Successful supplier finance programmes deliver tangible benefits to buyers and their suppliers while also helping to create more stable supply chains. In this Product Profile, Richard Hite, Vice President, Supplier Finance and Simon Enticknap, Director, Trade and Working Capital at Barclays, examine the reasons why corporates should consider supplier finance and what needs to be taken into account when deciding to progress with this strategy.
Director, Trade and Working Capital
Simon Enticknap, Director, Trade and Working Capital has over 37 years of trade experience across corporate, financial institutions and structured trade finance. He joined Barclays in April 2011 and moved to the Trade and Working Capital Product team in March 2012. Enticknap currently heads up the Product Execution team which is responsible for managing the delivery and governance supporting the trade product set.
Vice President, Supplier Finance
Richard Hite, Vice President, Supplier Finance joined Barclays in 2011 as a Supplier Finance product specialist. Hite has over 25 years of experience in banking, largely in relationship management, both in the US and the UK. He has also served as European Treasurer for a US Group as well as worked for independent Supplier Finance companies. He has a degree in Economics.
Companies continue to face significant economic and competitive pressures and, as a result, are increasingly focused on cash generation. Buying organisations are also increasingly aware of supplier risk and the reliance they have on their suppliers. What is more, procurement often represents the largest spend within a company and many companies believe there is value that may be extracted. This may come from improved efficiencies as well as from reducing the amount of capital tied up in working capital.
As such, most companies have working capital initiatives and targets. These are usually focused on improving their net working capital position, reducing their cash conversion cycle and reducing costs. There are various means of achieving these targets with the most straightforward ones being either to accelerate the collection of cash or to extend payment terms. Simply put, companies want to hold onto cash longer by paying later while getting paid earlier.
Large corporate buyers are aware of the consequences of paying their suppliers later and, with supplier risk and Corporate Social Responsibility becoming increasingly important, they are conscious of the need to support their suppliers. Suppliers are under similar financial pressures and many would benefit from the ability to accelerate the collection of cash.
Because of these competing interests, there is the possibility of a conflict between companies and their suppliers. One potential solution to this challenge is supplier finance.
A buyer-led solution
There are various products available to suppliers to accelerate the collection of cash and not wait until the invoice due date to be paid. The most common include receivables financing and invoice discounting. Supplier finance distinguishes itself from these products by being buyer-led rather than supplier-led. It also offers improved efficiencies and quicker processing.
For buyers seeking to extend payment terms, their reluctance is due to the potential impact longer payment terms will have on their suppliers. The primary impact is the additional costs that the supplier will incur as a result of having to wait longer to be paid. Most suppliers will seek to recoup these costs from the buyer by raising prices.
Supplier finance removes the cash flow impact – and the cost impact – of extended payment terms. The cash flow impact is mitigated because suppliers have the ability to accelerate the collection of receivables in exchange for an early discounted cash payment – in effect, suppliers are able to get paid early. The cost impact is mitigated because the discount charge, or price, the bank charges is calculated using the buyer’s cost of funds and not the supplier’s. The interest rate arbitrage opportunity or differential between a buyer’s cost of funds and a supplier’s cost of funds is usually sufficient that it results in a lower financing cost for suppliers despite the longer payment terms.
The early discounted cash payment is the approved invoice amount less the discount charge. The bank has recourse to the buyer and not the supplier thus the reason the financing charge is calculated using the buyer’s cost of funds. On the due date, the buyer pays 100% of the approved invoice amount. It is a simple calculation to compare the costs and quantify the financial benefits to the supplier.
Supplier finance is sometimes called ‘reverse factoring’ or ‘confirming’ – the latter is used in the Spanish market where the idea was originally conceived over 20 years ago. From rather humble origins, supplier finance has grown into a globally recognised solution. Today, rather than just ‘noise’ around the subject, experts are starting to see a genuine uptake in supplier finance activity in the corporate sector.
According to a report released in February 2014 by the Association of Chartered Certified Accountants (ACCA) and Aite Group, the current global market size for supplier finance is estimated to be between $255 billion and $280 billion. “Despite its already impressive growth, the potential for further expansion in the market as more buyers and suppliers come to realise the mutual benefits of supplier finance is significant,” says Richard Hite, Vice President, Supplier Finance, Barclays.
“As the solution matures, the business case is becoming much clearer and the misconceptions around it are being dispelled,” he adds. “Supplier finance is not about buyers coercing suppliers to accept longer payment terms with little or no regard for the financial strain that places them under – that is not our experience. Supplier finance is very transparent and there are not any hidden costs. It’s quite a straightforward product that, when successfully implemented, produces real benefits for both parties,” notes Hite.
Reaping the rewards
For most buyers, they need to extend payment terms to derive any tangible benefit. To quantify the benefit, a 30 day extension will generate £8.2m of working capital benefit per £100m of spend. But it’s not just about payment term extension. Hite comments: “In addition to the working capital benefits, supplier finance provides enhanced visibility and improved control over payments and collections, and supplier enquiries are often reduced, which may lower administration costs. Many companies are beginning to see supplier finance as providing a competitive advantage”.
Supplier finance also reduces the buyer’s supply chain risk. According to Hite, “suppliers gain access to low cost, non-recourse cash, which is valuable to many of them”.
For the supplier, the main benefits are driven from their ability to effect an early payment. This allows suppliers to improve their net working capital position, shorten their cash conversion cycle and reduce costs. The opportunity to view approved invoices, confirmed payment amounts and the due dates on-line are an added benefit.
The cost of financing is also typically lower than the cost of finance arranged directly with a bank. Supplier finance is also generally cheaper than other, more traditional, forms of supply chain finance such as factoring or invoice discounting and there is no recourse to the supplier.
