SUPPLY CHAIN FINANCE. Extracting value from the supplier tail. A Purchasing Insight report in collaboration with Invapay

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1 SUPPLY CHAIN FINANCE Extracting value from the supplier tail A Purchasing Insight report in collaboration with Invapay

2 Supply Chain Finance and Working Capital Management are important tools for any business and in 2012, there are compelling reasons why now is the time to adopt financial supply chain management tools in earnest. There is an economic perfect storm. A combination of constrained liquidity business struggling to maintain a line of credit and very low interest rates. This makes it less attractive for businesses to hold on to cash but very expensive to borrow. The ability for a buying organization to leverage Supply Chain Finance is predicated on the assumption that you are able to manage accounts payable efficiently and effectively, which in turn is reliant on purchase to pay process being sound. This is rarely the case and poor P2P processes can be a serious blocker for some areas of spend. But not all areas of spend are created equally. For some categories of spend the balance of power between the buyer and supplier can make strategic relationships untouchable and, where hard core supply chain process are in place, the complexity of the P2P process makes it difficult to manage. In contrast, there is one area that is often overlooked. The so called supplier tail the 80% of suppliers that represent 20% of spend. Too complex to be considered by many, the fact is that the supplier tail represents one of the most important areas of spend for Supply Chain Finance and it can provide rich pickings for those looking to enhance their working capital management strategy. Supply Chain Finance -

3 Section 1 how we got where we are Historically, Supply Chain Finance was very much supplier led. The aim was to extract value from unpaid invoices. By selling the outstanding invoices to the bank, a supplier can receive payment immediately. Of course there is a cost involved but faced with a wages bill due next week and an large order that needs fulfilling yesterday, immediate payment can be highly valuable even at what might be an equivalent annualized cost in excess of 20%. In it s place and at the right time, it s a powerful tool but it works best for suppliers with high values or volumes of transactions. On the other side of the fence, the buyers side, the accountants have been performing a mirror image exercise. Management of DPO (days payable outstanding - how long it takes to pay suppliers) is a key performance indicator for any business. There is a direct relationship between DPO and the cash requirements of the business and extending DPO as far as possible reduces the working capital requirement and, as a consequence, the cost of that capital requirement. But the world is changing and what we understand to to be Supply Chain Finance is becoming a little blurred. In the past it has been associated with banking products like factoring, but as supplier relationship and financial management technology evolves, there is a growing set of the tools and techniques that businesses are using to optimize their financial position as they trade all of which are falling under the banner of Supply Chain Finance. There are now buyer led techniques that allow the accountants to go beyond the use of DPO and cash management to gain a better return. By understanding how to manage the key areas of supplier spend, organizations can dramatically influence their working capital requirements. 2

4 Section 2 DPO - a blunt weapon When interest rates were in what we thought of as a normal range, fluctuating between a few percent and a little over 10%, payment terms was an important P2P lever. Paying late could give the buyer a significant cash advantage. Interest earned on cash (or avoided on the overdraft) can be the equivalent to a few percentage points off the price of the goods bought. To the supplier, it s a double pain. There s a cost of interest on extra borrowing but there s also a cash flow impact that effects their ability to pay for raw materials and manage demand effectively. This is why factoring is a useful tool. It improves suppliers cash flow albeit at a price. But interest rates aren t what they used to be. There s a new normal and interest rates are practically zero on cash deposits but still crippling for smaller suppliers looking to borrow. The cash benefit to a buyer of extending payment terms is negligible. The buying organization can reduce their working capital requirement but at the expense of the supplier whose cost of capital is, generally, much higher than that of the buyer. The buyer may enjoy a quick win but the cost across the supply chain - the cost of doing business increases. And it gets worse. To the buyer, interest rates are still high but only if the credit is available. For the supplier, credit being unavailable is worse than credit being expensive. For many small suppliers, an extension on payment terms is nothing short of disaster. For the buyer too it could be counter productive with no significant commercial benefit and a potentially disrupted supply chain. Delaying payment can be a blunt and brutal Purchase to Pay weapon that at best delivers a modest headline saving but at the same time, increases the overall supply chain costs. 3

5 Section 3 supply chain finance approaches It was noted earlier that supply chain finance was historically supplier led. Buyer led techniques are relatively complex and factoring in particular has been driven by a specific financial need of the supplier. But factoring is perhaps the least sophisticated supply chain finance approach and increasingly we are seeing alternative, collaborative approaches that deliver wins on both sides of the relationship Reverse factoring Factoring allows businesses to sell their outstanding invoices to their bank (where the buyers are good credit risks). The bank will take a fee, advance a proportion of the value of the invoices (typically 75%) and chase for payment. This is an effective tool but for a small business with not a lot of financial clout, it is expensive. Reverse factoring on the other hand allows even small businesses to take advantage of the financial standing of their customers to get a better deal and it can be an effective means for a buyer to extend DPO without impacting the suppliers cash flow. Instead of presenting a stack of invoices to the bank, the supplier works in collaboration with a single customer at a time. They pass the invoice to the customer as usual who then authorizes payment. This changes the status of the invoice. As an approved invoice it is more valuable and on the back of this, the bank is prepared to advance cash to the value of the invoice (minus a handling/credit charge.) The key here is that the bank assesses the financial standing of the customer when setting the fees not the supplier so for small businesses with large customers, reverse factoring can make sense for both parties. 4

