank.org/bitstream/handle/10 986/16636/825160WP0P148100Box379861B00PUBLIC0.pdf?sequence=1 (archived at https://perma.cc/D3FS-BYKW) United Nations Conference on Trade and Development (2006) [accessed 24 January 2020] Islamic finance and structured commodity finance [Online] https://digitallibrary.un.org/record/576402 (archived at https://perma.cc/ NG2T-9EKE) Visser, H (2013) Islamic Finance, Edward Elgar Publishing, Cheltenham Vizcaino, B (2015) [accessed 24 January 2020] Dubai-Luxembourg firm launches Islamic factoring for SMEs, Reuters [Online] www.reuters.com/article/islamicfinance-factoring/dubai-luxembourg-firm-launches-islamic-factoring-for-smesidUSL6N0V503E20150127 (archived at https://perma.cc/2RBY-DRT6)

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The future Volk, S (2010) Challenges and opportunities for Islamic retail banking in the European context: Lessons to be learnt from a British–German comparison, Journal of Financial Services Marketing, 15, pp 191–202 Wei, S (2013) Shadow banking system in China: Risk, regulation and policy, Journal of International Banking Law and Regulation, 1, p 20 World Bank (2010) [accessed 24 January 2020] Small and medium enterprises (SMEs) finance [Online] www.worldbank.org/en/topic/smefinance (archived at https://perma.cc/F9U6-226L) Xingjian, C and Shimming, D (2014) The development of supply chain finance in China, International Journal of Management Excellence, 3 (3), pp 475–79 Xusheng, Y (2014) Inside China: Reining in P2P lending, International Financial Law Review, 33 (5), p 224

Study question Read the case study below and answer the study questions at the end.

C A S E S TU DY  Cross-border cash pooling in China Bank of America Merrill Lynch Global Transaction Services (BofA Merrill GTS) has launched automated US dollar (USD) cross-border cash pooling services for corporations operating in the Shanghai Free Trade Zone. The group said that ZF TRW, a division of Germany’s ZF Friedrichshafen, which manufactures car safety systems, has implemented the working capital solution and is serving as the pilot client for this innovative service. BofA Merrill GTS added that the new service allows companies to take advantage of the cross-border pooling scheme policy liberalization announced by China’s agency The State Administration of Foreign Exchange, which allows for the wider cross-border utilization of funds sourced both on and offshore, and an increased quota for net inflows. USD cross-border cash pooling can assist companies operating in China by better addressing working capital requirements with on and offshore surplus funds. The banking group’s new service allows for USD payment and collection centralization, as well as netting arrangements. It also allows corporate entities in China to operate more in line with their global enterprise cash management practices by reducing cross-border payment fees, streamlining cross-border settlement and standardizing processing flows.

The global setting

‘China continues to deregulate its treasury management framework’, said Ivo Distelbrink, head of GTS, Asia Pacific at BofA Merrill. ‘This solution provides opportunities for those operating there to adopt more efficient and effective treasury management practices.’ ‘The launch of USD cross-border cash pooling is a key milestone for ZF TRW in integrating our China cash management function into our global structure, greatly helping us optimize working capital management, control foreign exchange risk exposures and improve funding efficiency’, said Jane Hua, Asia Pacific Treasurer for ZF TRW. SOURCE  Buck, G (2016) [accessed 3 March 2020] BofA Merrill launches USD cross-border cash pooling in China [Online] www.gtnews.com

Study questions 1 What does ‘on and offshore surplus funds’ actually mean? What are the

benefits for ZF TRW to operate with such financial resources in China? Are there any negative side effects? 2 What are the general opportunities of cross-border cash pooling for greater

China beyond the Shanghai Free Trade Zone? Could Chinese firms also profit from a liberalization of such an approach? 3 Would the cross-border cash pooling approach also work with the principles

of Islamic financing? 4 Which are the challenges for SMEs to use such a cross-border cash pooling

approach?

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The look beyond 09 Factors impacting the future of supply chain finance

O U TCO M E S The intended outcome of this chapter is to help you understand some of the broader issues likely to impact the future of SCF, including: ●●

optimizing SCs for tax and the complexity and risks this raises in SCF;

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the possibilities of connecting CSR and SCF;

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smart applications of SCF based on big data analytics;

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blockchain as a new industry-disrupting technology for SCF;

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other upcoming trends to consider in prospective SCF programmes.

By the end of this chapter you should be able to: ●●

identify benefits and drawbacks of financing with respect to tax and VAT;

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recognize goals of CSR in connection with SCF;

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determine possible action points of big data analytics in SCF;

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evaluate the disruptive nature of technological change – especially blockchain – for SCF; reflect on the possible trends affecting future SCF programmes.

Introduction The last chapter of our book will address factors and developments that have the force to affect the long-term sustainability of supply chain finance (SCF). These factors include tax issues (including VAT), corporate social responsibility (CSR), and of course new technologies (big data analytics and

The look beyond

blockchains) as well as macroeconomic trends. They not only impact SCF now, but their importance is increasing considerably and each will have an impact on SCF in the near and far future. Metaphorically speaking, tax issues are the ‘dark side’, CSR is the ‘bright side’, big data analytics are the ‘smart side’, new technologies are the ‘tech side’ and possible trends are the ‘pre-vision’ of the future of SCF. But why do we focus on these factors? Supply chains (SCs) have become increasingly global and complex and therefore, for all parties, the importance of transparency and risk management increases, especially where ­financial transactions are concerned. With many more cross-border transactions associated with SCF, legal and tax issues also arise. Tax rules vary from jurisdiction to jurisdiction, from goods to services, from exemptions to trade zone restrictions or liberties. There is the additional nuance that local common practice can be at odds with the written word of the law itself. Corporates want to minimize corporate tax, to reduce customs duties or justify VAT refunds. Globalization also affects CSR as SC networks become larger and span several countries. When dealing with SCs, corporates should not only consider their own financial benefits, they should also care about their business partners as well as social and environmental sustainability. Moreover, technological progress and innovative technologies change the world and how business is done, notably fintechs are seen as the source of fundamental change in the financial system. Lastly, general trends at the global macro-level (might) occur, which have to be taken into account while launching or driving SCF programmes in the future. These topics are ­ explored in the context of SCF.

Key issues This chapter addresses the following key issues: ●●

What are the opportunities for tax-effective SCM?

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Is there financial fair play in SCF?

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Can blockchain technology bring SCF to the next level?

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What are the potentials of artificial intelligence for SCF?

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What are the upcoming challenges for SCF in terms of political, economic, social, technological and legal terms?

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The dark side – tax issues: why direct and indirect taxes should be considered in SCF Taxes as a specific issue of financial supply chains Tax payments and duties are part of the financial SC. Thus, they belong to a comprehensive SCF understanding. So, how do diverse tax or customs regimes and a purposeful tax minimization correspond to SCs and thus to SCF? Whereas tax optimization has traditionally been seen purely in the context of shareholder value, efficient and elaborated SCM represents an effective operating approach to construct and exploit tax beneficial settings. In an environment where SCs are trying to respond to a multitude of challenges, a focus on tax may not seem to be the most obvious or relevant course of action in the first place. However, it can be complementary to most physical SC changes and can deliver significant benefits at the same time or add substantial costs if handled ineffectively. SC design is typically unique to each industry and, in many cases, to each particular company. Tax-efficient SCM uses a business model that integrates planning between SCs and tax including customs duties. Corporates need to have sufficient knowledge about the different types of taxes to be considered in their SC (design) decisions: ●●

●●

Direct tax (corporate income tax): In the eyes of tax authorities, profit is determined by those functions that are perceived as adding value, such as design, manufacturing as well as brand management, strategic policy setting and risk management. Therefore, we can briefly state: ‘Direct tax follows profit’. An SC redesign changes the physical location of where activities take place. This therefore impacts how much tax has to be paid in each location or link of an SC. Indirect tax: Indirect taxes include among others value added tax (VAT) and customs duties. VAT is a consumption tax and aims to tax end consumers, generally private customers, only. Nevertheless, companies are also affected as VAT systems are designed to achieve this goal by shifting the task of tax collection to the companies within the SC as ‘value is added’ and making them agents of the fiscal authorities. VAT becomes relevant when triggered by two events, namely (1) the exchange of goods

The look beyond

within a country with an implemented VAT system, and (2) cross-border transportation involving at least one country with an implemented VAT system. Customs duties are levied on goods that are brought into a country’s customs territory. They can also be called border tariffs. As inland duties generally no longer exist, the issue of customs duties is relevant for international (cross-border) SCs covered by International Commercial Terms (Incoterms). Very similar to VAT, a sales tax is a consumption tax imposed by the government on the sale of goods and services. A conventional sales tax is levied at the point of sale, collected by the retailer and passed on to the government. Note, the United States is one of the only advanced economies where conventional sales taxes are still used.

Consideration of direct taxes in supply chains For an example of the impact on direct taxation, we will look at the alignment of tax planning and procurement strategy. With so called ‘tax-effective procurement’, companies can both enhance operational benefits, such as supplier pricing, and manage tax liabilities to much greater purpose. A shift from traditional SC designs to tax-aligned SC designs is visible and is portrayed in Figure 9.1. However, not only are SC designs changing, procurement models are transforming as well. For instance, additional benefits can be achieved by allocating procurement savings to a tax-efficient location. The historically common decentralized governance structure – a corporate runs nearly every function in each country it operates in – is still prevalent. This is characterized by a low degree of detailed functional accountability, cross-geography management centralization and organizational change. In this model, procurement functions, risks and assets are often designed for local scale and have local impacts. An alternative concept is the so-called ‘centre-led procurement model’, as illustrated by PwC’s framework with its ‘pros’ and ‘cons’, as shown in Figure 9.2. This approach can consolidate purchases and so achieve better prices, can be designed with a strong regional focus, can easily be established with lower infrastructure and system needs, and incorporates relatively low inventory and supply risk. However, it does not force cross-­ regional improvement, lacks the ability to manage SCs and offers merely moderate tax ­benefits.

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Figure 9.1  Exemplary procurement enhancement propositions including tax-issues Traditional supply chain design Strategy

Strategy

Strategy

Strategy

Analysis

Analysis

Analysis

Analysis

Negotiations

Negotiations

Negotiations

Negotiations

Selection

Selection

Selection

Selection

Contract Contract Contract Contract management management management management SRM

SRM

SRM

SRM

Demand planning

Demand planning

Demand planning

Demand planning

P2P

P2P

P2P

P2P

UK

Germany

France

Switzerland

Aligned supply chain design including tax aspects Strategy Analysis Negotiations Selection Contract management SRM SRM

SRM

Demand planning

Demand planning

Demand planning

Demand planning

P2P

UK

Germany

France

Switzerland

SOURCE  PwC (2012: 3)

A third form, the so-called ‘procurement (buy–sell) principal model’ aims at cross-border leverage of spend resources and expertise through centralization and new accountabilities. It increases the speed of execution, enhances the ability to enforce global contracts and provides for global pricing and risk management strategies, as well as the opportunity for greatest possible tax benefits. Although this concept requires a major organizational shift, maybe less responsive to local needs, and might be more expensive to implement, the benefits mean switching to it may be worth considering.

The look beyond

Figure 9.2  Centre-led procurement model

Delivery of goods and services

Purchase order

Supplier

Local operating company

Payment for goods and services

Payment for procurement services

Framework agreement

Service level agreement

Central procurement company

Pros

Cons

• Stronger regionalization gives more unified voice to regional/global suppliers • Regional-level accountability still allows good interaction with decentralized stakeholders • People should be located where operationally sensible – probably similar to today • Small central strategy team to be located in low tax global or regional country • Easier to establish with lower infrastructure and systems needs • Less inventory and supply risk than buy– sell model

• Does not allow for cross-regional optimization • Does not allow global-level contract enforcement and ability to commit global volume • Does not provide one voice to global suppliers • Sub-optimal talent resource management • Inability to manage supply chain • Limited ability to implement global risk management strategies • Difficult to monitor and manage strategy compliance • Fewer tax benefits than in procurement principal model

SOURCE  PwC (2012: 4)

The model itself, as well as its pros and cons, are illustrated in Figure 9.3. Since the procurement (buy–sell) can optimize tax benefits, it is of high interest to corporates operating in multiple countries, therefore facing ­different tax regimes. The geographical ‘centralization’ of procurement organization is currently popular in Switzerland. As Table 9.1 shows, a considerable number of corporates have set up their procurement company in the alpine republic. Operational centralization seems to be the most common rationale, with the tax arrangements a close second.

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Figure 9.3  Procurement (buy–sell) principal model Local operating company Delivery of goods and services

Invoice Demand and fee

Rebate Logistics

Supplier

Pros • Allows global leverage of resources and expertise through centralization and new accountabilities • Increases speed of execution, consistency of approach and cost efficiency through simplified decision process • Provides ability to enforce global contracts and to commit global volume in supplier negotiations • Enables one voice and good interaction with global suppliers • Provides the ability to implement average pricing and risk management strategies at a global level • Enables global supplier-demand balance and inventory management • Provides optimal tax benefits and limits tax risks

Order and contracts

Central procurement company Cons

• Procurement nominally further removed from markets and business • Requires major organizational shift • May not be effective at catering for regional diversity and adapting to local needs • Limited ability to effectively manage development of regional/local suppliers • Potentially substantial infrastructure and systems set-up costs

SOURCE  PwC (2012: 4)

The three procurement models described all impact profitability differently. Figure 9.4 provides a schematic extract from the profit and loss statement (P&L) and shows how the different procurement models impact key figures. The ratios that are especially affected are costs of goods sold (COGS), selling, general and administrative expenses (SG&A), as well as earnings before income tax and income tax. First, the decentralized model does not create any tax reductions. Second, with the help of the centre-led procurement model corporates can decrease their COGS and their SG&A. Taken together, income tax can be reduced successfully. While the decentralized model deals entirely on a local level, there is a central impact from the ­centre-led procurement model and the procurement (buy–sell) principal approach. Third, compared to the centre-led procurement model, COGS and SG&A decrease to a stronger extent when corporates use the procurement (buy–sell) principal model. Of the three models shown, the procurement (buy–sell) principal model reduces corporate income tax the most.

