As companies seek to improve their working capital, suppliers may be seen as an easy target. Better tools and strategies can bring the interests of finance, procurement and suppliers into closer alignment, writes Andrew Sawers.

The financial crisis has taught the corporate world two important lessons: the importance of cash and the need to diversify your sources of funding. Between the beginning of 2008 and the middle of 2014, UK corporate cash piles increased by around 25%, according to a survey by the Association of Corporate Treasurers (ACT). Moreover, 43% of companies said they expected to continue to carry higher cash balances than they had in the past, with very few expecting to run down cash as the economy recovers.

“Since the start of the financial crisis, companies have said that they want to be less reliant on banks,” says John Grout, policy and technical director of the ACT. They are also more wary of capital markets.

Increasingly, one of the sources of finance that companies are turning to is their own suppliers as they lengthen their payment terms. “Most sensible CFOs would look at their working capital to see if there is a way they can release cash,” says Jennifer Pinney, a director at REL, a working capital consultancy within The Hackett Group. “You look inside your own garden first.”

The problem, Pinney says, is that suppliers can be perceived as “an easy target”: in trying to optimise the cash conversion cycle, it’s easier to insist on longer payment terms than it is to “change customer behaviour or change your inventory and production processes”. What happens then is that companies introduce blanket terms – in some cases, as long as 120 days. “That’s unsustainable,” she says.

Reputation risk tops the list of most experts’ warnings about longer payment terms, with the danger that large companies are perceived by consumers and regulators to be bullying small and medium-sized enterprise (SME) suppliers.

There is, however, a growing push-back against such practices – and some of that is coming from within the organisations that have been forcing through longer payment terms. “Not all suppliers are created equally,” Pinney says. “The stakeholders in the business that are dealing with suppliers on a day-in, day-out basis are putting forward very good and robust arguments as to why their suppliers won’t accept 120 days.”

Peter Loughlin, managing director of Purchasing Insight, a procurement consultancy, says: “There is a conflict between procurement and finance, with finance wanting to optimise DPO [days’ payables outstanding] and extend payment terms, which is a bit ‘old school’. In contrast, procurement is concerned about supplier relationship management. It works with the business in a strategic way, supporting innovation, for example, and building new supply chains for new, innovative products.”

Pinney and Loughin both say that suppliers typically manage to creep up their prices after a year or so, so the imposition of longer payment terms can be a false economy. At the ACT, Grout adds: “Some companies have seen that their supply chains are important to them: they have critical suppliers, suppliers that it would be time-consuming and perhaps costly if they were to change them.”

The new toolkit

To support suppliers, a number of tools have been increasingly coming to the fore in recent years. One of them is dynamic discounting. Historically, suppliers would offer a fixed price discount in return for early payment by a specified date. The problem, as Grout says, was “some large firms discovered that they couldn’t make a decision on whether to pay an invoice within the time their contract said they had to pay it.” They simply weren’t capable of processing invoices quickly enough to be able to capture the price discounts available. “A lot of work has gone on in some very large companies to try to shorten that approval of invoice period.”

Dynamic discounting has the benefit of a sliding scale of supplier price discounts, so if a customer misses the opportunity for a cheaper price by paying on, say, day 20 it can still perhaps get some benefit even if paying on day 35, for example.

Supply chain finance is another tool being deployed by more and more companies, offering suppliers the opportunity to receive cash for their invoices from a finance provider but at more favourable terms that reflect the strength of their customer’s balance sheet. “The cost to the supplier of the finance falls as a percentage therefore cushioning the fact that they are being asked to extend more credit,” says Grout.

Loughlin recently wrote a blog in which he said, “Supply chain finance is not a zero-sum game. It actually adds economic value and the question we should ask is not if it should be encouraged but rather, how the value within the financial supply chain should be best distributed.”

Pinney says of supply chain finance and dynamic discounting: “These solutions are great ways to approach a supplier to say, why don’t we both share the pain and gain of this using this solution.”

