SUPPLY CHAIN FINANCE ENDS THE TUG-OF-WAR OVER WORKING CAPITAL
When both purchasers and suppliers are trying to optimize their operating liquidity at the same time, the situation results in a sort of tug-of-war: progress by one party will tighten the situation at the other end of the rope. It’s time to cut the rope!
The financial turbulence has left small and medium-sized suppliers, in particular, trapped in a vicious circle: extending payment terms increase their need for liquidity, but at the same time the financiers refuse to provide them with finance.
“The large buyers are now starting to feel the financial pain of their suppliers and are looking into new ways to support them,” says Michiel Steeman, Professor of Supply Chain Finance at the Windesheim University of Applied Sciences in the Netherlands and also the founder and chairman of the international Supply Chain Finance Community.
“The emerging trend is to broaden the collaboration to the financial dimensions of the supply chain and to optimize not only the logistics but also the finance. The lack of operating liquidity and its cost for the smaller suppliers are making supply chains in Europe as a whole more fragile and less competitive than they should be in order to thrive in the prevailing economic conditions.”
Thus, Steeman believes supply chain finance solutions will become common in the Nordic countries and in Central Europe in a few years. Supply chain finance programs are already well established in some parts of Europe, for example in Spain and in Italy, where the payment horizon has always been long – up to a hundred days on average.
Supply chain finance usually refers to reverse factoring, a solution where the supplier receives funding from a bank based on an approved invoice and leveraging of the purchaser’s higher credit rating. The purchaser improves its working capital by maintaining cash liquidity longer while the supplier gains faster access to low-cost cash.
In the Netherlands, for example, it has been calculated that there is a total of 25 billion euros worth of working capital stuck in the supply chain, that is in receivables waiting to be paid. A little over a third of this concerns SMEs delivering to large purchasing corporations. Michiel Steeman estimates that effective supply chain finance solutions could easily free up 2,5 billion euros of this 25 billion as additional liquidity for suppliers.
“The longer the suppliers have to wait for the payment, the larger the number, if there aren’t viable options in the market.”
The most important driver that is currently boosting supply chain finance is the squeeze the SMEs are experiencing, as payment terms are creeping up from under 30 days to 60 days and even up to 90 days.
“Politicians have tried to curb this with new legislation, but for instance the EU payments directive actually made the situation worse in countries like Finland, where the payment terms were notably short to begin with. Focus has now shifted to promoting alternative financing solutions.”
Another driver is technological development and digitalization, which will promote wider adoption of supply chain finance even on the markets were it is already being utilized. Standardization and automation of the solutions will make it possible to reach out to a broader supplier base and also increase the benefits gained.
“Those actors specializing in the financial processes who already posses the right information have an important role to play. For example, the suppliers’ order-to-cash process, especially the parts concerning invoicing, needs to be solid.”
According to Steeman, the real development in supply chain finance will go beyond reverse factoring.
“I believe the collaboration will go deeper over the next decade and other solutions, such as inventory financing or other pre-shipment finance models will evolve throughout the multiple tiers of suppliers.”
Published in OpusCapita Journal 1/2015.
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READ ALSO The chain is only as strong as its weakest link where Michiel Steeman shares his perspective on the strategic reasons behind the decisions to start a supply chain finance program. [add a link to the article file “Journal-1-2015-SCF-Steeman-web-extra”]
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