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Improving working capital performancewith Supply Chain Finance
September 20, 2012
Big challenges to working capital performance
“Despite a global business environment where companies can be harshly punished by Wall Street for even small missteps in predicting revenue or earnings, most large companies say they cannot correctly forecast operational basics like inventory, receivables, payables, and the underlying cash requirements to support them…”
“... typical large companies in the annual REL 1000 analysis could generate nearly $2 billion in additional cash annually by optimizing working capital management.” REL Consulting (a division of The Hackett Group, Inc.), Working Capital: Successes, Challenges, and 2012 Objectives, (April 26, 2012)
“Since, on average, roughly 50% of companies’ working capital is tied up in the supply chain, there are very significant benefits to taking a more holistic view of the supply chain...”
Ernst & Young insight: Getting the most from your supply chain (March 12, 2012)
Payables… Extend Days Payables Outstanding (DPO)
Control financing costs
Manage A/P processes more efficiently
Receivables… Shorten Days Sales Outstanding (DSO)
Improve “quality” of receivables
Lower financing costs
Expand sales markets (revenue growth)
Reduce payment and FX risk
Inventory… Lower Cost of Goods Sold (COGS)
Align procurement terms to match sales terms
Accelerate inventory turnover
Ensure a predictable supply chain
may be the solution
3
More efficient financing
How do you improve performance?
Working capital benchmarking analysis — an example
Peer
com
pari
son
*
From a working capital perspective,how would you stack up against your peers?
* Standardized in USD MM 360-day calendar, based on the latest FYE results and average two-year balancesSource information: 2011 corporate annual reports (available online)
5
Evolution of finance in the global supply chain
Management of the Supply Chain has involved over time to a more holistic view
Convergence of the physical and financial supply chains
• Historically, the Supply Chain has addressed physical aspects: inventory flows, transportation spending
• Supply Chain Finance (“SCF”) expanded the focus to Inventory control and A/R reduction
• Today, efficiency in Payables has become a key component of Cash Conversion Cycle discussions
Effect of Global Financial Crisis on Working Capital Optimization
• The Global Financial Crisis illustrated that the cost and availability of capital can change dramatically in a short period of time and underscored the importance of counterparty and supplier risk management
• As a result, working capital optimization became a renewed area of high interest
Best in Class Companies
• Today most Fortune 500 companies are using programs such as Card Solutions, ePayables, SCF that enable them to generate a value proposition from their payables:
• Card solutions as a bottom up solution that can extend terms or more often generate fee rebates
• SCF provides a top down, more cost effective, solution for larger suppliers
Purpose
• Provides a “Buyer” with a means to stretch out payables or reduce COGS while also offering suppliers the ability to receive payments as quickly as possible
• Create a “value exchange” that can improve working capital or, alternatively, allow negotiation of pricing concessions
Program
• Suppliers can tap into funds earlier in their receivable cycle by allowing them to secure discounted funds against those receivables
• Web-based technology can provide a seamless solution for both parties
• Available to both domestic and international suppliers and can be used for foreign currency purchases
Pricing
• Suppliers bear the on-going cost of the program, at a cost of funds aligned with the Buyer, set as a per annum rate, fixed spread over the relevant LIBOR for the period of the discount
• Discount rate charged to vendors incorporates the credit spread and the program’s administrative costs
• Cost is generally lower than the suppliers’ cost of debt and well below their Cost of Capital, WACC or IRR
Overview of Supply Chain Finance
SCF: who it benefits
Buyers benefit by… Improving cash flow by extending DPO while
maintaining trade payables classification
Alternatively use a mechanism to negotiate better pricing
Reduced administration through end-to-end payables reconciliation solution
Strengthening supplier relationships/sustainability
Can be part of an integrated payment network solutionSuppliers benefit by…
Improving cash flow by reducing DSO in an accounting neutral way
Obtaining funding based on receivables as a financial asset, rather than supplier creditworthiness
Obtaining financing at rates more favorable than those offered by alternative finance mechanisms