Table 9.1  Corporates with procurement companies in Switzerland Revenue (procurement volume) in 2011 in million € Reasons

Former procurement organization Comments

Name

Location

SAB Miller

Zug

€14,686 (>€3,500)

Advantageous tax burden Headquarters in UK compared to the UK

2010: Foundation of Trinity Procurement GmbH in Switzerland

Carlsberg Group

Aargau

€8,545

Living standard, taxes, security, infrastructure

2008: Foundation of a central Procurement AG in Rheinfelden

Unilever

Schaffhausen

€46,467 (€19,253)

Savings in purchasing and Decentralized transportation, taxes, procurement in several joint purchasing power countries

Würth Logistics

Chur

€9,691

Centralization, synergies, Separate coordination of Centralization of cost-savings procurement of each procurement for Europe, Würth-subsidiary Americas, and Asia

Strauss Coffee

Zug

€796 (coffee only)

Switzerland as global centre for green coffee know-how

M&As of coffee companies in various countries

Green Coffee Procurement Center for entire company; also Green Coffee Promotion in Zug

Kraft Foods Europe

Opfikon

€10,109

Taxes, centralization

–

Centralization of procurement for Europe, headquarters in Zurich

Decentralized procurement

Centralization of procurement and production for Europe

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(continued )

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Table 9.1  (Continued)

Name

Location

Revenue (procurement volume) in 2011 in million € Reasons

Starbucks Coffee Trading Company

Vaud

€8,856

Business relationships Decentralized with Switzerland, procurement and improved synergies associated higher costs through EU market expansion, central location

2002: Foundation in Lausanne, global procurement of raw coffee (green coffee)

Nord Stream AG (Headquarters)

Zug

€0, since not yet due

Bank secrecy advantageous because projects are less transparent

–

Subsidiary of Gazprom, founded for underwater gas pipeline from Russia to Germany

Transocean Ltd (Headquarters)

Zug

€6,957

Lower tax burden

Headquarters on Cayman Islands

Migration to Zug under the motto «Redomestication Transaction»

Mercuria (Headquarters)

Genf

€35,714

Geneva as the second – biggest trading centre for crude oil, funding opportunities

Mercuria Energy Trading SA in Genf

Trafigura

Genf

€60,233

Geneva as the second Headquarters in Luzern biggest trading centre for crude oil, funding opportunities

Also present in Luzern, but shift of business activities to Geneva

Former procurement organization Comments

The look beyond

Figure 9.4  Impact on profitability of different procurement models P&L

Decentralized model

Centre-led procurement model

Procurement (buy–sell) principal model

100%

85%

75%

100%

90%

80%

Local

Central Local

Central Local

100%

95%

85%

Net sales COGS Gross profit SG&A Operating profit Other income or expense Earnings before income tax Income tax Net Income SOURCE  PwC (2012: 4)

Consideration of indirect taxes in supply chains Indirect taxes are levied on transactions in the SC, independently of who is involved in the transaction. These transactions are not triggered by the tax department, but by other departments such as SCM, procurement, production planning or sales. Decision makers along the SC need to rely on compliant standardized processes to make sure tax is handled appropriately as well as a defined and documented way on how to understand and handle exceptions. To assess the interconnection between SCM and indirect taxes we need to obtain a basic understanding of how indirect tax systems work and understand the main elements, such as what is being taxed, who the taxpayer is, and when and where the taxes arise.

Custom duties Tariffs are levied on cross-border transactions, mainly on the import of certain goods into a country, rarely on exports. Popular examples currently are tariffs on imports into the United States from China and vice versa. Since the EU is one single market, transactions between EU member countries are free from customs and tariffs. The main questions when assessing customs consequences are:

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●● ●●

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Are physical goods entering (or leaving)? Is it a permanent transfer (such as import of fruit to be consumed locally) or a temporary transfer (a vehicle used to import the goods)? What is the applicable tariff? What is the customs value of the goods (not necessarily equal to the paid price)?

Value added tax (VAT) As described above, VAT is a tax on consumption, more precisely on the final consumption. With some exceptions, VAT applies to all phases and all transactions within an SC. The central feature is a staged collection process. Each business in the SC is taxed on its value contribution towards the final product (the margin). Each business passes on the tax to the next business in the SC (on top of the sales price) until the chain reaches the final consumer. It is an indirect tax as the government levies the tax from the involved businesses, but in the end the tax burden is with the consumers who do not directly pay the tax but do so indirectly via increased prices. As opposed to customs, the EU is not a single market for VAT purposes, however. VAT law within the EU is harmonized, so the basic rules are the same in each country, with the main differences being the tax rates. VAT costs can be clustered as follows: (i) decreased working capital and subsequent funding costs, (ii) failed encashment and (iii) compliance costs. Main reference points when assessing VAT consequences include: ●●

Are goods moved?

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Is there a purchase (a payment)?

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Is there a change in the power of disposition (ownership) to the goods and when does it occur? How many VAT jurisdictions (countries) are involved in the flow (import, export, transit)? Who is involved in the transaction (seller, buyer, logistics provider)? Is it a permanent transfer (such as import of fruit to be consumed locally) or a temporary transfer (a vehicle used to import the goods)?

International Commercial Terms (Incoterms) When looking at transactions along the SC and analysing indirect tax consequences it is vital to know who is responsible for which step during, eg the

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transport and delivery of goods from a supplier to a customer. Depending on the distribution of responsibilities, tax consequences and administrative duties may fall to the supplier or the customer or partially to both. Incoterms are harmonized interpretation rules for common trade terms. The idea behind them is that seller and buyer do not have to include extensive agreements on these terms in their contracts but can just refer to one of the Incoterms instead. The Incoterms rule set consists of several rules to separate duties between seller, buyer and carrier in terms of: ●●

Who is in charge of the transport?

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Who bears the risk during transport?

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Who bears the cost of transport?

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Who is liable for insurance of goods in transport?

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Who is responsible for customs clearance and import VAT?

Differences between civil, customs and tax law It is important to make the distinction between customs and tax law, on the one hand, and civil law, on the other. Incoterms are terms agreed by the seller and the buyer and are based on civil law. Customs and VAT law may stipulate rules that cannot be changed with the choice of an Incoterm. This becomes relevant in customs and VAT for the question of who is held responsible for correct declarations and may be charged with penalties. To better understand, an example is given where customs law overrules Incoterms. Buyer G in Germany orders goods in Japan with Seller S. They agree on Incoterm DDP (‘Delivered Duty Paid’). Since seller S has no presence in Germany and therefore cannot act as importer based on customs law, they engage a logistics service provider (LSP) resident in Germany to do the import formalities at the German border. The LSP either performs the import in their own name or – if they do not want to bear the responsibility – in the name of Buyer G in Germany as importer. Buyer G becomes responsible for a correct customs declaration, even though DDP was agreed.

The notional case of HighCorp illustrates how tax enhancement in SCs may be implemented.

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CA S E S TU DY   Tax enhancement in supply chains at HighCorp The fictitious company HighCorp, the seller, is a high-tech enterprise with head­quarters in Sweden, where it also has most of its costs for research and product development. As HighCorp would like to have most of its revenue where it has most of its cost, the corporate income tax policy is to organize most contracts with the Swedish-based headquarters. The original idea from the logisticians has been to apply drop-shipment from HighCorp’s local plants or suppliers and ship directly to its local customers. When discussed with the corporate tax team, the logisticians learned that drop-shipment was impossible or too costly to implement from a tax perspective, and hence the goods flows were rerouted. European reroute HighCorp signs a contract with a French customer (CustCo) for the supply of goods in France. It acquires the goods from its local factory subsidiary and sells them to the French customer. The goods would be sent directly from the factory to the customer, which were both located in France. The result would be an obligation for HighCorp to register for VAT purposes in France. The company perceived that it had the option either to accept that the French Sub Factory charged VAT at 19 per cent, which was not refundable, or to register in France for VAT, in which case the VAT would be deductible. For various reasons unrelated to VAT (inter alia exposure to French tax authorities, and the overall corporate income tax strategy of having revenue in the Swedish HQ with as few as possible corporate income tax registrations outside Sweden) and the administrative costs involved in a VAT registration, HighCorp did not want to have any presence in France. So, the goods were first transported to a parking area in Belgium. Shipping documents were updated and the goods were transported back to France. The contract between Factory and HighCorp stated that the goods were delivered in Belgium. The contract between HighCorp and CustCo was for goods delivered from Belgium to the customer’s place of business in France. This way, a registration for VAT purposes in France was not necessary (Henkow and Norrman, 2011: 884–85). This is illustrated by the European Reroute in Figure 9.5.

Figure 9.5  The European Reroute (HighCorp example) Material/goods flow Payment flow Invoice flow Change of ownership

HighCorp HQ Contract Owner

HighCorp HQ Contract Owner

HighCorp Sub Factory

HighCorp VAT reg

HighCorp Sub Factory

CustCo FR

CustCo FR

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The example of HighCorp shows how corporates operating in different countries might design their SCs in order to reduce their financial burdens. In global markets, companies are often active in different countries with different tax and customs regimes. For these multinational corporations (MNCs), duties and tax burden become a relevant issue, like the ‘payment on behalf structures’ box example indicates.

Payment on behalf structures in MNCs The cost for maintaining bank accounts for each legal entity in several countries – potentially in numerous currencies – can be very high. In many countries, local bank accounts are required to make or receive (physical) cash payments (physical cash means money in a certain currency, eg bills, coins or in a bank account). One method to reduce the costs is to set up a ‘payment on behalf of’ (POBO) structure. In such a structure only one entity maintains physical bank accounts and handles all payments to third-party vendors and suppliers for all the other local entities. Usually a POBO structure is combined with an internal cash pooling structure. In such a structure, payments are settled via an internal cashless netting system limiting the need for physical money flows. Participants deposit all physical cash with the internal ‘bank’ and draw down physical cash only for thirdparty transactions (ie to pay taxes or salaries). Figure 9.6 describes such a POBO system, where A places the order with the supplier S, S delivers the goods to A (and drop-ships to B), but instead of A paying the supplier S, another legal entity C pays the supplier S ‘on behalf of’ A. The settlement of payables and receivables is done internally, but without physical cash flows (transaction IV). Usually cash and payment optimization is a treasury function, not an SC function. For completeness sake, we include the indirect tax analysis, however. For indirect taxes in general only the physical transaction is relevant. The payment flows as such are not taxable transactions. Therefore, a pure POBO structure does not cause any indirect tax consequences. Thus, POBO structures do not change the indirect tax – mainly VAT – treatment of the underlying transactions with physical goods. In general cash transactions are exempt from indirect taxes. This holds true for Germany, most EU countries, where VAT law is harmonized, and Switzerland. However, any charge by the bank or another party for providing POBO services needs to be analysed separately as it constitutes a separate (service) transaction

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Figure 9.6  Exemplary POBO structure Supplier (external)

3. Payment 1. Order

Customer (different legal entities)

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B

2. Delivery/ies

4. Internal recharge (reimbursement)

S

3. Payment (alternative)

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between the bank and the entity providing the POBO services internally. Beyond indirect taxes it must be verified whether cashless transactions (cash pooling, POBO structures) are permissible (they may be difficult or impossible to implement in countries with rigid capital controls or if currencies are not freely exchangeable, for example in China or India).

Finally, on this section on tax, we would like to underline that the identical transaction from a purely physical SC point of view – moving goods from A to B – can have many different consequences from an indirect tax point of view, depending on who is placing the order, how many parties there are and in what jurisdictions invoices flow. In addition, transactions that happen in parallel with only an indirect relationship to the product flow can impact indirect taxes as well (customs value). As outlined earlier, indirect taxes are generally not an expense factor for a company, as long as they are compliant (and as long they can be recovered from their customers). Therefore, the main goal of direct tax planning is net cost reduction, while for indirect taxation it is compliance and avoidance of costly adjustments, penalties and late payment interest. An adequate constellation can only be achieved if SCM, treasury and the tax team of an enterprise work closely together and analyse – like in SCF – SC transactions holistically, considering all sides carefully. Communication between these departments is key and something that needs to be actively managed, as they may have different KPIs.

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The bottom line is that managing the SC from a broader financial perspective (including customs, VAT and other taxes) could provide an additional variety of opportunities for corporates to optimize their ‘financial burden’. For national tax and customs authorities, it is almost impossible to keep track of all flows of liquidity across borders. Also, it seems unlikely that there will be a ban on tax competition among countries in the near future. So, while these conditions remain, it is likely MNCs will find it worthwhile to design and operating SCs to optimize their tax position and this will impact how SCF can be implemented.

The bright side – corporate social responsibility: is there financial fair play in SCM? Merging sustainability and value creation in global trade Even though SCF is still an emerging field, its focus on transferring cash more effectively up and down the SC offers opportunities to help address the management of environmental, social and governmental (ESG) issues. Companies can shift the more defensive posture, where actions towards more sustainable business approaches are decoupled from the core business and mostly seen as necessary costs, towards a posture, where sustainable business approaches are a means to seek new opportunities and create value. The shift towards sustainable trade, integrating ESG, not only addresses expanding regulatory requirements and increasing public awareness but also potential sustainability-related risks in SCs that are inextricably linked to financial and reputational risks. For instance, Levi Strauss shows how tough monetary approaches can be linked with soft sustainability topics and ethical standards via SCF. Economic priorities are not competing per se with the ecological and social aspects. Also, implementing measures towards sustainable trade in SCF goes beyond the current practice of picking the low-hanging fruit, where efficiency improvements and energy savings are the main drivers for change. Instead, SCF strategies must be designed in a way that negative impacts are minimized and environmental, social and economic benefits for all stakeholders are created (Bancilhon et al, 2018).