The benefits of these so-called treasury solutions are only really felt when payment terms are longer, but Pinney stresses that they cannot be used as an excuse to push payment terms out excessively. “Thinking about it in a more rounded way rather than just pushing everyone to 120 days is the right thing to get to optimal DPO. Then it’s an honest, open conversation between you and your supplier to a gain-share model that works for both sides.”

Technology has made the business case for these tools “much more compelling”, says Loughlin. “It couldn’t have been done ten years ago. The technology wasn’t mature enough, agile enough, or user-friendly enough. It just couldn’t be done. What they do now is very, very simple. But they execute it beautifully.”

Just as important however, is that procurement and finance should work together: payment terms and financial tools should not be left for finance to deal with alone. “It’s one of these fields that requires procurement and finance to collaborate closely,” says Loughlin. Typically, however, there are silos between the operational end of the two functions, even if at the top level procurement reports to finance or sits round the same board table. These silos need to be broken down, Loughlin says. “That’s not always easy to do. But when they do there’s real synergy. It’s crazy not to do it.”

The issues raised in this article will be discussed at two round-table meetings organised by the Working Capital Forum in London and Zurich in June 2015. For more details visit the events page.

24/4/2015 08:05:01 am

Excellent article that raises a point that I don’t see discussed enough. Supply Chain Finance will provide significant value to the supply chain. The real question for the buying organization is how should that value be apportioned between the buyer and their suppliers.

28/4/2015 01:40:33 pm

Thanks Robert. This is an issue we’ll be pursuing in the coming weeks; I know Andy is working on at least two follow-up articles in the broad area of SCF, which we hope to carry here.

27/10/2015 05:54:21 pm

While approved payable finance or what the market calls Supply Chain Finance by far injects the most capital in the supply chain out of the early pay techniques, but even here, there is success for some, and challenges for others. Most companies running programs struggle to implement with large service based suppliers such as freight and logistics, ad agencies, BPO and IT suppliers, etc.

But the most important point is that for a Buyer, SCF is uncommitted facilities. If a Big Bank yanks the reins on these programs, the companies relying on the money would be stuffed. Suppliers would not get money. If the executives of a big bank say we are in a different market environment, we need to reduce balance sheet exposure, they can cut SCF programs, that can happen. And this would greatly impact PrimeRevenues business. Its happened before, 2008, with the Great recession and the auto sector.

28/10/2015 08:49:14 pm

David, in today’s uncertain banking environment, I agree that Supply Chain Finance can magnify supply chain risk. However, that’s true only if companies implement Supply Chain Finance with bank owned SCF platforms. Bank owned platforms are dependent on a single bank, so if that bank decides to “yank the reins” on an SCF program the purchasing organization will have a serious problem on their hands. Not only did we see this during the financial crisis but we’re continuing to see it today, most recently with several large global banks exiting specific geographies. To address this supply chain risk issue, companies are now using bank independent Supply Chain Finance providers like PrimeRevenue who can add or replace any bank (or non-bank) as needed. Therefore, when banks exit Supply Chain Finance programs it actually helps PrimeRevenue’s business tremendously, as it did during the financial crisis, by enabling us to pick up additional clients and demonstrating the value of our model.

Regarding Supply Chain Finance implementations, we don’t see our clients struggle to implement with large service based suppliers such as ad agencies. In fact, our clients have had a great deal of success in these spend categories. To cite one independent source, a 2014 survey of over 100 managing directors and financial directors in the marketing and media sectors by Kingston Smith W1 accountants noted that 95% of ad agencies had accepted extended payment terms of between 90 and 180 days.

28/10/2015 09:29:50 pm

Bob, the main point is Prime Revenue has been getting their funding through banks since inception. You are not balance sheet. The asset distribution capability you added this year is great, and there are Insurers and others that are certainly interested in Libor + 20bps or 50bps assets especially given recent changes with NAIC. It would be interested to get more transparency here.