Treasury Today Country Profiles in association with Citi

Receivables: overhauling working capital management

Sun halo in middle Thailand with ferris wheel

With billions estimated to be tied up in excess working capital, optimising the flow of funds through the financial supply chain will surely continue to be a top priority for European companies in the years ahead. But how are transaction banks, technology solutions and treasury itself, changing in the quest for ever greater working capital efficiency?

Since the financial crisis, corporates have been labouring to rebuild balance sheets to ensure short-term obligations can be met in future stress scenarios. It is a goal which has led, among other things, to a renewed focus on working capital management with some companies pulling down old, localised structures and starting again from scratch.

In a panel discussion at the 2014 Receivables Finance International conference in Warsaw in April, representatives from both the corporate and banking world debated some of the changes seen in recent years. Treasurers, the panel unanimously agreed, are now taking much greater ownership of working capital performance at group level – a trend most visible in the recent post-SEPA vogue for payments and collections factories.

“We are seeing more and more corporates now giving their treasuries the mandate to fully manage and optimise their working capital from end-to-end,” Eugenio Cavenaghi, Director of Trade and Working Capital at Barclays told delegates. In this new paradigm, treasury’s mandate to find efficiencies across the procure-to-pay (P2P) cycle is becoming less tacit and more formalised, he adds. “Consciously they have taken ownership of working capital and, as a bank, our challenge is to present a set of solutions that helps them as owners of working capital to meet the challenges they face.”

One of the ways banks are helping treasurers meet their working capital challenges is through the financing of receivables (see the fundamentals box at the end of this article for a reminder of common techniques). It is an activity which has seen spectacular growth in recent years. Since 2009, domestic invoice factoring across the globe has grown at a compound annual growth rate (CAGR) of 13.1%, while cross-border transactions have seen an even bigger upsurge, with a CAGR of 24.8%. Once considered as a last resort for companies that had become too risky for conventional loans, receivables financing is evidently much more mainstream now. Even large multinationals with investment-grade credit ratings are realising the benefits it can bring in terms of working capital optimisation (WCO).

Taking control

One company that epitomises this fresh approach to working capital optimisation is Siemens. Friedemann Kirchhof, Head of Supply Chain Finance at Siemens began by telling delegates the journey his company has taken since beginning to explore working capital improvements over a decade ago. The company, he explained, decided a more centralised methodology was required. A split approach was taken; one unit was assigned responsibility for the physical supply chain while another brought in expertise to bolster the financial supply chain – both forwards and backwards.

Chart 1: Fundamentals of receivables financing
Chart 1: Fundamentals of receivables financing

Source: PwC 2014

On the forward side, Kirchhof oversees the group’s efforts to improve DPO through extension of SCF facilities to strategic suppliers. But the most novel aspect of the system, perhaps, relates to the receivables side and the establishment of a ‘credit warehouse’. Siemens were dealing with large amounts of receivables data from its multiple business units and wanted to get a clearer picture of which companies posed extraordinarily high credit risk globally. The Siemens Credit Warehouse is an in-house unit that provides bank-like services to the company’s entities. Its principle function is to purchase and bundle the short-term trade receivables from subsidiaries and manages the Group’s credit risks by selling, securitising or hedging exposure to specific customers.

“For the moment, it is more of a risk management tool used to gain transparency on where our customers’ risks are,” said Kirchhof. “But there is the option on the receivables side, when it is needed, to turn them around very quickly into cash.”

Tools for the job

New concepts such as Siemens’ Credit Warehouse have led banks and treasury technology specialists to develop up-to-date services and solutions to assist corporate treasurers with the evolving challenges they face. In fact, such has been the pace of technological advancement in treasury over the past few years there is an argument that solutions are now often leagues ahead of what processes can actually achieve, says Robert O’Donoghue, Managing Director and Global Head of Working Capital Management at ING.

O’Donoghue offers the example of a client that used SCF to extend payment terms only to see any benefits cancelled out by the time it took them to approve invoices. “Although I think it is clear that technology is an enabler,” he explained, “if you’ve got a SCF programme that extends your terms to 60 days, but it is taking you 45 days to approve an invoice, then you have a problem.”

Evidently, treasurers today need to focus on more than mere DPO improvements. Solutions that have the potential to speed up DSO, such as the Bank Payment Obligation (BPO), should, therefore see increasing acceptance in the coming years. That is provided bankers can overcome their initial hesitancy and begin building strong commercial propositions. Angela Koll, Product Manager International Business, Commerzbank believes that will be key to the success of the BPO, as it often is with treasury solutions. “We are trying to motivate everybody to look at this and encouraging banks to become more active in this space,” she says. “If we don’t, then there is a chance the instrument will fail to fully enter the market, and that would be a real pity.”