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Ethical SCF scheme – The case of Levi Strauss in developing countries In 2014 apparel manufacturer Levi Strauss & Co announced that it had partnered with the International Finance Corporation (IFC), a member of the World Bank Group, to launch a new SCF scheme that would reward suppliers in developing countries who score highly when it comes to environmental, health, safety and labour standards. Levi Strauss uses IFC’s Global Trade Supplier Finance (GTSF) programme of tiered pricing of short-term financing for garment suppliers and offers lower borrowing costs to those who score highly on performance ratings under Levi Strauss’s environmental and social monitoring system. The new programme was implemented in partnership with the SCF service provider GT Nexus, a cloud-based business network and platform for global trade and SCM. In Levi Strauss’s case the programme rewards suppliers that receive high scores on its terms of engagement (TOE) assessments, which measure labour, health and safety, and environmental performance. Through the GTSF programme vendors were offered lower cost rates on financing their working capital; the higher the vendor’s TOE score, the more they would save. ‘Levi Strauss & Co believes vendors that score highly on our strict standards should be recognized and rewarded in ways that allow them to reinvest in their business and improve their sustainability performance. This innovative program provides financial incentives to our vendors who perform well on sustainability metrics’, said David Love, Levi Strauss & Co chief supply chain officer. ‘We applaud the IFC for establishing this program and look forward to partnering to make it a success on the ground.’ Alzbeta Klein, IFC director of manufacturing, agribusiness and services, said: ‘Our experience shows that strong environment and social management correlates with stronger financial performance. Levi Strauss & Co is a first major international buyer to partner with a financial institution to offer its suppliers a direct financial incentive to improve compliance’ (Procurement Leaders, nd).

10 SCF characteristics as possible enablers for sustainable trade In the following, we highlight 10 key characteristics of SCF that help understand how SCF can act as an enabler to facilitate sustainable trade. Rather than focusing on SCF solutions, such as factoring, RF or IF, the 10 c­ haracteristics

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shed light on SCF from a meta-level perspective, highlighting organizational implications and cultural changes that occur in an organization that ­applies SCF: 1 Willingness to take an SC perspective: rather than a single firm perspective. This goes hand in hand with the ability to emphasize with other players in the SC and understand their problems as well as the root causes of those problems. 2 Creation of a state of constant information exchange: to be well informed about the economic situation of its suppliers and customers, as well as their competitive landscape, market trends, management abilities and the like. This extends to information about the suppliers of the suppliers and the customers of the customers. 3 Ability to help other SC partners: can offer assistance in order to keep the overall SC healthy. Beyond financial help, such assistance can be the provision of knowledge. 4 Awareness for permanent risk coverage: better risk management assessing, among other things, the financial strength of suppliers, industry dynamics, buyer–seller relationship interdependencies or country and currency risks. 5 Use of technological inventions: to establish continuous information exchange, overarching SC initiatives or other data integration. Not only do technological inventions make the interactions within an SC and SCF solution more efficient, they often also lead to more interactions and therefore act as an impetus for deeper cooperation. 6 Understanding of improvements over time: a periodical assessment to determine a possible adaptation to new circumstances, be it through an adjustment to current instruments, the introduction of new instruments or the launch of new SC overarching initiatives. 7 Promotion of holistic understanding: SCF interconnects functions and is explicable only by looking at the SC as a whole, eg a focus on WC AND on SC competitiveness, not an OR priority focus, not only within the different departments affected by SCF but throughout the whole firm. 8 Appreciation of long-term effect of firm actions: Through constant SCF improvements, eg payment processes, and new technical inventions, eg artificial intelligence, a firm develops an appreciation for the long-term effects of its actions, be it a simple extension of payment terms or the implementation of a new SCF initiative.

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9 Open-mindedness towards alternative financial options: SCF offers various financial options, most of them outside the traditional area of trade finance. New players provide financial instruments that, although less proved and widespread, allow for more efficient or cheaper ways of financing. 10 Recognition of non-financial values: Such non-financial aspects include, among others, less risk exposure, better company or brand image as well as deeper relationships leading for example to preferred suppliers. One way of conceptualizing the approach of merging sustainability and value creation in global trade is by utilizing corporate social responsibility (CSR) as a framework.

Definition of corporate social responsibility Organizations consider the interests of society (social dimension) by taking responsibility for the impact of their activities on customers, suppliers, employees, shareholders, communities and other stakeholders, as well as the environment (ecological dimension) in all aspects of their operations. This responsibility is seen to extend beyond the statutory obligation to comply with legislation and sees organizations voluntarily taking further steps to improve the quality of life for employees and their families, for the local community and society, as well as protection and preservation of the biosphere (Sharma, 2011).

How to integrate CSR with SCF Four steps can be identified linking CSR and SCF, as illustrated in Figure 9.7. It is important to note that progress is made from the bottom to the top and that the proximity of the approaches gets smaller the further the progress advances. At the top of the pyramid, corporates make use of an integrated SCF and CSR approach. Step 1: SCF and CSR are entirely separate from one another. For instance, suppliers may become regular suppliers only if they fulfil certain sustainability standards. SCF remains unaffected by any CSR initiatives.

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Figure 9.7  Four-step model to an integrated CSR and SCF approach

Integrated SCF & CSR approach SCF & CSR are interdependent

Step 4 SCF access Progress

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CSR alignment

Step 3 SCF initiatives

CSR initiatives Step 2

SCF initiatives

CSR initiatives Step 1

CSR as prerequisite for SCF

SCF as enabler for sustainable code of conduct

SCF & CSR are independent from each other

Proximity of the approaches

Step 2: SCF initiatives serve as an incentive to enforce CSR initiatives. Socially responsible investments (SRIs) serve as an example where the social, environmental, governance and ethical principles of the investor (whether an individual or institution) influence which organization or venture they choose to place their money with. It also encompasses how investors might use their power as shareholders to encourage better environmental and social behaviour. SCF should raise the claim to establish and implement SRI guidelines and to commit itself to acting according to them. However, CSR and SRI activities are often dismissed as ‘philanthropic’ with limited financial benefit to the initiator, but they are also meant to link and align economic, ecological and social objectives. For instance, when a supplier’s electricity and waste can be reduced, the savings can be passed onto the focal company. However, in another example, the social aspect could be emphasized. Weaker suppliers and

The look beyond

regions could be promoted, without taking any economic aspects into consideration. In the near future, pressure to integrate sustainable practices in operational and investing activities will increase. Any SCF activity, at least in emerging and developing countries, will have to be in line with new CSR directives and will have to comply with supranational initiatives such as the United Nations principles for responsible investment or the ‘equator principles’. Step 3: In the third step, CSR implementation becomes a prerequisite for SCF. For instance, a supplier may get SCF access if they have implemented sufficient CSR initiatives. For this purpose counter and barter trades are key elements. Step 4: The fourth step represents SCF-driven supplier development. SCF is construed in such a way as to support suppliers’ potential – especially in developing countries – in the best possible and sustainable way. In this step, long-term development, sustainability of the partnership and financial support are crucial. This may also include supplier development programmes. For instance, by using an integrated SCF and CSR approach, corporates could outsource parts of their SC to countries and suppliers that fulfil CSR requirements. By using this approach both the focal company and the supplier contribute to the economy by creating value and jobs and by paying taxes.

Supranational initiatives – The example of United Nations principles for responsible investment or the ‘equator principles’ Since their launch in 2006, the PRI, which encourage the investment industry to integrate environmental, social and governance risks and opportunities into investment decisions, have been adopted by 381 signatories, representing US $14 trillion in assets under management. EPs ensure that banks only give loans to projects that meet environmental and social standards. The EPs have become the global standard for project finance and have transformed the funding of major projects globally. SOURCE  www.unpri.org and www.equator-principles.com

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Financing agrichemical business – The Syngenta barter case In their report, Ligi and Kolesnikova (2009) describe how farmers can gain liquidity by bartering crops for chemicals. It shows how corporates such as Syngenta increase their sales by mitigating one of the farmers’ most pressing problems: the shortage of cash in spring. Instead of exposing themselves to payment risks, they accept part of the farmers’ crop stocks in exchange for agrichemicals they need for the next season. By selling the crop on the futures market, they virtually eliminate all risk for themselves. In this example, one can claim that, through a barter trade, the farmers ‘pay’ the agrichemical company immediately. Thus, for the agrichemical company the payment terms are zero, as it is ‘paid’ immediately by the farmers. On the other side, there are real cash flows. Even though they ‘pay’ immediately, the farmers do not have an actual cash outflow, because they pay in kind. Furthermore, the agrichemical company can choose the timing of its cash inflow, by accordingly selling the future on the crops. Moreover, the corporate can decide which farmer will be offered an SCF solution. This offer may be linked to compliance with sustainable farming principles. It follows that barter trades can be an innovative form (even though barter is an ancient form of trade) of integrating SCF with CSR principles. The provider of capital in this case is ultimately the buyer of the crop future, and the premium for the future will most probably be passed on from the agrichemical company to the farmer.

Well then? Integrating the circular economy into the SCF approach Even though CSR has continuously improved the social and environmental performance of many companies, most of those improvements still remain within the boundaries of a linear ‘take-make-dispose’ economy set-up that is not environmentally sustainable in the long run. Global megatrends such as the increase in the world’s population, the rising life expectancy or global wealth growth put massive pressure on emissions, waste production and source depletion. Additionally, increasing and more volatile prices for commodities show growing concern about the scarcity of natural resources (Ellen McArthur Foundation, 2012; Kok et al, 2013). Changing this dominant linear business model towards a circular ‘repair, reuse and recycle’

The look beyond

­ usiness model is essential to create a sustainable industrial system that is b regenerative by design. In this sense the so-called circular economy takes a narrower approach that does not aim at continuous improvement of social and ecological standards but tries to change the economic system as a whole by taking a mainly ecological view. Looking at SCF, it is observable that solutions such as inventory finance can help in reducing funding hurdles to transform towards a circular business and that the 10 characteristics outlined earlier that have organizational or cultural implications are of importance in these changes.

The smart side – Artificial intelligence: How can new technologies be harnessed to enhance decision making in SCF? A consistent supply of data from and about members of the SC, provided by technological tools, allows a higher level of visibility. With regards to SCF, technology is able to make data more accessible in real time about payments if positioned at the intersection of multiple company functions. Nowadays, the amount of data that is produced, stored and processed is growing exponentially, which leads to both challenges and opportunities. A big data set could consist of company internal data as well as streams of data collected from APIs or sensors. Armed with the power of big data, it is possible to make financial decisions more rapidly – and also within the SC. However, it first must be stored, cleaned and filtered. In a next step, advanced statistical methods in the form of machine learning algorithms may be used to gain insights that compute sophisticated predictions and pattern recognition models. These algorithms form the core of what is known as artificial intelligence (AI). In its most general terms, AI is a catch phrase encompassing all methods and algorithms based on advanced statistics and logic to interpret events, automate decisions and take actions independently (Gartner IT Glossary, 2012). It is crucial to distinguish between general AI and narrow AI. Most media talk about general AI, which is corroborated by science fiction scenes where robot characters perform intelligent tasks at human-like level. The high uncertainty about general AI ‘use cases’ often brings about an overstatement of the benefits and a fear-mongering agenda, while ignoring that technological change takes time to unfold and often requires entire ecosystems to adapt (Catalini, 2017).

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However, most of AI methods and tools, especially in SCF, are based on narrow AI. While limited in thematic scope, narrow AI tackles specifically framed and defined tasks. Thereby, AI should be seen more as a tool for optimizing process efficiency, rather than an all-in-one solution to all existing operational problems. With regard to SCF, the systematic distribution of big data sets the foundation for unprecedented transparency into all the transactions and interactions that take place in the SC. Historically, credit rating was used as a basis to assess risks, mostly in evaluating the buyer side. With the availability of big data, a lot of additional factors, apart from the creditworthiness of a buyer, could be included in the evaluation due to the fact that the systems in place are more and more skilled at providing a real-time picture as well as maintaining a long-term record of transactions. Based on this information, decisions and rates can be defined resulting in a new type of SCF solution: the data-enforced and performance-based financing. The following section will illustrate selected opportunities and challenges that can be addressed with big data analytics with a focus on AP solutions.

Selected data challenges of SCF solutions Challenge of time due to process The time between the SCF trigger point (supplier requesting financing) and the payment of the supplier is still one of the meaningful difficulties of SCF solutions (Euro Banking Association, 2014). AI may enable corporate treasurers to achieve better transparency and control of their current liquidity situation and so optimize supplier payments. Furthermore, FSPs are able to be informed about more than just one company’s transaction and liquidity data. Backend algorithmic intelligence could provide in-depth forecasting possibilities into cash forecasting or other forecasts, eg potential liquidity risks. This is different from the standard process of sending out spreadsheets to business units and filling in their projected cash flows manually. Not only could they rely on structured data, but they could even use unstructured data such as general business developments or social media feeds to better predict liquidity needs to come. Furthermore, a positive aspect is that these predictive forecasts are not tied to quarterly or yearly forecasts, and are therefore dynamic, which makes them more valuable and reliable.

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Challenge of partner selection Due to cost and time associated with each additional supplier integrated into an AP-orientated SCF solution (especially in reverse factoring and reverse securitization), one of the challenges is the question to which suppliers a buyer wants to offer buyer-led SCF. Supplier track record and a trustful relationship are the main requirements most buyers define as qualities suppliers need to fulfil. Additionally, a minimum transaction volume is a requisite – automatically making a stable or high financing need by the supplier also a prerequisite. Furthermore, securing the financial stability of their own supplier network is another goal of SCF solutions. To support this selection there is an abundance of – currently unused – data available, not just operational and financial characteristics of each supplier but also the metrics of the relationship between buyer and supplier. Which data to use depends on the key motivations of the buyer, eg to use SCF to improve payment terms or to strengthen the supplier network.