6 Purchasing Cards In some circumstances, purchasing cards can be deployed very effectively to manage low value and one off spend. The key benefit of the card is that suppliers can be paid early (in effect immediately) without the need for buyers to pay in the same timescale. The disadvantage is that the interchange fee is relatively high. cards, this is a bank agnostic arrangement, indeed, the full value of the arrangement can be shared between the buying and selling parties. In simplistic terms, if a bank charges a supplier 20% to borrow and rewards the buyer with 2% on cash balances then a dynamic discounting arrangement releases 18%. The other notable benefit of purchasing cards is the reporting that is delivered alongside them. Unlike a credit or debit card statement, all of the associated transaction data is compiled. This can negate the need for paper invoices even in the tightly regulated environment where VAT reporting is mandatory. Dynamic discounting Dynamic discounting is simple at least in conceptual terms. A buyer and supplier agree a scale of discounts with corresponding early payment terms. Unlike factoring and 5

7 Section 4 priority spend categories Different areas of spend derive different benefits. Areas where there is high value or volume would, at first sight, appear to be obvious target but look a little closer and the picture is not necessarily that straightforward. There are characteristics of some spend categories that make it more difficult to address even if value and volumes are high and it is important to understand these characteristics in order to prioritize effort. From a supply chain finance or working capital management perspective, supplier spend can be divided into 3 main categories: 80% spend, strategic suppliers, and the supplier tail. extracted there s only so much that can be squeezed out - it may be extremely difficult to achieve anything at all. The ability to optimize your financial supply chain is predicated on the assumption that your purchase to pay processes are in control. It s no use looking at discounts for early payment if your AP process barely allow you to pay to terms. This area of spend is the area where P2P controls are most rigid. They need to be and, if like most organizations 80% spend Clearly, the most obvious target area of spend is the 20% of suppliers that represent 80% of spend. But there is an issue that may make this less of a priority. Quite apart from the fact that any cash flow benefits may well have already been 6

8 this produces bottle necks and delays on the payment approval process, you may have an uphill battle on your hands to improve your financial supply chain management. Strategic suppliers Strategic suppliers are generally, but not necessarily, a subset of the 80% spend but for these suppliers there may be further P2P barriers that get in the way of introducing supply chain finance initiatives. Strategic suppliers won t always play ball. If they are the dominant supplier in your industry they may well be the dominant party in your relationship and it may be necessary to take a defensive position. But even in the absence of a dominant supplier relationship, the supply chain processes are often complex and do not lend themselves to a simplistic purchase to pay view. Supplier tail While the supplier tail, the 80% of suppliers that represent 20% of spend, may not be an obvious first priority, there are features that makes it an attractive target for supply chain finance initiatives. Unlike strategic and direct spend, the purchase to pay control required for supplier tail and one off suppliers require far less rigidity. From setting new suppliers up to receipting and matching process, a light touch will often suffice. Options like 2 way matching and the use of purchasing cards or simplified supplier set up for example make it far easier to put in place a highly controlled P2P environment. But there is a more compelling reason why the tail is attractive as a means of working capital management. 7

9 Section 5 your most important supplier Map your organization s suppliers by value of spend and it s easy to see why most of your spend is with a small proportion of suppliers. It s a typical 80:20 with 80% of spend with 20% of suppliers and classically, it s within the 20% of the largest suppliers that there is most return to be derived from spend management. There is nothing wrong in focusing attention where it gives the greatest reward but, particularly for mature organizations, when major supplier spend has been optimized the significant benefits available from managing tail spend could be a new and as yet untapped source of savings. But take a step back for a moment and compare the tail, the 80% of suppliers that represent 20% of spend, with your other suppliers. When you aggregate the tail spend, it often proves to amount to more than your biggest suppliers. Your tail could be your most important supplier! So if the tail spend exceeds that of your bigger suppliers, why is it ignored? Of course it s more complex. Engaging with multiple small suppliers is very different than with a smaller number of large suppliers. But this is 2012 and in the era of big data management there are tools and techniques available to support even the complex supplier landscape. 8

10 Section 6 actions When a project is de-prioritized because it is too complex or too difficult, you need to be very careful what that actually means. Is it really difficult or complex? Or is it really just too difficult or complex for you? The tools and techniques available to treasury and spend managers advance all of the time. What was unthinkable 10 years ago is perfectly achievable today and there is a timely opportunity to revisit areas of spend previously deemed inaccessible. Perform detailed analysis of spend to understand areas where Supply Chain Finance can support better working capital management Examine tail spend carefully. Aggregate it and explore methods of simplifying purchase to pay processes to unlock it s potential Actions Get to grips with the various means and methods of improving your organization s financial supply chain. Understand the accounting treatments of Supply Chain Finance products and how they could be relevant. 9

11 Section 7 about invapay Invapay Payment Solutions saves business money by helping to manage the purchase to pay process for the long tail of one-time-only and tactical vendors. Our cloud-based trading and payment portal delivers control, compliance and spend visibility and helps procurement and finance to be truly aligned. Invapay provides the user with tools to buy from any vendor while retaining the corporate power to control procurement and payment decisions. miscellaneous and ad hoc spend, the platform is multilanguage, multi-currency, multi-tax and VAT compliant. At the heart of the Invapay solution is a powerful and flexible Supply Chain Finance engine that provides option to pay suppliers early and negotiate discounts. Rich management information including line item detail, provides management reporting tools and financial analytics to stay in control. The Invapay platform reduces the cost of doing business by putting one-time-only vendors and tactical procurement in plain sight, eliminating the headache of managing 10

12 Copyright Statement 2012 Purchasing Insight Group All rights reserved. No part of this document may be reproduced or transmitted in any form or by any means without explicit written consent. xi

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