TMI171 ING info plat :Info plat.qxt 19/12/2008 17:02 Page 29 ING Guide to Financial Supply Chain Optimisation Creating Opportunities for Competitive Advantage Section Four: Supply Chain Finance Introduction vastly exceeding supply, particularly for months ahead. lower-rated firms, tapping into the financial In this section of the Guide, we explain Gregory Cronie, supply chain is an increasingly important some of the different ways of unlocking value Head Sales, means of sourcing finance. from the financial supply chain and how they Payments and At ING, we have over 40 years experience can contribute to an appropriate and flexible Cash of providing both pre- and post- shipment financing strategy. In addition, we look at Management, ING financing to corporates of all sizes and some of the new and evolving opportunities industries. One of the important distinguish - for supply chain financing n the last edition of TMI, we explored the ing factors of our financing services is that elements, which comprise the financial we assess our clients not just on their past, Types of Supply Chain Isupply chain. We looked in some detail at but on their future too. 2009 is likely to be a the order-to-cash (receivables) and purchase- difficult year for virtually every organisa - Finance to-pay (payables) processes and how these tion, which could further damage corpo - can be optimised to create internal efficien - rates’ ability to raise finance. However, at The term “supply chain finance” itself is used cies, reducing the number of cash days for a ING, we recognise the challenging environ - in various ways within the industry and can company and therefore working capital ment in which every company is operating be used to describe: requirements. and look at their strategy and prospects as The benefits of automating internal well as recent and longer term performance. Asset-based Financing processes are not restricted to internal effi - In consequence, supply chain financing The process of using the assets created ciencies. Reducing the working capital with a financial partner that has the vision through the supply chain to unlock working requirement enhances the balance sheet and and balance sheet to support a company capital. This can take various forms, such as reduces the need for short term borrowing, over the long term could mean the differ - selling receivables at a discount to a financial improving financial ratios and therefore ence between success and failure during the institution or using different stages in the increasing the ability to obtain financing for more strategic purposes. Furthermore, once a company has achieved good visibility over their order-to- With risk pricing very high for many corporates, and cash and purchase-to-pay processes, particu - demand for credit vastly exceeding supply, particularly for larly the former, receivables at different stages lower-rated firms, tapping into the financial supply chain in their life cycle, including purchase orders is an increasingly important means of sourcing finance. and invoices, can be used as a source of financing. With risk pricing very high for many corporates, and demand for credit TMI | ING Guide to Financial Supply Chain Optimisation 29 TMI171 ING info plat :Info plat.qxt 19/12/2008 17:02 Page 30 Fig 1: Traditional and Innovative Approaches to Supply Chain Financing Source: ING supply chain, such as purchase orders, ing opportunities available for supply chain value of the receivables, as a financial asset, receivables or inventory as assets for loan col - financing, particularly in buyer-led financing rather than the company’s credit worthiness. lateral. as we shall explain later in this section. Typically, companies can factor between 70% and 90% of the value of their receiv - Buyer-Led Financing Asset-based Financing: ables, according to criteria such as the per - Financing provided by large buyers to their centage of non-payment of invoices etc. smaller suppliers, working with a financial Traditional Model Unlike borrowings, which are subject to a institution to leverage the buyer’s credit credit limit, the amount available to a firm standing to enable suppliers to be paid earlier, Factoring through a factoring arrangement varies supporting suppliers and therefore enhancing Factoring, or accounts receivable financing, is according to the value of receivables due. the stability of the financial supply chain. It is a well-established method of business There are ways of increasing the proportion this type of financing that we will refer to as financing, traditionally used by companies of receivables which can be factored, Supply Chain Financing or SCF during this with a lower credit rating. Increasingly, including outsourcing credit management to section of the Guide. however, we are seeing customers across a a specialist provider such as ING Commercial wide spectrum of credit quality seeking Finance. Supplier-Led Financing accounts receivable financing as a flexible A typical factoring arrangement takes