The Keys to Effective Financial Supply
Chain Management
Financial
Supply Chain Management is not an entirely new concept, interest in the
discipline has increased dramatically over the past year with the focus
shifting from theoretical discussion to the practical implementation of
programmes with tangible benefits. Interest has been driven by banks seeking to
adapt their transaction banking product offerings to new market conditions, as
well as buying corporates looking to squeeze added value from their existing
procurement arrangements.
The
physical supply chain can be defined as the activities involved in planning and
executing the movement of goods and their documentation, while the financial
supply chain describes the activities involved in planning and executing
payments between trading partners - what could be described as the
order-to-cash and the purchase-to-pay cycles for suppliers and buyers
respectively. For every physical movement of goods between supplier and buyer,
there exists a financial flow travelling in the opposite direction. Financial
supply chain management involves taking a holistic approach to these processes
in order to achieve a range of benefits that include improved efficiency and
visibility across the supply chain and a more favourable working capital
position.
A
distinction should also be drawn between what can be defined as 'supply chain
services' and 'supply chain finance'. The former refers to the realm of
providing services in order to increase supply chain efficiency - services that
are not necessarily finance related such as the dematerialisation of paper
invoices or an increase in straight-through processing (STP). Supply chain
finance (SCF), on the other hand, relates more specifically to providing the
appropriate financing facilities at the relevant points in the physical supply
chain.
From
the buyer's perspective, offering financing in this way represents an
opportunity to more effectively manage relationships with suppliers and
increase payment terms without damaging goodwill between trading parties. And
from the perspective of the supplier, the main benefits relate to improved cash
flow as reduced days sales outstanding (DSO) mitigates the need for working
capital during the production process.
A Holistic Approach
While
traditional trade finance offerings tend to be focused around individual
transactions and the strength of participants' balance sheets, SCF takes a more
holistic approach. Rather than looking at transactions in isolation, SCF
considers the entirety of a trading relationship and is altogether more
encompassing. This approach has been determined in no small part by the
changing nature of global trade flows - in particular the growth of trading on
open account.
With
many emerging market economies fully recovered from the financial crises of the
1990s, trade between the developed and developing world is currently growing at
around 13% a year according to SWIFT. However, documentary supported trade has
only been growing by around 3% a year, meaning that the bulk of the increase is
taking place on an open account basis. In addition to this, the trend towards
production taking place in countries that are traditionally considered less
credit worthy has added a new level of risk and complexity to procurement
arrangements. These developments have established a need for new approaches to
mitigating risk and financing suppliers. SCF seeks to address this by taking an
approach that looks beyond the strength of an individual supplier's balance
sheet and any associated country risk, and instead considers the strength and
depth of the relationship between buyer and supplier, and buyer and bank.
In
common with traditional factoring or invoice discounting arrangements, the
supplier receives a percentage of the due payment up front. However, with a
supplier finance approach, the process is initiated by the buyer through its
own bank and, thanks to the buyer's stronger credit rating, the terms are
likely to be more favourable than the terms on offer to the supplier through a
local bank. Indeed, in this respect, SCF schemes represent a form of credit
arbitrage that capitalizes on the gap between the price at which a buyer can
finance a product between production and payment, and the price at which a
supplier could finance itself for the same period.
Financing
suppliers in this way is heavily dependent upon the relationship between the
trading parties. In order to accurately price products, banks need to be
supplied with data from their clients detailing the history of the relationship
with the supplier, and will also need to be notified at the first sign of any
problems with a supplier meeting its obligations. In this respect, a track
record of problem free production will be the ideal scenario.
Banks
should also see some regulatory benefits to financing trade in this way. By
transferring the credit risk to large, well-rated buyers, banks are also able
to lower their capital reserve requirements with respect to the Basel II
accords. Indeed, Deutsche Bank research shows that trade related finance
carries a lower risk of default than equivalent non-trade related instruments -
even if those instruments were used to finance trading. And this data should
allow for the more accurate pricing of risk on SCF products.
To download the complete report click on:
No comments:
Post a Comment