Challenge of KYC policies KYC policies are those regulations that ‘financial institutions and other regulated companies must perform to identify their clients and ascertain relevant information pertinent to doing financial business with them’ (Euro Banking Association, 2014: 131). Not only do banks comply with the regulation to prevent money laundering, KYC as well entails knowing their customers better to be able to manage their risks better (ACCA, 2014). The prominent use case exists due to how KYC is handled by banks. There is information gathered regarding money laundering, the country of origin, the company itself, and many other factors. It is an identified opportunity to gather all data in a centralized spot and then applying big data technologies to gain insights, eg for regulatory bodies or for their own risk analysis or to provide more appropriate solutions to clients. Regarding SCF solutions, this can lead to the benefit of easing the process of KYC processes when on-boarding additional suppliers or customers. Another use case is which data is stored by SCF service providers. This means that the customer’s identity and a link to a credit rating is less important, but the customer’s transaction history, usual payment methods and other data (eg country of origin) gain validity. This could, for instance, use an outlier detection method that systematically identifies customers that engage in unusual behaviour, eg completing all payments in cash. Just as the aforementioned use case, this could lead to savings in time and money when it comes to the

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SCF process. Due to the potential of being able to analyse risk better, there are potential additional savings due to having less ambiguity of risk.

Challenge of securitization bundling One challenge of the SCF solution ‘reverse securitization’ is how the securitization should be compiled. Securitization works by bundling the assets (in this case the AR of the suppliers) and then selling these to investors. They are usually split up into different tiers, mostly according to their risk or duration. Before bundling a securitization, multiple questions have to be answered, eg what will be the duration? what will meet the market’s demand? what will be the mixture of the security? Being able to answer these questions will lead to securities that hit the demand of investors, buyers and suppliers.

‘Not-yet-approved payables’ financing A typical question in AP-orientated SCF is the type of financing prior to ­invoice approval (see purchase order financing solution in Chapter 6). A ­possible solution to tackle this challenge would be an invoice approval prediction and a risk estimation of non-approval. This would further enable ‘not-yet-approved payables financing’. The usage of predictive analytics leads to two possible ways of measuring this risk: 1 Use case 1: Default risk of the buyer + Prediction of the risk of a nonapproval by the buyer. 2 Use case 2: Risk solely based on the transaction history. These two use cases can provide financing earlier, yet at the potential cost of higher associated risk unless analysis can show no real increase in risk. One example for the first use case is the start-up Remitia (www.f6s.com/ remitialtd/about). Remitia’s value proposition is to quantify the risk of nonapproval of an invoice by using historical payment and invoice files and other data sets, mostly based on historical (transaction) data. One example for the second use case is the company GT Nexus (www.gtnexus.com/solutions/network-financial-supply-chain). GT Nexus’s value proposition is to offer financing based on big data by basing funding decisions on the trading partners’ performance history, instead of the buyer’s or supplier’s credit. They collect historical metrics such as the number of late shipments, cancelled orders or chargebacks to measure the risk of non-­ payment. By neither using the buyer’s nor the supplier’s credit, this use case

The look beyond

not only enables suppliers to get funding earlier, but also the requirement of a high credit rating of the buyer is mitigated, because it is no longer the focal point of risk measurement. The use cases and their associated benefits naturally come with specific challenges and requirements. The technological requirement is not just analysing the data but also to have a system enabling data to accumulate. It is especially important to possess a system of e-invoicing, sending invoices and associated documents via an online platform, and not physically via post. Only this makes the matching of documents, eg invoice to purchase order, possible. This presupposes the correct data format and full availability for an enhanced risk assessment. Additionally, the used data formats and connectivity between all parties need to be ensured. In a further step, not only transaction and document data by the direct parties involved in the SCF solution but also that of those parties solely involved in the transaction, could be used for data aggregation purposes, eg data by logistics service providers. Those suppliers that are going to profit from AP-orientated SCF solution are usually smaller and have a worse credit rating than the large buyer’s company. Furthermore, they might not have their financial or other data in the market, especially if they are a private company, due to less financial regulatory requirements. This in turn would make convincing them to share such in-depth data even more of a challenge, especially in an environment with high focus on data privacy and anonymity. In this case, a federated data aggregation approach may be considered, concealing the source of the data.

AI fintech companies in SCF There are several fintech players that have built SCF solutions powered by AI for business clients. One recently announced example is CapitalBay, a multi-supplier Malaysian SCF platform that provides peer-to-peer (P2P) financing. The company enables customers to finance digital SCs through its platform. With the government’s approval of P2P financing, private investors can access and invest in the platform. CapitalBay specializes in the financing of short-term working capital and offers products such as AR finance for SMEs. Traditionally, banks’ credit checks have a high rejection rate for SMEs, as SMEs are higher risk, require smaller loan sizes and shorter funding periods, and this may not be profitable for banks. CapitalBay, in comparison, is developing a payment risk valuation model that predicts, using machine learning, the risk of each transaction on its ­platform. As a result, SMEs also have easier access to financial resources.

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A different solution for SCF is provided by TenzorAI (https://tenzorai.com/), which seeks to help suppliers, buyers and financiers to extract value from ‘untapped’ SC data, including ERP, CRM, procurement integration, credit files, emails, etc. To address data protection and data governance issues, and to provide limited information sharing between the engines without disclosing internal data, they use a type of distributed ledger (blockchain). Their goal is to implement customized intelligent decision making by making the data available in near real time for credit, risk and pricing decisions. This can be achieved with a range of self-learning predictive models that are continuously updated and enriched with new data. These approaches to data transfer and integration allow the inclusion of all available and relevant data sources, both structured and unstructured, allowing the resulting models to account for complex internal, cross-organizational and external factors. Additionally, Taulia, which uses machine learning models in their dynamic discounting platform, helps buyers better understand supplier behaviour and risk (https://taulia.com/intelligent-platform/). The platform will collect data such as historical payments, the percentage of annual premiums accepted by suppliers, and fluctuations in their financial position. Because of this, it is then possible for customers to make better decisions regarding their early payment programmes. In doing so, machine learning algorithms seek to assist the buyer with knowledge of whether the supplier is fairly paid and defines areas where they can unlock WC by adjusting their payment terms to industry and/or network averages. Finally, big data and AI are increasingly used in the area of AR financing programmes. The technology is applied to tackle the issue of fraud (counterfeit bills) or to address inadequate credit scoring for SMEs in SCF programmes. Thus, companies like TrustBills (www.trustbills.com/en) or tradeteq (www. tradeteq.com/) are applying machine learning for even excluding risk associated with the legal validity of receivables, or for predicting risk for portfolios and transactions, or for gathering insights where no public ratings exist.

The tech side – Blockchain technology: Can fintech companies bring SCF to the next level? The financial services industry is currently experiencing drastic changes due to the emergence of powerful technology and the simultaneous introduction of austere regulation. Large technology and IT firms with considerable financial strength are entering the finance market increasingly aware of their

The look beyond

access to and influence on society. For instance, Facebook would like to set up an international money transfer system, Libra. Google is interested in providing asset management services, since they have the analytical capacity to predict micro and macroeconomic trends. Also, Google already manages its own liquidity and set up a venture capital arm (Hartley, 2014). Alibaba and Tencent, two Chinese IT competitors, raised the ante and both already successfully offer asset management products and services (Marriage, 2014). Beyond that, innovative and agile start-ups and fintechs are massively stirring up the traditional financial services industry. Until at least 2010, there were many different national payment types and standards such as MT940 Reporting, DTAUS and DTAZV. Since 2015, a shift towards more harmonized systems – XML and SEPA CT – is observable. However, the next wave of change is imminent. Although SCF is still a niche market, double-digit growth is expected in the future (Demica, 2012). This might be driven by new technic-driven approaches – crypto-currencies and blockchain technology.

Introduction to cryptocurrencies and the link to distributed ledger technology Cryptocurrencies, the most famous of which is Bitcoin, are, at their core, digital files that list accounts and transactions in a distributed ledger, much like a physical ledger. A distributed ledger is a technology sharing of information between all parties of a network. Transactions are verified and recorded through a process of consensus, which encrypts the transaction, making it incorruptible and much faster for the whole community to see. Moreover, this ‘money’ is a self-regulating decentralized digital currency that does not require a central bank in charge. This hierarchical financial structure is circulated through different types of distributed ledgers, the most prominent being blockchain technology (BCT). In the following, we will focus on BCT as it is the most used type of distributed ledger with the highest degree of maturity in research and industry. It is public, free to use and available in one digital ledger that is fully distributed across the network. Through this approach everyone (who is authenticated) knows about everyone else’s transactions (unlike using a bank where one only knows about one’s own transactions). Note, there are also ‘private’ blockchain systems that are only open to participating organizations. While the technology is first and foremost used in the world of finance, the protocol lends itself to all kinds of needs. Ranging from data transfer to decentralized governance, KYC processes, trade surveillance, regulatory reporting, collateral management, trading, settlement, clearing and even r­ eplacing

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databases – the possibilities seem to be nearly endless. However, to give an example of how BCT works, the cryptocurrency transaction is the most ­developed and easiest to see. In order to send money within the network a user has to broadcast to the network that the amount in their account should go down and that the amount on the receiver’s account should go up. Subsequently, nodes (the computers) in the network apply this transaction to their copy of the ledger and pass on the transaction to other nodes. This is a distributed network of information and in every individual node there is a note of every single transaction that has ever taken place. Cryptographical hash functions transform a collection of data into an alphanumeric string with a fixed length, called a hash value. Even tiny changes in the original data drastically change the resulting hash value. It is essentially impossible to predict which initial data set will create a specific hash value. The system orders transactions by placing them in groups called blocks and connects them in the blockchain. Having a reference to the previous block, each block is placed after another in time. A crucial part in this process is that each valid block must contain the answer to a complex mathematical function, which at the same time protects the system. The security of the technology is designed in a way to prevent fraudsters from altering the legitimacy of the information being exchanged. There are checks and balances in the system so, should a fraudster attempt to corrupt a transaction, the nodes will not arrive at a consensus and will therefore refuse to incorporate the transaction into the blockchain This way everyone has access to a shared single source of truth that, at the same time, is a great approach to increasing transparency and trust in the blockchain (Figure 9.8). One use case being actively developed is for smart contracts, as counterparties agree on contractual terms via computer protocols.

Definition of smart contracts Smart contracts are essentially simple programmes embedded within the blockchain that define rules for when assets get transferred, allowing procedures such as dividend and interest payments and escrow arrangements to be automated with logic stored in the same shared database as the assets themselves. Transactions where nodes can monitor and detect contracts concerning changes in ownership and contract rules can be improved in terms of efficiency as many contractual clauses could be automated, thereby enhancing security.

The look beyond

Figure 9.8  How blockchain technology works 1

2

Buyer orders product from a supplier in a classical way, through an internet of things process or directly via the blockchain

3

Supplier receives order and automatically receives buyer’s credit score via the blockchain

A smart contract within the blockchain either rejects or confirms shipment based on credit score blockchain

Offering via internet Supplier

Supplier

Buyer

blockchain Shipment approval?

Buyer’s credit score

Order

Yes

4

6

5

Shipment of goods and confirmation through blockchain that money will be paid

Transaction is recorded in blockchain after creation of a new hash value and the verification by the network

Goods’ shipment Supplier

Money is transferred from buyer to supplier through the blockchain, even classical fiat money or cryptocurrencies

Payment

Buyer

Transactions represent a block that needs to be approved by the network

No

Supplier

The result of the hashing goes into the new block’s header and becomes part of the cryptographic puzzle Transaction A Transaction B Hash value #A

Hash value #B

Hash value #AB New block

Buyer

A new block is added to the chain, providing an indelible and transparent record of transactions

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Thus BCT serves as an enabler of trade, increases transparency, and improves and automates processes through smart contracts. In the context of SCF various new opportunities emerge on how to use BCT to transfer rights and assets: Example 1: Assigning buyer-approved AR could be done via blockchain, whereby the buyer receives legal certainty that they will not be purchasing AR already assigned to a third party. This would benefit SCF acceptance and decrease risk premiums. Example 2: Securities such as securitized AR would no longer have to be cleared and settled by a central securities depository (for instance, SIX in Switzerland or Clearstream in Germany). Instead, the transfer of securities would take place between issuer and investor directly, recorded in the blockchain. Consequently, costs for securitization would decrease considerably, securities would be settled faster and payments would be made earlier.

Benefits of smart contracts in SCF SCF represents a comparatively simple use case. If a company wants to enter into a short-term loan agreement to finance a cross-border order by using inventory as collateral, it currently has to engage in a time-consuming ­paper-based process. During this process, as shown in the upper half of Figure 9.9, the bank has to ensure the correctness of the documents and check the status of the collateralized inventory. In a world in which BCT is implemented into the workflow, the transaction could be executed significantly faster and with a higher level of automation and transparency. The bank’s offer for a short-term inventory-backed loan can be found by authorized parties as a smart contract in the ledger. As a condition, the seller has to submit a purchase order (PO) and an identifier of the collateralized inventory. Thus, in computer logic, ‘if PO and inventory identifier are received, extend short-term funding to seller’ could be written in the smart contract. In the shared ledger all documents are instantly distributed to all parties. The immutable nature of the ledger allows all parties to refer to the same source of information when tracking the progress of the transaction. If BCT is implemented as well, all uploaded documents are additionally validated through the consensus mechanism. A proof-of-stake verification protocol creates a hash value that serves as the identifier for the validation. Therefore, the seller no longer has to transmit a physical copy of the PO and the bank no longer has to validate the PO or check the status of

The look beyond

Figure 9.9  Transactions before and after BCT and smart contract adoption Seller bank

3

Verifies PO

Seller sends PO and 2 information about collateralized inventory

Manually Checks inventory 3 executes 4 payment

1

Seller

Seller and buyer enter into contract

Buyer

Check if conditions of smart contract are fulfilled

Seller bank

Payment order

Smart contract

Contract activation PO and inventory

Contract confirmation

Payment execution

3 Payment is executed automatically

Inventory information

Shared distributed ledger

Payment reception Seller activates

2 smart contract Seller

Purchase order

1 Seller and buyer enter into contract

Buyer

Information uploaded into and automated actions executed within the ledger

the inventory manually, because all information is instantly available and validated in the ledger. Once requested by the seller, the smart contract selfexecutes a predetermined set of actions, thereby making any additional manual work unnecessary, as seen in in the lower half of Figure 9.9. For the parties involved, the transaction after the integration of BCT looks very simple as it is executed in a highly efficient manner. But ‘behind the scenes’

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within the distributed ledger, key pieces of information, marked in green, are automatically exchanged, and predetermined actions are executed. When making the information flows and automated actions visible, the process looks a lot more complex than before, but is actually more efficient, significantly faster and much safer.