Finally, using a supplier finance platform compared to invoice or receivables discounting, introduces a highly automated technology solution compared to what is often a largely paper-based process. This improves visibility, control and reporting functionality for both buyers and suppliers, while promoting process efficiency.
Table 1: Supplier and buyer benefits
Mitigates the impact of the payment term extension.
Enables early settlement of receivables to reduce Days Sales Outstanding (DSO).
Mitigates supply chain risk.
Offers more predictable cash flow and supports greater control and visibility over payments.
Provides tangible support of suppliers thus fulfilling CSR objectives.
Offers non-recourse cash at a competitive finance cost.
Source: Treasury Today’s Managing the Financial Supply Chain Best Practice Handbook 2010
Getting on board
For buying organisations that have decided to establish a supplier finance programme, choosing the right provider and solution is critical to success. This might sound a fairly simple process but it is actually not that straightforward. The decision is really driven by your requirements and what you need from a provider, and there are a number of factors to assess.
Hite says, “there are a number of important considerations. These include relationship, experience, approach and methodology. Depending on your geographic requirements, footprint may be a deciding factor. Credit appetite is another important consideration. Finally, don’t underestimate supplier on-boarding. It is often overlooked with implementation frequently being the focus, however supplier on-boarding is probably the most important consideration”. And as Simon Enticknap, Director, Trade and Working Capital at Barclays notes, “there is an increasing polarisation around the choice of provider and platform. Is it better to choose a proprietary solution or to look for more neutral technology? Corporates are understandably torn between the two.”
In Hite’s view, relationship plays an important role in making the right decision. “Buyers should seek a provider that understands their objectives and requirements. They should avoid a situation where a supplier finance programme is successfully implemented only to find further down the line that the funding is being withdrawn. Relationship banks that have a broad relationship with a buyer are likely to be more inclined to work with and support their client and its suppliers, particularly in a downturn.”
Understanding the buyer’s objectives is essential because it drives the entire process. The provider will take on board the client’s objectives when it conducting its working capital analysis and in developing a supplier on-boarding strategy. An analysis of the buyer’s spend with suppliers is key to a successful programme. The provider is able to quantify the benefits of supplier finance both to buyers and suppliers and calculate other financial metrics, including building a business case. This should be formally presented to the buyer along with a recommended best solution. “The buyer is making part of its credit limit available to these suppliers, so it is absolutely natural for the buyer to ensure that it is getting maximum value out of the arrangement,” Enticknap points out.
Supplier finance at Barclays
“We have a team of dedicated experts who work closely with the buyer to offer a solution that is aligned, and specifically tailored, to their working capital needs. Our approach is consultative and collaborative,” says Enticknap. “We also do all of the on-boarding legwork.”
Once the implementation of the Barclays programme is complete and suppliers have been on-boarded, it is a highly efficient process and very light touch. This is how it works on a day-to-day level:
The supplier submits their invoice to the buyer for approval.
The buyer approves the invoice and electronically transmits the payment instruction to Barclays. The payment instruction is the buyer’s commitment to make a payment of a specific amount on a date in future.
The supplier is notified that their invoice has been approved by email and can view the data online, including the invoice details, amount due and the confirmed payment date.
The supplier has the option to request an early discounted cash payment electronically via the platform.
Upon Barclays’ acceptance of the request for discount, the net amount will be credited to the supplier’s designated bank account within 48 hours.
On the payment due date, Barclays debits the buyer for the full invoice amount.
If the supplier has not submitted an early payment request, Barclays pays the supplier the full amount on the due date.
Setting up your supplier finance programme: best practice for buyers
Find a provider committed to understanding your objectives and which completes an analysis of your spend. This will quantify the financial metrics, build the business case for supplier finance and identify suitable suppliers. It will also assist in developing the supplier on-boarding strategy. Most importantly, the output from this analysis will confirm if supplier finance is appropriate for your business.
Consider all aspects of a provider’s offering. A great deal of attention is on implementation, for example, however supplier on-boarding is essential to a successful programme and perhaps the most important aspect. The provider’s approach and methodology and ‘after-sales support’ should be assessed.
Key internal stakeholder buy-in is essential. Finance, procurement, legal and IT must all be committed to the project.
Obtain auditor sign off for accounting treatment before implementation. Buyers want their trade payables to remain classified as trade payables, not reclassified as debt, as does your bank.
Form a project team and appoint an internal project champion. The team should include representatives from finance, procurement, legal and IT. The project champion will drive the programme within the buyer’s organisation.
Internally communicate the details of the supplier finance programme ensuring every party understands their responsibilities and the benefits from their own functional perspective. Engaging internal stakeholders at every level is vital to the programme’s success.
Choosing an experienced, committed and reliable provider that understands your requirements and objectives as well as having the credit appetite to support your programme, should be among the key considerations. Pricing is often a key differentiator but when evaluating a provider, it is actually one of the least important considerations.
Evolution and future
Now that companies are quite comfortable with the premise of supplier financing, we are also seeing some interesting tweaks to the vanilla model, Enticknap believes. “A handful of companies actually have in place self-invest programmes, which essentially put them in charge of buying their own risk. Others are looking further into the area of rebates and how these can be leveraged more effectively. So there is a lot of interesting and creative thinking going on in this space and the product continues to mature at an impressive pace,” he notes.
Likewise, the wider supply chain and trade marketplace continues to come of age. With the bank payment obligation (BPO) slowly gaining traction and e-invoicing now being integrated into supply chain solutions, the way companies carry out their commercial transactions is certainly changing. What remains constant, however, is the need for intelligent finance solutions that enable companies to maximise value across the supply chain.
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