I am somewhat bewildered that the take up of supply chain finance by Australian businesses has (at least in my experience) been very low. Given the extent of the benefits it offers while imposing minimal costs and risks, one would have expected the vast majority of mid-size and large businesses to be offering such a program to their suppliers.
In this article I have set out a brief description of the supply chain finance program I have in mind and then set out an overview of both the benefits and costs I see for a business that implements such a program.
The supply chain finance program I am referring to is one that gives one’s suppliers the option of selling their invoices to the ‘Investor’, at a discount, in return for receiving early payment. Those that exercise the option receive payment shortly after one has confirmed the invoices to be payable. Notwithstanding the supplier receives payment shortly after completing the supply, one still only pays the invoiced amount as and when it is due for payment under one’s supply arrangements.
The program could be used to reduce one’s working capital – in that it gives one the ability to increase one’s supplier credit terms without adversely affecting one’s suppliers. That is, if one fully compensates the suppliers for the effective interest cost associated with the longer credit term.
Foreign suppliers often require payment on shipment, weeks before one receives the goods and even longer before receiving any income associated with the on-sale of those goods. The program would enable the suppliers to continue being paid on shipment and one getting the credit terms one needs to match the timing of that payment with the receipt of the sale proceeds.
One’s suppliers, particularly unlisted companies, will be better able meet one’s current and additional orders – as they can use program to fund the working capital related to satisfying those orders.
It reduces the time one (in particular one’s treasury and accounts payable people) would spend dealing with suppliers contacting one (by phone or email) requesting early payment or otherwise enquiring as to when they can expect to receive payment.
It improves one’s corporate social responsibility in that one’s suppliers get reliable access to working capital at a low cost, which makes them more financially stable, better able to fund their growth and potentially leads to their employing more people.
Suppliers benefiting from one’s financial strength – which could reduce the suppliers’ cost of funding the working capital related to supplying one, which in turn could lead to the supplier reducing its pricing. (The market for capital is inefficient, particularly for unlisted companies who have much greater difficulty attracting capital and those that are successful invariably need to pay a much higher price for it. If one has greater financial strength than one’s suppliers, those suppliers would probably be able to secure the additional working capital through the supply chain finance program at a much lower cost than the cost at which they would otherwise have to pay for a similar amount of capital.)
It would reduce the exposure of one’s suppliers to the whims of the banking sector, thereby improving their capacity to continue supplying goods and services to one.
Since one would in effect be originating invoice finance business for the Investor, one would have some justification for requesting a ‘business introduction’ or other success based fee on each invoice purchased by the Investor. One’s net profit before tax would increase by an amount similar to the fee one earns – perhaps an easy way to convert one’s accounts payable department to a profit centre.
The Investor will provide highly automated systems, systems adapted for use and already used in many countries around the world, in both developed and developing economies. The Investor will also provide the documentation and the capital, operate the program and promote the program to one’s suppliers.
As a result one would be exposed to minimal implementation costs and minimal operating costs. One would also be exposed to minimal risks. I suppose one would be exposed to a risk of fraud on the part of the Investor. One would however expect there to be checks and balances within the system and provided one is dealing with a reputable party, that risk and its impact would probably be very low.
One’s obligation to pay the Investor would not give rise to an additional obligation. It is just that rather than paying one’s creditor one pays the Investor. That liability would not be reported as an obligation on one’s Balance Sheet and nor would it be reported as a contingent liability. One may be required to report on the existence of the program but in doing so one would state that the program does not impose on one any additional obligations.
I argue the expected return-for-risk is attractive and the ‘payback’ period short. Nevertheless, some argue that the potential benefits are not sufficient to justify distracting one’s senior management team from pursuing projects that are expected to have much greater financial impact. One could argue in response that very little of senior management’s time would need to be allocated to the program. Even the sign-on documentation is likely to be only a few pages long.
I have argued that the potential benefits far outweigh any likely adverse consequences for a party offering such a program. I have also indicated that by implementing such a program one would be providing a benefit to one’s suppliers, particularly to smaller businesses with less financial strength and they in turn, by also implementing the program, would provide a benefit to their suppliers. Competitors would probably feel the need to follow one’s lead. In other words one could start a domino effect benefiting one’s industry and the economy generally.
In an article to follow I will show how one can use a supply chain program to materially increase the returns one would otherwise earn on one’s ‘cash equivalents’ as well as reduce one’s risk in relation to that money.
By Mark Morris (July 2017)