CA S E S TU DY   Current blockchain-driven SCF initiatives A significant number of start-ups and initiatives are currently in the process of developing their own BCT solutions for trade finance. But for widespread adoption, a broad network utilizing a common standard is necessary. Therefore the landscape of initiatives and start-ups will experience significant consolidation. As of now though, it is impossible to predict which underlying technological architecture and which initiatives will succeed. Two initiatives are gaining traction at the time of writing: Marco Polo and we.trade. Marco Polo initiative Formed as a joint initiative between TradeIX, the software company R3, various leading banks and corporate clients, Marco Polo aims to develop a whole ecosystem that facilitates international trade and provides easy access to SCF (Marco Polo, 2019). TradeIX develops an open trade finance platform based on DLT (TradeIX, 2019). The platform has a modular approach with four different levels of integration. On the first level, TIX apps allow customers to solve a particular business problem via the TIX Platform. The author app for instance focuses on invoice management, enabling early settlement and reconciliations. On the second level TIX Developer enable companies to integrate a broad set of trade finance solutions via API and software development kit (SDK). Through access to the trade ecosystem, companies can use simple smart contracts or directly connect themselves to a global network of banks. On the third level, TIX Composer is a trade finance management engine that allows companies to customize the rules and logic of smart contracts and enhances the functionality through additional tools, such as anti-money laundering or pricing rules. On the fourth level, TIX Core is the actual DLT infrastructure of the ecosystem. Its integration enables companies to take advantage of the broad set of DLT functionalities, such as sharing documents in real time or automatically settling contracts.

The look beyond

The Marco Polo initiative is one of the fastest growing trade finance networks in the world. Currently, the developers focus on SCF solutions, such as AR and Inventory Finance. In its recent proof-of-concept Sumitomo Mitsui Banking Corporation and Mitsui & Co. executed a receivable financing transaction (Coindoo, 2019). The network aims to integrate a broad range of clients. But due to the need for the ERP integration of the technology, Marco Polo initially targets larger corporations as key customers (Ledger Insights, 2018a). The key advantage of Marco Polo is that it is the only network that does not require both trade partners and the involved banks to use TradeIX technology. we.trade initiative we.trade is a digital platform founded by KBC Bank and Rabobank. The platform aims to provide SMEs with access to cross-border trade through enabling the exchange of information within a distributed ledger. Also, real-time tracking of transactions and bank payment undertakings, which guarantee payment by the buyer bank to the seller, similar to a bank guarantee, are implemented to reduce risk for SMEs (Ledger Insights, 2018b). Additionally, SCF solutions are available, and invoices can be settled automatically via smart contracts. All services require the buyer, buyer bank, seller, seller bank and logistics provider to be part of the we.trade network. we.trade initiated full operations and processed the first real transaction in July 2018 (IBM, 2018). As the underlying technology, we.trade uses IBM’s Hyperledger Fabric. IBM Hyperledger is an open source blockchain platform for businesses (IBM, 2019). Hyperledger Fabric is a modular architecture for the i­mplementation of DLT, consensus mechanisms and smart contracts as plug-­and-play solutions. ‘Channels’ limit the parties that can access the data to members of a specific channel or transaction, so that no other party has access to the bank’s client information or the transaction data.

When comparing the emerging initiatives, one can see that there are key differences in the target group and in the functional focus. Marco Polo implicitly targets larger organizations, while we.trade aims to enable SMEs to participate in cross-border trade. Also, Marco Polo develops solutions mostly focused on SCF and we.trade focuses on the simplified execution of cross-border transactions. Although, both initiatives leverage the central BCT functionalities of sharing and validating information, the respective underlying use cases are different. But when looking at the target picture of BCT in trade finance, both angles are necessary to develop the trade finance ecosystem DLT/BCT can ­create.

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Marco Polo simplifies SCF and fosters an increase in global trade finance volumes, thus freeing up capital. we.trade improves the access and reduces the risk of SMEs in cross-border trade. This clearly shows that despite being different, both Marco Polo and we.trade are integral parts, necessary to ­realize the full potential of BCT in trade finance, and thus both their vision and underlying use cases are clearly in line with the target picture discussed earlier. For BCT to change the trade finance industry, the majority of FSPs, ­customers and other parties in cross-border trade must use the underlying technology or at least support the development of an interface between the legacy systems and the DLT network (Deutsche Bank, 2017). Specifically, for smaller companies or public actors, such as customs authorities, an ­implementation might either be too costly, time consuming or politically difficult to execute. The ERP integration requirement of the Marco Polo network provides an excellent example of how technology can create entry barriers that stop the technology from achieving critical mass. Finally, for a distributed ledger to work, members of the network need to share a significant amount of information. Without this, the advantages of the ledger, such as being a ‘single source of truth’, cannot be realized anymore. Also, for the consensus validation mechanism of BCT to work, different nodes in the network need to validate each new block, meaning that a member of the network will receive encrypted, yet highly confidential, information a party might not want to share. For a bank for instance, the fear of sharing information about their customer relationships with other competitors could be a significant obstacle in implementing a distributed ledger across a whole ecosystem. Remember, if the quality of uploaded information is poor, the usefulness of the DLT ecosystem will be questionable and very limited at best.

Tokenization of assets as the next wave of blockchain-driven SCF Tokens represent the physical object in the digital world. This concept allows algorithms and smart contracts to access specific objects and makes the physical world ‘tangible’ for the digital world. Furthermore, the use of tokens for physical objects increases the transparency of possessions.

The look beyond

What is tokenization? Simply put, tokenization converts the rights to an asset into a digital token that is stored and managed on the blockchain. This can be anything from money to a physical object; the token acts as an asset representing that item and is operated on a particular blockchain network through smart contracts. On their own they are worthless, so they need to be backed or exchangeable with other valuable things.

Tokens allow the division of larger values into smaller units by their arbitrary subdivision. For example, a certain property or asset can be divided into units of 100 euros. In this way, illiquid assets, such as orders or shipments, are broken down into liquid, tradable pieces. Such a ‘breaking down’ enables and simplifies investments in these SC assets including their trading. Furthermore, tokens allow micropayments in small fractions at the SC shop floor level. A shop floor is the area of a factory where people work on machines, or the space in a retail establishment where goods are sold to consumers. Tokens can be divided into the following classes: ●●

Payment tokens: Currency character (eg Bitcoin). Their focus is on the exchange of (monetary) value.

●●

Utility tokens: Use of a right or a service. Their focus is on usage.

●●

Asset tokens: Share of an asset. Their focus is on the investment of value.

The concept of tokenization can be used to develop and establish deep-tier financing solutions in SCs (see box for Excursus).

Excursus: The vision of tokenized deep-tier financing in the supply chain The start-up Tallyx (https://tallyx.com/) is launching a decentralized platform for trade and SC finance. They aim to simplify trade transactions for buyers, sellers (suppliers), distributors and financiers by creating a level playing field and adding value through the implementation of a global platform. With the use of blockchain and AI technologies, they want to achieve improvements in terms of financial supply chain inefficiency, data breach and trade fraud. Above that, they target to make working capital finance

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accessible to 85 per cent of the suppliers who are not sufficiently served at the current SCF offerings. To create a frictionless and trustworthy global trade environment, Tallyx augments an ecosystem with one trade obligation protocol (TOP) that is an open standard for businesses to manage the balance of a supplier’s fulfilment obligations and a buyer’s payment obligations while facilitating settlements and adding deep liquidity to the market and three decentralized applications: 1 TOP on-boarding will manage the enrolment and services subscription of

ecosystem participants. 2 TOP supply chain enables buyers and sellers to actively manage their

end-to-end trade processes (from procurement to payment). In addition to that, they are able to automatically raise working capital as well as allowing inter-operability among various SCF programmes. 3 TOP marketplace is an open working capital marketplace for the trading

of tokenized trade assets. It links trade assets to the right investment, as well as financial institutions such as banks and non-bank organizations. The decentralized Tallyx trade platform aims to ensure that all tiers of suppliers are funded by an integrated set of ‘cascading supplier finance marketplaces’, serving a variety of suppliers and funding options. This cascading marketplace feature enables suppliers to have multiple funding options. This is allocated by supplementing dynamic discounting with a bank offering approved payable financing as well as an open marketplace that enables non-bank lenders and asset managers to participate in financing the SC (see Figure 9.10). Tallyx also supports the securitization of trade assets as a funding source. Tokenization of trade receivables using Tallyx TOKI might be an efficient and secure way to achieve a high degree of flexibility. The ‘Approved Payable Draft (APD) Token’ allows deep-tier finance through a token split and assignment model. Suppliers are funded at low rates by democratizing access to approved payables, financing at rates in accordance with the anchors’ credit ratings. The APD additionally allows deep-tier financing on a dynamic discounting basis by enabling a TOP tier to request an approved payable facility to be assigned to a subsequent tier-2 supplier. Tallyx TOKI wallet makes this process frictionless by implementing deep-tier TOKI recipients to track due payments and request financing. This will result in a partial transfer of title from TOP tier to tier-2

The look beyond

Figure 9.10  The idea of deep-tier financing in the supply chain Funding sources Open

Tier-2 supplier requests from open marketplace financer Send to wallet of upstream supplier Tier-3

Anchor buyer confirms draft

Bank A

Apply for APD token multiple invoices

Tier-2 supplier requests finance from bank A Issue split token to tier-2 supplier wallet Tier-2

Approved payable invoices

APF TOP tier

Corporate (anchor buyer A)

Number of suppliers involved in the deep-tier financing programme

supplier, which enables financing for the tier-3 supplier by discounting the digital draft. The number of suppliers involved is continuously increasing along the upstream SC. Such a tokenized deep-tier financing solution would offer the following benefits: 1 For corporates (anchor buyers), a single portal with multiple SC options

maximizes the reach and effectiveness of deep-tier financing. In addition, branded tokens will enable anchor buyers to have greater transparency and association regarding suppliers in their supply chain. 2 For suppliers, marketplace rooms will add further possibilities for

financing. The ability to split TOKI will authorize suppliers to take advantage of either all or only a certain percentage of their TOKI in order to pay upstream suppliers seamlessly. 3 For financial service providers, an enlarged pool of assets due to better

packaging of the underlying supplier risk will be established. The available base of suppliers resulting from the TOP on-boarding programme will be considerably extended.

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Effects of blockchain-driven SCF Potential drawbacks of blockchain-driven SCF Since BCT is still in its infancy, more (favourable) developments should be expected to follow. However, although BCT has many benefits, there are also drawbacks to consider: ●●

Currently, it is very difficult to exchange cryptocurrencies (like Bitcoins) for other currencies.

●●

Cryptocurrencies are cited as a haven for illegal activity and tax evasion.

●●

It is unclear how smart contracts are governed by law.

●●

●●

●● ●●

●●

●●

There is uncertainty as to whether issues in the blockchain concerning scalability, latency and security can be overcome in the foreseeable future. The trade-off between blockchain throughput capacity and real-world transaction volumes is still not solved. BCT is not yet sufficiently tried and tested. New and innovative technology encourages fraudsters to take advantage of them. Possible cost issues of operating blockchain-driven activities are not yet covered. Considerable work is required to open up the system for the complex nature of organizational SCs and the large number of suppliers.

The prevision – Possible trends: What to consider in prospective SCF programmes (This sub-section was co-authored by Philipp Wetzel, research associate and pro­ ject manager, Supply Chain Finance-Lab, Institute of Supply Chain Management, University of St Gallen, Switzerland.)

Rome wasn’t built in a day: the same is true for SCF. A helpful tool to assess mid-term market and environmental developments is the so-called PESTEL analysis (Fahey and Narayanan, 1986). The framework supports a company’s strategic decision making by analysing the political, economic, social, technological, environmental and legal factors that have the potential to become key drivers of change. In this chapter we present selected trends that appear to have a great possibility to significantly impact SCF on a mid-term basis. A trend can affect the nature of SCF programmes either directly or indirectly by first having an

The look beyond

impact on businesses in general, which then also affect their physical SCs and consequently the financing of these SCs (Figure 9.11). We assess whether a trend will tend to increase or decrease the supply and demand side of SCF. Figure 9.11  Direct vs. indirect impact of trends on SCF Direct impact

Trends

Businesses

Supply chain

SCF solution

Indirect impact

Political trends and their impact on SCF Political factors in the PESTEL analysis can be defined as the ‘influence that governments have on industries’ (Witcher and Chau, 2010: 91). On the one hand, we can assume that trade tariffs overall have historically tended to decrease and thus facilitate trade between economies (Engman, 2005). This encourages external trade and internal market growth, which in turn stabilizes the economy and thus leads to a more prosperous business environment. New businesses develop and prosper. All require increased means of funding, which then gives rise to an increased demand for SCF solutions. However, on the other hand, if we assume that trade wars increase in frequency and intensity, this results in more closed economies, protectionism and higher tariffs. This leads to a decrease in global trade putting businesses at risk of losing their current markets and their access to funding. As an example, the ongoing trade war between the United States and China hinders Chinese producers to sell products in the United States – but also German carmakers with factories in the United States might suffer from less profitable exports. With businesses and the economy generally struggling, we overall conclude that trade wars tend to decrease the demand for SCF. Tax policies are expected to become stricter with an enhanced focus on indirect taxes as well as on location criteria. This also has an impact on transfer pricing, which requires businesses to rethink their strategic financing decisions (Webber, 2011). Furthermore, tax policies focusing on companies’ ‘assembly’ or ‘main activity’ locations, R&D, headquarters, etc may put businesses without an establishment in a specific country at a permanent ‘assembly’ risk under which they need to conduct a risk assessment and consider alternative approaches. This might in turn affect their need for third-party financing in order to build the respective workarounds for the physical distribution of goods. As

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the location of profit creation may be subject to change and thereby affecting a business’s financial situation, SCF decisions might also be subject to change. Overall, due to higher administrative and restructuring costs, we assume that tax regulation will probably increase the demand for more sophisticated SCF solutions, assuming it does not lead to a reduction of trade as described earlier. Another important political factor is a government’s attitude towards market regulations. We expect that single markets like the European Single Market will become increasingly deregulated. In deregulated markets the costs of SCs decrease and, therefore, the overall trade possibilities and quantities increase. This gives rise to a new demand for SCF solutions. Other examples are the Trans-Pacific Partnership (TPP) Agreement, enabling free trade between the participating countries, or China with the introduction of its New Silk Road, aiming to reshape global trade – more than 157 nations and organizations have signed up to the major infrastructure and trade project. Even in the face of various criticism, both initiatives will have great effects on the economic and cultural interconnections between countries and facilitate trade across the world, probably increasing the demand for SCF. As discussed in Chapter 6, a number of governments are seeking to regulate payment terms and/or provide incentives to encourage standardized payment durations for suppliers, particularly SMEs. These initiatives, eg prompt payment, maximum payment term and SME policies, can reduce the demand for SCF in some situations, such as in France, while increasing the demand in others, such as in the UK. Overall, as trade continuously rises, we expect political factors to tend to increase the need for SCF solutions (see Table 9.2).

