All posts by admin

What is Supply Chain Finance?

What is Supply Chain Finance?

Global supply chains have become increasingly complex and new financial infrastructures are developing to support these increasingly complex networks of firms. A set of financial service firms, including large banks and specialized financial institutions, have developed services to support suppliers that require liquidity and working capital. An executive at Citibank estimated that Citibank alone performs $2-3 trillion per day in trade finance transactions, which typically include loans to suppliers to buy raw materials, components and finished goods. Given that 2013 U.S. GDP was less than $17 trillion, this is a substantial amount of activity designed to primarily support procurement operations around the world. As large manufacturers have tightened their supply chains and extended payment terms, their suppliers have had difficulty financing their operations. This difficulty of obtaining funding has severe implications on cash flow, working capital, and profitability and can sometimes lead to bankruptcies and supply disruptions.

With Capital difficult to procure, firms must develop methods that organizations use to finance their diverse and increasingly underfunded supply base. While, factoring and reverse factoring inventories and receivables has often been called supply chain finance (SCF), the topic as we define it, goes far beyond those practices. Broadly speaking, SCF is about how firms are funded through their supply chains and how they fund their supply chains. We believe that SCF will have a great impact on all entities in the supply chain in the future. There is little published research on the topic of SCF in the supply chain literature, and we believe the topic is in the early stages of development.

SCF is larger than simply finance plus supply chain management. That is, there is a symbiotic effect of the combination of supply chain management and finance that makes the whole greater than the sum of the parts. As finance is related to funding, our definition of supply chain finance is:

Using the supply chain to fund the organization, and using the organization to fund the supply chain.

Supply chain finance involves utilizing the supply chain to develop savings, generate profits and efficiently manage assets to fund the firm. It includes both working on improving the Income Statement and the Balance Sheet for a firm and/or its suppliers. The supply chain can be a source of funds for the firm: a firm can use its supply base to generate funds and act as a source of funding for the organization. Additionally, helping one’s suppliers fund themselves is part of SCF. Supply Chain Finance enables a firm’s managers to optimize the balance sheet to fund the supply chain and by using financial instruments to mitigate risks in the supply chain. In addition, SCF complements standard Corporate Finance activities by reducing the firm’s reliance on other sources of funding reducing costs to ensure that profitability/ retained earnings is maximized.

Need for Supply Chain Finance

Firms have constrained access to external capital because of Buying firms have tightened their Supply Chain and suppliers have had difficulty in financing their operations to supply these larger firms. This difficulty to obtain funding can increase the cost of business and sometimes leads to bankruptcies and shortages. Large corporations have had to develop methods to finance their diverse and sometimes underfunded supply base.

World trade is projected to grow faster than US GDP. However, there is been a dramatic shift of trade flows into emerging markets that desperately need capital to supply the developed world. Small and medium-size businesses in these emerging markets are often underfunded (find citation). As their supply chains expand so does the need for abundant, low-cost financing.  Non-investment-grade companies and small to medium enterprises (SME) find it difficult to finance their working capital requirements. The result is that there is a significant credit arbitrage between large firms in established markets and their suppliers. Working capital management is needed to become part of the buying firms consideration when developing suppliers. Working capital solutions can assist buyers to monetize these arbitrage opportunities while assisting their suppliers. But, only solutions that are mutually beneficial will work in the long run for buyers and suppliers. Buyers and suppliers typically have conflicting objectives, and strong buyers tend to take advantage of weaker suppliers.

 

Global supply chains have become increasingly complex and consist of numerous firms from all over the world. Financial infrastructures and had to develop to support these increasingly complex networks. Buying firms have tightened their Supply Chain and suppliers, especially small and medium-size enterprises and those from emerging economies, have had difficulty in financing their operations to supply these larger firms. This difficulty to obtain funding can increase the cost of business and sometimes leads to bankruptcies and shortages. Large corporations have had to develop methods to finance their diverse and sometimes underfunded supply base.   Using supply chain finance tools has the potential to contribute €368 billion to Western European economies (COST Proposal, 2013) while reducing overall costs and decreasing supply chain disruption. This will also give access to finance for small and medium-sized enterprises (SME) and allow access to new export markets by making them more liquid.

 

There are three major flows in the supply chain: product, information, and financial.  Most of the existing supply chain literature focused on the first two, and so far, only little attention has been paid to the financial side of supply chain management.  While the focus of most of the literature is on the product flow and information flow, it is the financial flows that exert a strong influence on the definition of the structure of supply chains. In many cases the financial flows determine the structure and complexity of the supply chain. Typically, supply chains are not designed merely to facilitate product or information flows. Instead, they are designed to optimize the financial objectives of a single firm.  Generally, the financial structures and issues drive the structure of the supply chain and operational methods.

 

A serious issue for firms is access to capital.  Credit markets have improved considerably since the worst periods in early 2009,  (Ciibank  citation from Donna) McNamera)  but it still is often difficult for a firm to obtain access to credit.  Without access to capital a company cannot expand into new markets,  fund research and development, or execute most any activity that requires investment.

 

Funds available to firms include (1) loans and other debt instruments such as corporate bonds, (2) equity funds via releasing and selling stock, or attracting new investment, or (3) reducing the cost of  supply chain processes and utilizing the supply chain to increase revenues.

 

Because of the recent global recession, many firms have not had easy access to credit. As mentioned above there are limited sources of funds available to firms. Despite general easing in credit markets, many non investment grade companies and Small to Medum-Sized Enterprises (SMEs) continue to find it difficult to finance their working capital requirements.

The Basel III restrictions introduced in 2010 to be phased in over the next five years requires banks to create capital buffers which impacts bank capital requirements by requiring them to increase liquidity and reduce their leverage. Basel III has forced many small banks to cut back on loans to businesses.  (Small Banks Are Blunt in Dislike of New Rules: WSJ – Aug 2012) These regulations in addition to a general move towards conservative capital management have forced companies to figure out how to find alternative methods of self funding their growth.

 

Also, the equity markets have not seen much growth in several industry sectors.  For example, consumer packaged goods company products have sold well around the worl but their stock value – and therefore the value of the firms – CPG companies have not grown their stock price in the last years, thus investors will not  fund them.  Need citation  Firms cannot really issue more equity because they generally do not want to dilute their stock holdings.

 

There is a significant credit arbitrage between large companies and  their suppliers.  Supply chain finance programs that allow for reverse factoring such as the Citibank or Orbian programs which are described later in the article can assist buyers to monetize this arbitrage while at the same time improving operations for their suppliers.