Financing provided by large suppliers to their means of maintaining working capital place as described in Fig 2 below. smaller customers, working with a financial without affecting capital ratios. In some cases, specific large invoices are institution to leverage the supplier’s credit Factoring is seller-led i.e. the company factored, or invoices due from one or more standing to enable customers to access more which has provided the goods/services and is specific customers; however, in most favourable payment terms, whilst not jeopar - awaiting payment decides to enter into a instances, companies aim to factor a large dising the supplier’s working capital. In this financing arrangement with a financial insti - proportion of their receivables. Usually, but way, suppliers can encourage customer tution. Rather than waiting for the due date not always, customers are notified of the loyalty and create competitive advantage. for payment, which may then be late or the sale of the receivable, and amounts are then Asset-based financing linked to the timing unpredictable, the company may seek paid directly to the financial institution physical supply chain is not a new concept. to receive the amount due earlier, which they (factor), but this is not always the case. For As illustrated in fig 1, there are a variety of pay for in the form of a discount to the example, ING Commercial Finance has a traditional techniques for accessing finance receivable. This improves the firm’s ability to confidential arrangement in which both pre- and post-shipment, of which forecast cash flow accurately so they can customers are not made aware that the inventory financing, factoring and invoice manage their working capital requirements invoices are being sold to a financing discounting are well-established methods. more effectively. company. Invoices are collected into the However, with the development of Unlike a loan, where the assessment is company’s account as usual and then eCommerce, which is having an increasing based on the company’s credit status, debited or paid on to ING. impact on processes in the financial supply factoring involves the direct purchase of the As the financial institution takes on the chain, such as eInvoicing, there are increas - firm’s receivables. Therefore, it is based on the risk of non-payment by customers, 30 TMI | ING Guide to Financial Supply Chain Optimisation TMI171 ING info plat :Info plat.qxt 19/12/2008 17:02 Page 31 factoring can prove a relatively expensive Fig 2: Typical Factoring Arrangement financing option for some companies where they do not have a record of payments from regular, reliable customers. However, credit insurance can mitigate this risk and therefore reduce the cost of factoring pro - grammes. Although credit insurance has a cost, in the form of a premium, many companies find that the reduction in the cost of the factoring programme more than compensates for the cost of taking out the credit insurance. Invoice Discounting In many respects, invoice discounting closely resembles the factoring process. However, there is an important distinction to be made: Source: Asymmetric Solutions Ltd while factoring is “non-recourse financing” – i.e. the rights and risks associated with the invoices are passed to the buyer, invoice dis - Credit, and affects a company’s credit util - l be experiencing similar pressures on cash counting is a secured borrowing where the isation far less than an unsecured loan as flow; and invoice value is used as collateral i.e. the the stock is used as collateral. l be in a weaker position to obtain company ultimately takes responsible for financing. payment by its customers as opposed the New Demands for Financing financial institution. The techniques described above can be This creates instability for both buyers and Consequently, invoice discounting can be a very helpful for companies which are sellers. In the case of buyers, there is the risk more economical option for companies looking to accelerate cash flow and use of interruption to essential supplies, which looking to enhance their working capital, as their financial assets for loan collateral. could jeopardise the company’s own produc - they are not paying the bank to take on the With traditional forms of financing tion, distribution to customers and therefore credit risk. Again, credit insurance can becoming less easily accessible and more customer satisfaction. For sellers, revenues reduce the risk of non-payment by customers expensive, these types of financing and working capital could be put at risk, and for many companies. solutions can be extremely valuable in cash flow tied up in surplus inventory. maintaining working capital levels. However, despite the importance of Inventory/Asset Based Financing “shoring up” the financial supply chain, cor - Alongside accounts receivable financing pro - Addressing imbalances in the Financial porates do not want to become a bank to the grammes such as factoring or invoice dis - Supply Chain partners in their supply chain.