Table 9.2  Political trends and their impact on supply and demand of SCF solutions Impact on supply of SCF solutions

Impact on demand for SCF solutions

Trade tariffs

↑

↑

Trade wars

↓

↓

Tax policies

↑

↑

Market regulation

↑

↑

Political trends

Economic trends and their impact on SCF Economic factors influencing a business’s environment are generally ‘costrelated matters for the organization’ (Witcher and Chau, 2010: 91).

The look beyond

First, rates, eg currency, exchange, interest, growth and inflation rates, fluctuate in response to economic developments and, at the same time, affect demand for business financing and have a direct impact on the cost of SCF. An example of the impact of changing currency rates is the value of the British Pound (GBP). Due to the political turmoil and uncertainty in regard to Brexit, the GBP’s value has been very volatile, which in turn puts off foreign investors and creates unfavourable conditions for the overall economy. When businesses optimize their net working capital, the interest rate is one of the most influential factors to consider. When interest rates are low, organizations generally have a higher incentive to pay their suppliers early due to early payment discounts. With rising interest rates, it becomes more attractive for businesses to pay suppliers later and search for alternative solutions on the market in order to maximize their returns. As interest rates are likely to increase in the mid-term future, the demand for SCF rises (Gregory and Jeffery, 2020). The cost of funds is oftentimes indexed to LIBOR (London Interbank Offered Rate) and is therefore highly affected by economic developments. During the financial crisis, for example, LIBOR, and consequently the cost of funds, spiked, which left many businesses in a difficult situation and with an increased need for SCF. On the other hand, as described earlier, an overall economic growth results in a more stable economic environment and also an additional increased need for SCF. New demand for SCF solutions can also lead to the development of new financing options, which creates new supply-side opportunities. As businesses become gradually specialized, collaborative business ­approaches become increasingly popular. The rise of P2P (‘peer-to-peer’) concepts, developments like the ‘sharing economy’ and a tendency towards decentralized business models as a countermovement to centralized platform models encourage the need for alternative financing solutions. With multiple businesses interconnected, new and various forms of SCF solutions become necessary and thus increase both the supply of and the demand for SCF programmes. The rise of fintech start-ups increases the availability of alternative financing solutions. New business models can disrupt conventional SCF business approaches and thus represent a threat to traditional FSPs in the SCF market. At the same time, a more competitive environment has the power to create improved customer-orientated solutions. Furthermore, new offerings may also enable smaller businesses to take advantage of new SCF solutions that had previously been unable to participate in conventional programmes

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due to limited resources and scale. This development increases the SCF market as a whole (Extra et al, 2019). Economists see a high chance of the emergence of a recession in the midterm future. An economic recession potentially alters the population’s consumption behaviour to which businesses will have to adapt by lowering their prices or adjusting their production. Therefore, with the rise of a recession the demand for SCF will probably decline. After the financial crisis in 2008–09, an interesting phenomenon regarding SCs was noted. Due to the shift in consumer demand, some industries were even facing supply shortages, as the demand for those typically cheaper products increased rapidly. A recession generally, however, would decrease the supply and demand of SCF programmes. To conclude, mostly favourable economic conditions lead to an increased demand for SCF solutions, which encourages the rise of improved financing offerings (see Table 9.3). Table 9.3  Economic trends and their impact on supply and demand of SCF solutions Impact on supply of SCF solutions

Impact on demand for SCF solutions

Rates

↑

↑

Collaboration practices

↑

↑

Availability of alternative financing solutions

↑

↑

Recession

↓

↓

Economic trends

Social trends and their impact on SCF Social factors assessed in the PESTEL analysis consist of ‘changes in society’ (Witcher and Chau, 2010: 92). A growing global population especially affects the long-term development of markets. With emerging markets in particular recording high population growth rates, global trade will increase in the medium term. More trade leads to a rising need for financing solutions for SCs. In addition, standards of living in the emerging markets are rising and with that, new demand for luxury products and services emerges, which again increases the demand for SCF.

The look beyond

The economic development in emerging markets leads to more participants in the global economy and an intensified competitive field. This ­requires new solutions for more interconnected SCs and thus raises the ­demand for SCF solutions (Scott et al, 2011). In addition, the digital penetration rate among those populations is high, which facilitates access to new financing solutions. As businesses in non-OECD countries tend to struggle to be accepted into the traditional SCF programmes due to the riskier business environments they are facing, new SCF solutions out of these regions have the power to be transformative for those countries. Regional solution providers can, for example, invest in the local infrastructure, which is u ­ sually rather unattractive for foreign vendors. The current demographic development leads to a rise in the average age of the global population. As older people will generally be wealthier and have more money to spend while, at the same time, having more active years, businesses need to create new offerings focusing on this target group. This increases the need for financing solutions for businesses and thus the demand for SCF. Furthermore, debt structures will change, making it possible to distribute debts over several generations. This requires adjusted or alternative financing solutions. With the emergence of online shopping and major platform providers and online sellers like Amazon, people’s consumption behaviour changes. Fast delivery options and constant availability of products have massive effects on SCs. This development requires investments in the logistics and SCs of companies, which therefore increases the demand for financing and SCF. In addition, Amazon recently launched Amazon Business, providing a supplier financing platform and thus creating new opportunities from the supply side of SCF. Business and financing solutions will increasingly adapt to religious environments. Islamic financing, for example, is growing rapidly in many Muslim economies. Islamic financial systems are based on the prohibition to include any forms of predetermined rates of return. This requires the development of new SCF solutions in order to serve those markets and offer innovative solutions. As a consequence, new markets can be served that have a positive impact on both the demand of and the supply for SCF p ­ rogrammes. In summary, social developments in the mid-term future will lead to an intensified global market that is favourable to the demand of SCF solutions (see Table 9.4).

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The future

Table 9.4  Social trends and their impact on supply and demand of SCF solutions Social trends

Impact on supply Impact on demand of SCF solutions for SCF solutions

Population growth

↑

↑

Economic markets development / emerging markets

↑

↑

Demographic development

↑

↑

Religion and beliefs

↑

↑

Technological trends and their impact on SCF Technological factors discussed in the PESTEL analysis are in general ‘trends in the technical and material foundations of an industry’ (Witcher and Chau, 2010: 92). The rise of business process automation is expected to have a similar revolutionary impact to that of manufacturing automation – another industrial ‘revolution’. The inter-operability of different systems including master data management facilitates an enormous increase in productivity and results in a decreased need for capital as physical processes become more efficient. However, at the same time, SCF becomes less costly for the supply side and thus enables the development of cheaper offerings. This stimulates demand and gives additional businesses the possibility to take advantage of such programmes. Automation may therefore have a neutral impact on the supply of and demand for SCF. AI facilitates the rise of new technologies such as blockchain, which enable fully transparent and traceable SCs (Zijm and Klumpp, 2016). Greater transparency of SCs leads to a higher level of certainty – businesses have the possibility to gain greater insights into their customers and can apply the KYC principle faster. As a consequence, they can reduce their inventory and respond better to customer demand. This may reduce the need for SCF. However, as a company’s creditworthiness can be assessed more reliably, the default risk decreases, which stimulates trade and the opportunities for financing. Furthermore, companies can analyse their WC requirements as well as the situation of their suppliers faster, which increases the attractiveness of global and interconnected SCs and thus the need for financing solutions. As discussed earlier in terms of economic trends, fintechs are an emerging source of SCF solutions. A number of these use big data to ­understand

The look beyond

the specific risk and provide new SCF solutions. Previse is an example of one offering immediate supplier payment based on a historic view of invoice settlement (https://previ.se/). Overall, we expect AI and data to increase supply and demand for SCF solutions. Higher SC visibility and the increased knowledge about customer behaviour and preferences enables businesses to optimize their offering and thus create a certain level of security and stability. Consequently, trade and the need for SCF increase. For example, the Swiss-based company Arviem offers real-time tracking and monitoring of cargo, which creates greater transparency and also allows businesses to uncover inefficiencies in their SCs (https://arviem.com/). In the long-term future, it might even be possible that machine data becomes the new means of payment in order to constantly optimize existing processes. New manufacturing methods (eg 3D printing) decrease the cost of production. Lower production costs result in less needs for financing. At the same time, new business models develop that enable the establishment of novel methods, which then require financing. Therefore, the impact on the demand and supply of SCF programmes remains unchanged. In summary, technological developments strongly contribute to the rise in new business models that need to fund their SCs and therefore contribute to an increased demand for SCF (see Table 9.5). Table 9.5  T echnological trends and their impact on supply and demand of SCF solutions Impact on supply of SCF solutions

Impact on demand for SCF solutions

Automation

↑

↑

Artificial Intelligence

↑

↑

Supply Chain Visibility

↑

↑

Manufacturing development

↑

↑

Technological trends

Environmental trends and their impact on SCF The PESTEL analysis also includes ‘trends in environmental factors, such as the awareness of the damaging effects of industrialization on the limited space’ (Witcher and Chau, 2010: 92).

411

412

The future

Consumers start to incorporate more and more ethical considerations into their purchasing decisions, they become generally more aware of the origin of the products they are consuming and they demand better production conditions. This requires businesses to adapt and redesign their physical SCs in order to meet customer demands, eg by sourcing their products differently or by installing new tracking devices. There is also evidence of increased use of SCF, for example by the World Bank and by some global consumer brands, to increase finance availability for raw material and primary producers at the ‘start’ of the SC. Consequently, in the long term, all these business model adjustments require additional financing, which increases the demand for SCF programmes. Furthermore, consumers demand more environmentally friendly ‘green’ products. Consequently, businesses need to redesign and adjust their SCs in order to meet customer demands, which may result in an increase in the need for financing solutions. Additionally, suppliers’ manufacturing and production sites need to be redesigned in order to meet customer demands for more sustainable processes. This redesign implies additional costs for businesses and increases their need for financing. New SCF solutions with specific lending criteria will develop on the supply side, in which companies need to demonstrate that they comply with specific sustainability criteria. In the face of climate change, natural scenarios become increasingly extreme and disastrous. Natural catastrophes affect SCs and lead to greater levels of uncertainty. This increases the need for alternative risk-based financing solutions, eg because of constraints on the infrastructure caused by severe weather conditions that make SCs and the transportation system less reliable. Furthermore, lower levels of certainty require more ad hoc solutions, which call for redesigned financing options. In addition, future markets will move towards the principle of ‘cost-truth’, in which all negative externalities like pollution from production and transportation are included (Tate et al, 2009). Consequently, new SCF solutions will need to develop, eg by CO2 compensation schemes. Overall, climate change will increase the supply of and the demand for SCF solutions. Market developments towards a closed loop economy, which is based on the principles of the sharing, leasing, reuse, repair, refurbishment and recycling of products, require new forms of traceability along the SC and imply the redesign thereof. After a ‘refit’ upgrade, capital goods in particular can be returned to a secondary market for used goods. This requires suitable new SCF solutions. On the contrary, with the decreased need to source new materials and produce new products, the demand for financing decreases.

The look beyond

However, as the user in a circular economy is usually not the owner of a product, collaboration between companies is necessary in order to provide the end user with the expected service level. This requires new financing solutions. Overall, we expect the movement towards a closed loop economy to increase the supply for SCF solutions. In summary, we assume that overall, environmental factors will have a positive impact on the demand and supply of SCF solutions (see Table 9.6). Table 9.6  E nvironmental trends and their impact on supply and demand of SCF solutions Environmental trends

Impact on supply Impact on demand for of SCF solutions SCF solutions

Ethical consideration

↑

↑

Attitude towards ‘green’ products

↑

↑

Climate change

→

→

Closed loop economy

→

→

Legal trends and their impact on SCF Legal factors in the PESTEL analysis consist of ‘changes in the law and regulation’ (Witcher and Chau, 2010: 93). Uncertainty about rigid accounting treatments of SCF programmes has the potential to negatively affect the demand for SCF. Even though accounting firms provide clearly established frameworks and handbooks, no explicit official accounting standards for SCF exist yet (Hofmann et al, 2018). New SCF solutions bear new insecurities about accounting and legal concerns, such as whether the SCF is a payable or a finance borrowing, which businesses on the demand side might be hesitant to adopt. It is therefore likely that both the supply and the demand side of SCF programmes will be negatively affected. As banking regulations and compliance requirements become stricter, such as Basel III, SCF programmes operated by banks need to fulfil these new specifications. This results in higher associated costs on the supply side, which decreases the attractiveness of the business for some SCF providers. Consequently, less attractive offers also have a negative effect on the demand side.