Receivables financing: the fundamentals

Factoring

In a factoring arrangement, finance is provided by a third party, the ‘factor’, who provides the supplier with a cash advance of (usually) up to 80% of the face value of the invoice. The factor then takes over the task of chasing in payment from the purchaser. Once payment has been received, the factor pays the supplier the remainder of the invoice value, minus a discount. Factoring may be done with or without recourse. Factors are frequently, but not always, bank-owned enterprises. Although traditional factoring only deals with the supplier side of financing, factors sometimes provide billing and collection services, so the buyer will be aware of the arrangements in place.

Invoice discounting

As in a factoring arrangement, payment is advanced to the supplier based on outstanding invoices. However, the invoices remain in the possession of the supplier, who is still responsible for collecting the outstanding payments. As such, the arrangement should not be visible to the buyer. Usually up to around 80-90% of the value of the invoice is advanced; however, some discounters will increase the advance against the security of assets including stock, machinery, land and buildings. Once these have been paid into a trust account, the discounter collects the payment and pays the supplier any outstanding funds minus the discounting fee. Invoice discounting can provide an effective method of improving or stabilising cash flow, though this may not be the most cost-effective financing solution for all firms.

Forfaiting

Developed in Switzerland in the 1950s, forfaiting is generally used to finance longer-term receivables and may be used by suppliers selling on extended credit terms of three to five years, although time horizons can vary from as little as six months to ten years. This flexible discounting technique can be particularly useful in turbulent times, as the uncertainties to contend with and consider when deciding whether or not to extend long-term credit now include heightened commercial and country risk.

Unlike a factoring or invoice discounting arrangement, which is based on the invoice itself, the forfaiter purchases drafts of letters of credit, accepted bills of exchange, promissory notes or other freely negotiable instruments on a non or without recourse basis, and for 100% of the value. The forfaiter then takes on the responsibility of chasing in the debt or alternatively sells the instruments to another investor. Finance can usually be arranged on either a fixed or floating rate basis. A guarantee or aval is usually required from the purchaser’s bank in support of the supplier’s obligation.

Receivables securitisation

For larger companies, more complex financing solutions might be employed. One such technique is receivables securitisation, which involves the sale of a portfolio of receivables without recourse to a special purpose financing vehicle. In practice, most companies use a revolving pool of receivables as these are generally short-lived. This means that once receivables are paid, they are replaced with new ones. Under normal market conditions, the special purpose vehicle issues securities to the capital markets based on these receivables. Meanwhile, the company’s receivables are replaced with cash and are therefore not included on the balance sheet.

Unfortunately, the financial crisis meant that use of the structured finance market, and securitisation in particular, was reined in for a period of time. However, efforts have been made by governments worldwide, particularly in the US, to re-open the securitisation channels and market opinion agreeing the concepts behind it are fundamentally sound, the unfairly maligned practise appears to be in the early stages of a comeback. It is the way that securitisation is put into practice that needs to be addressed, and the return of securitisation is expected to bring less complex and less opaque structures to the market. Where available, receivables securitisation can be a good source of alternative funding for those companies that have been subject to credit rating downgrades.

Going mainstream

Given the evident success of the Credit Warehouse approach will others be following Siemens’ lead with their own centralised solutions? In the long run, almost certainly, says Barclays Cavenaghi. “We do expect that once corporates have done their homework then concepts such as payments and collections factories, and what Siemens is doing right now with their Credit Warehouse, are going to become much more mainstream.” SEPA, he adds, now makes all this easier to implement. “Once you have an overview of your receivables profiles across a number of countries those volumes will become much more visible and it will make more sense as a corporate to look at solutions that gets them off the books.”

Not every corporate has the resources to set-up its own in-house unit to sell-on receivables though. What steps can smaller, less technologically sophisticated corporates do to unlock greater efficiency within their supply chains? “For other companies, who lack the benefit of a “credit warehouse” like Siemens have, the important thing is to discuss the strategy on payables and receivables with the areas of the company that are buying and selling,” Anil Walia, Head of Supply Chain Financing at RBS told Treasury Today in a later interview.

Breaking down silos in the buying, selling and finance functions remains the biggest working capital challenge for many companies. Walia believes a large part of the problem is that the departments speak different ‘languages’; if procurement, sales teams and finance all understood each other’s objectives better greater efficiencies could be realised across the business. “The key performance indicators (KPIs) of the various business divisions are sometimes contradictory. If KPIs of the buying, selling and finance functions could be harmonised to a greater extent, that would be the first step in breaking down the silos,” says Walia. At Siemens, KPIs are already improving as a result of their centralisation efforts. However, Kirchhof cautions that treasurers should not expect miracles overnight. Making such changes naturally entails a lot of hard work and sometimes, he adds, it can take a while before the impact is seen. “It takes a lot of discussions, presentations, internal and external arguments to get there. But in the end you see more than a working capital benefit – you are bringing stability and structure into your supply chain.”

Maybe the benefits won’t be visible immediately. But that should not deter any treasurer from looking to garner longer-term working capital improvements.