Avoiding use of often limited credit availability from their bank
Improving cash flow forecasting and flexibility
Having a tool to manage the concentration of receivables
for both buyers and suppliers
A win-win
SCF: how it works
Bank System
Buyer Supplier
Purchase order
Invoice
A
ppro
ved
invo
ice
Payment
Deb
it
D
iscount
request
1. Buyer transmits purchase orders to Supplier
2. Supplier submits invoices to Buyer
3. Buyer reconciles and feeds approved invoice file into Bank’s platform (web-based)
4. Supplier selects and requests discount of approved invoices (or auto-discount) – all or part
5. Bank discounts invoices and remits proceeds to Supplier
6. Bank debits Buyer account on invoice maturity date for total due and remits amounts not discounted.
Objective: Decrease DSOs Objective: Increase DPOs
Assets Equity & Liabilities Assets Equity & Liabilities
BuyerA/R
ABCA/P
ABC A/R = Buyer A/P
Traditional negotiation of terms - “zero-sum game”
Buyer receivables are a substantial part of its suppliers’ working capital costs
Supplier Buyer
Benefit: Decreased DSOs Benefit: Increased Lending Benefit: Increased DPOs
Assets E&L Assets E&L Assets E&L
BuyerA/R
BuyerA/R
ABC A/P
Buyer DPO = 51(reduce working
capital)Bank owns A/R 41Supplier DSO = 10
(unlock cash flow)
Supply Chain Finance offers a “win-win” solution
SCF enables Buyer suppliers to discount approved invoices at a very competitive rate
ABC Company Bank Buyer
Typical financing inefficiencies – both domestically and internationally
A Supply Chain Finance (SCF) program can help allocate financing more efficiently to the benefit of both
parties
While many suppliers face… High cost of debt or other capital
alternatives
Non-investment graded
A/R concentration limit issues
Restrictive or limited bank credit lines
Many buyers enjoy… Low cost of financing
Investment graded
Strong balance sheet
Access to low cost capital
Many banking options
* Based on S&P 2012 rating scale
Cash flow improvement — an example
Imp
roved
cash
flow
2.30% 4.97%$46,875 $5560.1875% 0.0022%
$1,736,111 $1,736,111$0 $2,013,889
Supplier's Break-Even RateSupplier's Interest Savings ($)Supplier's Interest Savings (%)Supplier's Cash Flow Increase
Buyer's Cash Flow Increase
Supplier's A/R
$2,083,333 $347,222 $347,222
Buyer's A/P
$2,083,333 $2,083,333 $4,097,222
Supplier's Interest
Rate5.00% 2.30% 2.30%
Supplier's Interest
Cost$104,167 $57,292 $103,611
Payment Terms
30 30 59
DSO 30 5 5
SCF Rate 2.00%LIBOR 0.30%
TodayToday's Terms
Target Terms
Target Terms 59Invoice Approval Days 5Supplier's Capital Rate 5.00%
Supply Chain Finance Benefits Calculator
Supplier NameSupplier Sales to Buyer $25,000,000
Current Terms 30
2.49% 4.98%$95,868 $7640.3835% 0.0031%
$3,819,444 $3,819,444$0 $3,819,444
Supplier's Break-Even RateSupplier's Interest Savings ($)Supplier's Interest Savings (%)Supplier's Cash Flow Increase
Buyer's Cash Flow Increase
Supplier's A/R
$4,166,667 $347,222 $347,222
Buyer's A/P
$4,166,667 $4,166,667 $7,986,111
Supplier's Interest
Rate5.00% 2.49% 2.49%
Supplier's Interest
Cost$208,333 $112,465 $207,569
Payment Terms
60 60 115
DSO 60 5 5
SCF Rate 2.00%LIBOR 0.49%
TodayToday's Terms
Target Terms
Target Terms 115Invoice Approval Days 5Supplier's Capital Rate 5.00%
Supply Chain Finance Benefits Calculator
Supplier NameSupplier Sales to Buyer $25,000,000
Current Terms 60
Company A multinational company with over $2BN in revenues in the wholesale manufacturing market
Objective Dramatically extend its very short supplier terms and improve its Cash Conversion Cycle.
Situation Company was well below its peers in both DPO and CCC, had already extracted all possible benefits in inventory control and was being pressed to extend sales terms to its customers
Response Through our recently established program the Company expects to achieve the following:
Dramatically extend its DPO, which will approach industry leaders
Generate approximately $60mm in additional cash flow by year end 2011 and increasing to $150mm by year end 2012
Set a new standard for negotiations with new suppliers as to terms
Seek to further extend supplier terms in the future
Example of successful application of Supply Chain Finance
In Summary
Corporate focus on working capital metrics can be a more cost-effective effort than capital raising or increasing bank debt
Solutions that benefit both a buyer and a supplier are an easier sell
Payables programs can often be easily implemented and should be targeted where supplier adoption is most likely and provides the most benefit
Can be part of an overall streamlined and automated payment process designed to generate capital/revenue and reduce administrative burden and cost