413

414

The future

As privacy concerns grow, data protection and privacy laws become significantly stricter. Stricter regulations require businesses to invest more in data protection, which increases their need for funding, which might in turn lead to an increase in demand for SCF. Simultaneously, the automated upload of company data onto SCF platforms bears the risk of data breaches, which is a high risk for SCF providers. This makes the business less attractive and might negatively affect the supply side of SCF solutions. Also, companies on the demand side might fear a loss of data, which decreases their motivation to participate in SCF programmes. Varying regulations in different countries pose a risk to companies with globally distributed SCs, as insecurities about legal frameworks arise. The absence of robust credit structures in many countries therefore poses regulatory challenges on companies, as the creditworthiness of suppliers becomes increasingly harder to determine. We assume a tendency towards an increasing lack of will to harmonize cross-border trade regulations, except within trading blocks, as discussed earlier. The need to comply with numerous inspections and regulations increases the associated costs for SCF providers, which in turn lowers their motivation to invest in widespread solution offerings. In summary, legal factors are expected to have a negative impact on the supply and demand side of SCF solutions (see Table 9.7). Table 9.7  Legal trends and their impact on supply and demand of SCF solutions Legal trends

Impact on supply Impact on demand of SCF solutions for SCF solutions

Accounting treatment

↓

→

Banking regulations / compliance

↓

↓

Data protection

↓

↓

Regulatory challenges

↓

↓

Recommendations on future prospects for SCF Based on the trends discussed in this chapter, we can conclude that the midterm future for SCF looks positive overall. The increase in global trade as well as technological advancements give rise to increased demand for SCF solutions but will also enable the supply side to invest in new offerings.

The look beyond

Legal factors are the greatest risk for the development of SCF solution models as the amount and intensity of regulations increase, which creates uncertainty and makes SCF solutions less attractive. However, almost all of the identified trends can be categorized as indirect influences or impacts on SCF. This increases the uncertainty about the future of SCF. It is also crucial to acknowledge the linkage between the individual elements, as they can influence each other. For example, social trends can have a major effect on legislation, as recently seen in the case of single use plastics. We thus advise all solution providers and all companies considering the adoption of SCF to conduct a PESTEL analysis.

References ACCA (2014) [accessed 24 January 2020] A study of the business case for supply chain finance [Online] www.accaglobal.com/content/dam/acca/global/PDFtechnical/small-business/pol-tp-asitbc.pdf (archived at https://perma.cc/CH2QETBV) Bancilhon, C, Karge, C and Norton, T (2018) Win-Win-Win: The Sustainable Supply Chain Finance Opportunity (Report), Business for Social Responsibility, Paris Catalini, C (2017) [accessed 24 January 2020] Seeing beyond the blockchain hype, MIT Sloan Management Review [Online] https://sloanreview.mit.edu/article/ seeing-beyond-the-blockchain-hype/ (archived at https://perma.cc/PJ7Y-WXFT) Coindoo (2019) [accessed 24 January 2020] Japan’s second largest bank – SMBC, completes its R3 blockchain-based trade finance proof-of-concept (PoC) trial [Online] https://coindoo.com/japans-second-largest-bank-smbc-completes-its-r3blockchain-based-trade-finance-proof-of-concept-poc-trial/ (archived at https://perma.cc/9H3E-F6DF) Demica (2012) [accessed 24 January 2020] Passport to liquidity [Online] www. demica.com/images/PDFs/passport_to_liquidity.pdf (archived at https://perma. cc/ME9E-6Q7A) Deutsche Bank (2017) [accessed 24 January 2020] Trade finance and the blockchain: Three essential case studies [Online] http://cib.db.com/insights-and-­ initiatives/flow/trade_finance_and_the_blockchain_three_essential_case_studies. htm (archived at https://perma.cc/CB8Y-CUGL) Engman, M (2005) The economic impact of trade facilitation, OECD Trade Policy Papers, 21, OECD Publishing, Paris Euro Banking Association (2014) [accessed 24 January 2020] Supply Chain Finance: EBA European market guide, Version 2.0 [Online] www.abe-eba.eu/ media/azure/production/1348/eba-market-guide-on-supply-chain-finance-­ version-20.pdf (archived at https://perma.cc/WTU4-H395)

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The future Extra, W, Kortman, R, Siemes, D, Caniato, F, Gelsomino, A, Moretto, A, Bonzani, A, Corten, R, Dellermann, S, Monagan, L and Ronchini, A (2019) [accessed 24 January 2020] Supply Chain Finance Barometer 2018/2019 [Online] www. google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=2ahUKEwj Xxb2iq4LlAhXNblAKHQUVAe0QFjAAegQIBBAC&url=https%3A%2F%2F www.pwc.com %2Fvn%2Fen%2Fdeals%2Fassets%2Fscf-barometer2018-2019.pdf&usg=AOvVaw3ewRB0jyVPLczZmCd-Ys0I (archived at https://perma.cc/SRP3-CYUQ) Fahey, L and Narayanan, VK (1986) Macroenvironmental Analysis for Strategic Management, West Publishing, St. Paul, MN Gartner IT Glossary (2012) [accessed 24 January 2020] Glossary: Artificial Intelligence [Online] www.gartner.com/it-glossary/artificial-intelligence/ (archived at https://perma.cc/2A3R-BX63) Hartley, J (2014) [accessed 24 January 2020] How Google is poised to become a dominant investment manager [Online] www.forbes.com/sites/jonhartley/ 2014/10/06/how-google-is-poised-to-become-a-dominant-investment-manager/ (archived at https://perma.cc/UHY7-KD8E) Henkow, O and Norrman, A (2011) Tax aligned global supply chains, International Journal of Physical Distribution & Logistics Management, 41 (9), pp 878–95 Hofmann, E, Strewe, UM and Bosia, N (2018) Supply Chain Finance and Blockchain Technology: The case of reverse securitisation, Springer International Publishing, Heidelberg IBM (2018) [accessed 24 January 2020] Case study: we.trade [Online] www.ibm. com/case-studies/wetrade-blockchain-fintech-trade-finance (archived at https://perma.cc/WDC6-3VRZ) IBM (2019) [accessed 24 January 2020] Hyperledger: blockchain collaboration changing the business world [Online] www.ibm.com/blockchain/hyperledger (archived at https://perma.cc/C368-C4V6) Kok, L, Wurpel, G and Wolde, A (2013) Unleashing the Power of the Circular Economy, IMSA for Circle Economy, Amsterdam Ledger Insights (2018a) [accessed 24 January 2020] Trade finance blockchain consortia: How they differ [Online] www.ledgerinsights.com/trade-financeblockchain-consortium/ (archived at https://perma.cc/5HHS-WQBP) Ledger Insights (2018b) [accessed 24 January 2020] Trade finance blockchains consolidate into we.trade [Online] www.ledgerinsights.com/trade-financeblockchain-­consolidate-wetrade-batavia/ (archived at https://perma.cc/UA32275L) Ligi, A and Kolesnikova, M (2009) Crops-for-chemicals barter gives farmers liquidity, Bloomberg MacArthur, E (2012) Towards the Circular Economy: Economic and business rationale for an accelerated transition, Ellen MacArthur Foundation, Cowes

The look beyond Marco Polo (2019) [Online] https://www.marcopolo.finance/ (archived at https:// perma.cc/W2N8-LS95) Marriage, M (2014) [accessed 24 January 2020] Tech giants pose threat to fund houses [Online] www.ft.com/intl/cms/s/0/0ceee29c-c594-11e3-a7d4-00144feabdc0. html (archived at https://perma.cc/S3GZ-P696) PwC (2012) Tax-optimising your supply chain: The franchise model (part 1), Tax Planning International Review Scott, C, Lundgren, H and Thompson, P (2011) Guide to outsourcing in supply chain management, in Guide to Supply Chain Management, pp 169–82, ed C Scott, H Lundgren and P Thompson, Springer, Berlin/Heidelberg Sharma, JP (2011) Corporate Governance, Business Ethics and CSR, Ane Books Pvt Ltd, New Delhi Tate, WL, Ellram, LM and Kirchoff, JF (2009) Corporate social responsibility reports: A thematic analysis related to supply chain management, Journal of Supply Chain Management, 46 (1), pp 19–44 TradeIX (2019) https://tradeix.com/ (archived at https://perma.cc/S8VB-6CSV) Webber, S (2011) The tax-efficient supply chain: Considerations for multinationals, Tax Notes International, 61 (2), pp 149–68 Witcher, BJ and Chau, VS (2010) Strategic Management Principles and Practice, Cengage Learning, South-Western Zijm, H and Klumpp, M (2016) Logistics and supply chain management: Developments and trends, in Logistics and Supply Chain Innovation, ed H Zijm, M Klumpp, U Clausen and M Hompel, Lecture Notes in Logistics, Springer, Cham

Study question Questions for self-assessment of your business, in the context of SCF: 1 Have you established approaches within your business to detect trends in your environment that might affect your SC and its financing directly? 2 Are you regularly investing time in familiarizing yourself with developments that might not directly affect your business, but may have indirect consequences? 3 Are you aware of the various factors that might affect your partners’ businesses? 4 How do you prepare for an uncertain future?

417

418

The future

5 Do you consider yourself ready to face considerable threats to your business? If not, what could you do to improve your situation? Table 9.8 provides you with the framework to capture the results of your self-assessment. This outside-in perspective allows you to assess opportunities and risks that might be of relevance for your business. Assessing how these trends affect the demand and supply side of SCF programmes will help you to react internally and adjust your portfolio accordingly.

Table 9.8  Template of your personal SCF self-assessment PESTEL elements

Witcher and Chau (2010); Definitions

POLITICAL

‘influence that governments have on industries’

ECONOMIC

‘cost-related matters for the organization’

SOCIAL

‘changes in society’

TECHNOLOGICAL

‘trends in the technical and material foundations of an industry’

ENVIRONMENTAL

‘trends in environmental factors, such as the awareness of the damaging effects of industrialization on the limited space’

LEGAL

‘changes in the law and regulation’

Opportunity/risk for Opportunity/risk for the demand side the supply side

419

420

INDEX academia  180, 181, 217–18 accountants  208–09, 212 accounting perspective on inventory  114–15 standards 249–50 treatments  413, 414 accounts payable (AP)  55, 57, 187 extending  29, 31–32, 34–35 option of SCF  135, 136, 137–39, 143–44 SCF solutions  226, 227, 228–38, 272–73 decision tree  266–67 accounts payable (AP) based buyer leasing  227, 237–38, 273 accounts payable days (DPO) 59, 60, 61–62, 115–16 working capital management  68, 72, 77, 78, 79, 81 accounts receivable (AR)  55, 57, 187 option of SCF  139, 142–43 SCF solutions  226, 227, 238–43, 274–76 decision tree  267–68 shortening  30, 32–33, 34–35 accounts receivable days (DSO)  59, 61–62, 64, 115 working capital management  68, 71–72, 77, 78, 79, 81 acid test (AT) ratio (quick ratio)  31, 57, 58 adoption 283–84 advisers  180, 181, 208–09 alternative financing solutions  407–08 alternative FSPs  197–98 appropriateness of SCF  285–89 artificial intelligence (AI)  387–92, 410–11 asset school  145–47 asset tokens  401 asymmetric information  342 auditors 208–09 automation  410, 411 awareness, building  285, 286, 297–303 balance sheet (BS)  24, 26–27, 69 forecast  111, 112, 120–21 Bankers’ Association for Finance and Trade – International Financial Services Association (BAFT-IFSA)  210 banking/banks  157, 164, 165, 193–95 China  323, 324, 327, 329–31 impact of debt crisis on SME financing 346

Islamic  334, 335–40, 341 regulations and compliance  413, 414 Western conventional banking  327, 339–40 barter 386 benefits of SCF  158–60, 251–54, 292, 306–08 net benefit derivation  258–65 Betaalme.nu scheme (‘pay me now’)  214, 347–49 big data analytics  364–65, 387–92 blockchain technology (BCT)  365, 392–404 boards 184 boomerang effects  128–30 Bursa Suq Al-Sila’ platform  340 business case developing for SCF implementation  285, 286, 305–08 SCF solutions  251–65 business partner base  285, 286, 294–97 business rationale of SCF  167, 169 buyer leasing  227, 237–38, 273 buyer-led SCF solutions see accounts payable (AP) C2F0 155 CapitalBay 391 case studies  303 cash  55, 57 cash conversion cycle see cash-to-cash (C2C) cycle cash equivalents  55, 57 cash flow forecast  110–11, 119–20 generation 42 importance of managing  109–13 see also working capital management (WCM) cash-to-cash (C2C) cycle  59–63, 77–78, 79, 80–82, 164 managing 73–74 times 107 working capital management  68–74 centre-led procurement model  367, 369–70, 373 China  322–23, 323–33, 357 chocolate supply chain  97–98 circular economy  386–87, 412–13 civil law  375

Index climate change  412, 413 closed loop economy  386–87, 412–13 collaboration  171, 407, 408 in planning, forecasting and replenishment 271 in SCF  131–33 team work  285, 286, 312–13 collaborative inventory management  227, 244–45, 277 collaborative sale and leaseback  141 collateral  329, 330, 396, 397 collective invoices  227, 238–39, 274 compensation 170 complication 284 conferences 303 consignment stock (CS)  270 consortia  182, 213 consultants  180, 181, 182, 207 consulting services  161 corporate finance function  186–87, 190 corporate income tax  366, 367–73 corporate social responsibility (CSR)  364–65, 380–87 integration with SCF  383–85 cost of capital (COC)  38 WACC  22, 38–40, 67 working capital management and  66–67 costs of SCF  158–60, 161–62, 251–52, 254, 255, 256, 306–08 hidden 128–30 credit card service providers  196–97 credit insurance  198–201 credit rating agencies  198–201 credit ratings  150 credit spreads  341–42 CreditEase 326 cryptocurrencies 393–96 current assets (CA)  54–57 current liabilities (CL)  35–37, 54–55, 57 current ratio (CR)  31, 57–58 custodian service provider  248, 249 custom duties  366–67, 373–74 customers listening to  285, 286, 294–97 payment terms see accounts receivable days customs law  375 data protection  414 debt crisis  346 decentralized procurement  367, 368, 369–70, 373 decision trees  265–69 deep-tier financing  149 tokenized 401–03

demand for liquidity  52–54 demographic development  409, 410 dependences 105–09 design of implementation approach  285, 286, 303–05, 306 Deutsche Bank (DB)  131–32 developing economies  215–16, 380, 381 DIH see inventory days direct taxes  366, 367–73 distributed ledger technology  393 see also blockchain technology (BCT) DPO see accounts payable days drop-shipping 270–71 DSO see accounts receivable days Du Pont model (DPM)  21–22, 27–37 dynamic discounting  227, 231–33, 272 net benefit derivation  259–65 EBIT after asset charge (EAC)  22, 43 economic trends  406–08 economic value added (EVA)  43 ecosystem  7–8, 179–224 electronic bill presentment and payment systems (EBPP)  165 electronic data interchange (EDI)  99–100 emerging markets  409, 410 enablers of SCF implementation  304, 306 end-to-end supply chain process  105–07 environmental trends  411–13 ‘equator principles’ (EPs)  385 ethical considerations  380, 381, 412, 413 Euro Banking Association (EBA)  210 European e-invoicing Service Providers Association (EESPA)  212 European Payments Council (EPC)  212 European reroute  376–77 export financing  140, 142–43 exports 215 external financing  154–56, 187 external network  155, 156, 332–33, 344, 356 inside network  154, 156, 331–32, 343–44, 353–56 factoring invoice factoring  227, 241–43, 259, 260, 275 reverse factoring see reverse factoring (RF) Factors Chain International (FCI)  211–12 failures 283–85 financial chain school  145–47 financial flow  7, 93–96, 101–02, 105, 111–13, 122 financial intermediaries  131–32, 195

421

422

Index financial markets  149, 150 financial performance  6, 13–50 financial service providers (FSPs)  133, 180, 181, 182, 193–201 financial statements  24–27 see also under individual statements financial supply chain management (FSCM) 135 financially sustainable supply chains  80–83 financing charges  161 Findlay, Charles  4 finished goods (FG)  56 finished goods (outbound) financing  144–45 fintech companies  391–2 blockchain technology  392–404 flows see supply chain flows forecast to fulfil  107–09 formal sector  345–46 four-party model  182 fragmented approach  90–91 freight receivable securitization  332–33 functional approach  90–91 functional integration  91, 113–16 functions/departments involvement in SCF  310 multifunctional implementation team  285, 286, 310–12 users of SCF  184–90 funder-pool model  227, 235 funding models  227, 234–35 future of SCF  9–10, 364–417 Gartner Supply Chain Masters 2019  15–16 Gartner Supply Chain Top 25 for 2019  15–16 gearing  22, 38 global setting  9, 321–63 Global Supply Chain Finance (GSCF)  133 governments  54, 180, 181, 182, 213–17 initiatives for SME supplier financing 346–50 support for SCF in China  328–29 ‘green’ products  412, 413 halal  334, 341, 344 Hesse, M  91 hidden costs of debt/financing  128–30 Hofmann, Erik  4 holistic approach  90–91 implementation costs  161 implementation of SCF  9, 281–318 failures/pitfalls 283–85 guidelines 285–314 risk reduction approaches  314–16

import financing  140 importance of supply chains  17–20 in-transit financing  140 income statement (IS)  24, 25–26, 69 forecast  111, 120 Incoterms 374–75 indirect taxes  366–67, 373–80 individual company  149, 150 industry fit  287, 288 industry groups/associations  180, 181, 182, 209–13 infinite ROTA-CL (ROCE)  35–37 informal sector  345–46 information flow  7, 93–96, 98–101, 104–05, 111–13, 122 inhibitors of SCF implementation  304, 306 inside network external financing  154, 156, 331–32, 343–44, 353–56 inside network internal financing  154, 155–56, 331, 342–43, 353 insurers 198–201 intangible benefits  251–52, 253 intangible costs  251–52, 255, 307, 308 integration  90–91, 162 of CSR with  SCF  383–85 functional  91, 113–16 interest  335, 336, 343 intermediary financing  157 internal financing  154–56 inside network  154, 155–56, 331, 342–43, 353 internal information  80 International Chamber of Commerce (ICC) 209–10 international trade  150–53 International Trade and Forfaiting Association (ITFA)  211 inter-organizational financial performance 45–46 intra-firm flows  93, 94 inventory  55, 56, 64 functional integration  114–15 reducing  29, 30–31, 34–35, 69, 70 vendor-managed (VMI)  100, 270 inventory days (DIH)  59, 60, 61–62 working capital management  68–71, 77–80, 81 inventory financing  140, 144–45, 226, 227, 244–51, 277–78 decision tree  269 LSP-based  132, 191–92 investment, working capital as  64, 65 invoice discounting (ID)  227, 240–41, 275 invoice factoring  227, 241–43, 259, 260, 275 invoice securitization  227, 243, 276

Index invoices 183 collective  227, 238–39, 274 Islamic financing  323, 334–44, 357–58, 409 IT function  188–89 IT operating costs  161 Jain, J  91–92 just in time (JIT)  271 Knorr-Bremse (K-B)  131–32 know your customer (KYC)  237, 341, 389–90 knowledge building  285, 286, 297–303 legal advisers  208 legal team  188 legal trends  413–14, 415 letters of credit (LCs)  151–53 levels of SCM  92–96 Levi Strauss  380, 381 linkages 105–09 liquidity 57–59 demand for  52–54 ratios  31, 57–59, 62–63 liquidity domino effect in supply chains  82–83 listening to suppliers and customers  285, 286, 294–97 logistics  186, 212 logistics service providers (LSPs)  132, 180, 181, 182, 190–92, 329–31 long-term financing solutions  136–37 make or buy decision  24, 94–95 manufacturing 185–86 developments in  411 Marco Polo Finance  182, 213, 398–99, 399–400 market regulation  406 marketing function  114 marketplaces online 205–06 for SCF  155 Marks and Spencer Group plc  78, 79, 80 materials management  91 monitoring effectiveness of SCF programmes  285, 286, 313–14 Mudaraba financing  336, 337, 342, 343 multi-funder model  227, 234–35 multifunctional implementation team  285, 286, 310–12 multinational corporations (MNCs)  327–28 payment on behalf of (POBO) structures 378–79 multiple–win situations  166–70 Murabaha financing  336–37, 342

negative (net) working capital  36–37 Nestlé 23–24 net benefit of SCF  167–70 derivation 258–65 net working capital  54–57 demand for liquidity and  52–54 Netherlands, the  214, 346–49 network financing  149–58 categories of  155–56 new technologies  364–65, 387–404 non-current assets (NCA) financing 141 outsourcing  30, 33–35 ‘not-yet-approved payables’ financing  390–91 objectives  285, 286, 289–94, 295 off-balance sheet inventory financing  227, 244, 247–51, 278 Oliver, RK  90–91 on-balance sheet inventory financing  227, 244, 246, 249–50, 277 on-boarding of SME suppliers  354–55 one-funder model  227, 234 one-off costs of SCF  161 open account (OA) terms  151–53 operational efficiency  165 opportunity cost (OC)  22, 37–38 order to cash  107–09 organizations involved in SCF  7–8, 179–224 outbound inventory financing  144–45 outsourcing of non-current assets  30, 33–35 ownership of SCF  190 of working capital management  74–76 partial credit guarantees (PCGs)  358 partner selection  389 payable days (DPO) see accounts payable days payment on behalf of (POBO) structures 378–79 payment tokens  401 peer-to-peer (P2P) lending  324–27, 357 PESTEL analysis  404–15 Pharmacy Earlier Payment Scheme (PEPS) 349 physical flow  7, 93–98, 104, 111–13, 122 platform providers of SCF  133, 180, 181, 182, 201–07, 331–32, 353–55 political trends  405–06 population growth  408, 410 Porter’s value chain (VC)  21, 22–24 priorities 289 Procter & Gamble (P&G)  132

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Index procure to pay  107–09 procurement  185, 190, 212 tax planning and  367–73 procurement (buy–sell) principal model  368–69, 370, 373 procurement cards (P-Cards)  227, 228–29, 272 professional associations  180, 181, 182, 212–13 profit-loss-sharing (PLS)  336–38 profitability 373 managing the C2C cycle  73–74 ratios  25, 26 working capital management and 63–67 Project Bank Accounts (PBAs)  215 project management framework  285, 286, 308–09, 311 purchase order (PO) financing  227, 229–31, 272 quantitative modelling school  145–47 Quran 334 RACI method  76 rates  407, 408 ratios liquidity  31, 57–59, 62–63 working capital  59–63, 77–80 raw materials (RM)  56 receivable days (DSO) see accounts receivable days recession 408 recurring costs of SCF  161 regulation 216–17 market regulation  406 regulatory challenges  414, 415 relaxed working capital management policy 66–67 religion  323, 409, 410 see also Islamic financing remit of SCF  146, 147 reputation  284–85, 316 research interest in SCF  217, 218 restricted working capital management policy 66–67 return on total assets minus current liabilities (ROTA-CL)/return on capital employed (ROCE)  21–22, 27–37, 121 inter-organizational financial performance 45–46 revenue-sharing contracts  163 reverse factoring (RF)  135, 138–39, 143–44, 164, 227, 233–35, 273

net benefit derivation  259, 261, 262, 263–64 school of thought  145–47 reverse securitization  227, 235–37, 273 riba (interest)  335, 336, 343 risk reduction in implementing SCF  314–16 SCF solutions  255–58 risk managers  198–201 risk school  145–7 Rodrigue, JP  91 Royal Bank of Scotland (RBS)  133 Salam financing  337–38 sale and lease back  209, 251, 278 sales 184–85 sales and buying markets  149, 150 sales offer financing (SOF)  227, 239–40, 274 scale  189, 288–89 SCF community (SCFC)  4–5, 303 SCF platform providers  133, 180, 181, 182, 201–07, 331–32, 353–55 scope of SCF  135–37 securitization 176–78 bundling 390 freight receivable  332–33 invoice  227, 243, 276 reverse  227, 235–37, 273 trade receivables  166, 176–78, 332, 356 selection external SCF support criteria  294, 295 SCF solution  265–69 self-financing  157–58, 187, 234 self-financing growth rate (SFG-rate)  351–52 service operations  185–86 shareholder value (SV)  22, 40–42 framework for SCF  257–58 shariah 335 SCF practices conforming with  335–42 short- and mid-term financing solutions  136 short-term borrowing  55, 57 single-company financing  154–55 small- and medium-sized enterprises (SMEs)  189, 322 China 329–31 financing SME suppliers  130–31 government support programmes  214–15 Western SME financing  344–56, 358–59 smart contracts  394–98 social trends  408–10, 415 socially responsible investments (SRIs)  384 Society for Worldwide Interbank Financial Telecommunication (SWIFT) 210–11

Index sources of finance  157–58 staff costs  161 stakeholder school  145–47 stakeholders  7–8, 179–224 building awareness and knowledge in SCF 297–303 Stevens, GC  91 strategy  285, 286, 289–94, 295 supplier-oriented SCF solutions see accounts receivable (AR) SupplierPay pledge  348, 349–50 suppliers listening to  285, 286, 294–97 payment performance reporting  314 payment terms see accounts payable days supply chain finance (SCF)  7, 127–78 characteristics enabling sustainable trade 381–83 economics 158–62 evolution of SCF practices  147–49 general options  137–41 integration of CSR with  383–85 network financing  149–58 operating modes  141–45 schools of thought  145–47 scope 135–37 sources of finance  157–58 win–win solutions  162–70 supply chain finance community (SCFC)  4–5, 303 supply chain finance solutions  8, 225–80 AP  226, 227, 228–38, 266–67, 272–73 AR  226, 227, 238–43, 267–68, 274–76 business case  251–65 inventory  226, 227, 244–51, 269, 277–78 selection and decision trees  265–69 supply chain flows  7, 89–123 financial flow  7, 93–96, 101–02, 105, 111–13, 122 information flow  7, 93–96, 98–101, 104–05, 111–13, 122 linkages and dependences  105–09 physical flow  7, 93–98, 104, 111–13, 122 supply chain management (SCM) defining 17–18 evolution of  90–92 and financial performance  6, 13–50 and financial statements  24–27 levels 92–96 shareholder value and  40–42 supply chain operational approaches  270–71 supply chain purchase order financing  230–31 supply chain ratio (SCR)  22, 43–45 supply chain visibility  271, 411

sustainability 380–81 characteristics of SCF enabling sustainable trade  381–83 SwissPostLogistics (SPL)  132 Switzerland  369, 371–72 Syngenta 386 Tallyx 401–03 tangible benefits  251–52, 253 tangible costs  251–52, 255, 307, 308 Taulia 392 taxes Islamic financing and  342, 344 issues  364–65, 366–80 policies 405–06 team work  285, 286, 312–13 technological developments  364–65, 387–404 technological trends  410–11 Templar, Simon  3 TenzorAI 392 three-way match  99 time due to process  388 tokenization of assets  400–03 top management support  285, 286, 310–12 total cost of ownership (TCO)  252 track and trace  100–01 trade facilitation  206–07 trade and other accounts payable  55, 57 trade and other accounts receivable  55, 57 trade receivables securitization (TRS)  166, 176–78, 332, 356 trade tariffs  405, 406 trade wars  405, 406 training costs  161 transaction hubs  204–05 transition stages of SCF  147–49 treasury function  187–88, 190 trends  365, 404–15 triple–win situations  166–70 Unilever 130–31 United Kingdom (UK)  54, 214, 215, 346, 348, 349 United Nations principles for responsible investment (‘equator principles’) 385 United States (US)  214–15, 346, 348, 349–50 users of SCF  180, 181, 183–90 utility tokens  401 value added tax (VAT)  342, 366–67, 374, 375, 376, 378 value chain  21, 22–24

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Index value creation  380–81 vendor leasing  227, 243, 276 vendor-managed inventory (VMI)  100, 270 visibility of supply chains  271, 411 we.trade  182, 213, 399–400 Webber, MD  90–91 weighted average cost of capital (WACC)  22, 38–40, 67 Western SME financing  344–56, 358–59 win–win situations (WWSs)  162–70

‘window dressing’  78 work in progress (WIP)  56 working capital (WC)  346 negative 36–37 optimization  66–67, 80 ratios 59–63 limitations 77–80 working capital cycle see cash-to-cash (C2C) cycle working capital management (WCM)  6, 51–88, 122, 164–65

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