Supply Chain Financing: An Alternative to Bank Lending and Supplier Risk Management
The following article summarises the discussion during a roundtable event in January 2011 in Geneva, Switzerland, hosted by J.P.Morgan and chaired by Sebastian di Paola, Partner, Corporate Treasury Solutions Group, PwC.
Sebastian di Paola, PwC
Welcome, everyone. I would like to start by asking Kieran to give us an overview of what supply chain financing solutions look like. With a variety of products available, treasurers are sometimes a little confused about the difference between factoring, reverse factoring and supply financing. Can you help with this?
Kieran O’Regan, J.P. Morgan
Supply chain finance, as we know it today, has evolved since the late 1980s, initially in Spain,during a period of high inflation and interest rates.This environment created considerable challenges for corporates in terms of working capital and a high cost and constrained liquidity, resulting in the launch of a domestic product known as confirming.
During the 1990s,supply chain finance started to become more widespread in the US, initially amongst automotive firms, as companies increasingly recognised its value in optimising working capital.Since 2003-4, alternative financing techniques, including supply chain finance, have also become prevalent in Europe.
As Sebastian mentioned, one of the difficulties is the variety of terminology that is used to describe the same solution: some banks refer to supplier finance; others, reverse factoring; some, supply chain finance. These typically refer to the same product: essentially, a large corporate buyer with a high credit quality can extend credit terms to its suppliers by enabling them to discount their receivables. Suppliers who are most attracted to this are typically, although not exclusively, those with a lower credit rating and therefore more constrained access to credit. Suppliers can seek early payment of invoices through the buyer’s bank, while the buyer pays its bank according to the original or longer payment terms. There are a variety of reasons why a company would do this:
Firstly, working capital optimisation, by pushing out days payable outstanding (DPO).
Secondly, pricing. If a supplier is able to obtain cash quickly at a preferential rate through the buyer’s credit, he may be willing to provide more favourable commercial terms.
Thirdly,supplier sustainability. This has become particularly poignant following the crisis, certainly in certain sectors. For example, automobile companies found that some component suppliers were under particular stress, due to lack of liquidity. This in turn jeopardised the automobile company’s supply chain. Consequently, buyers with critical suppliers use supply chain finance to ensure the future viability of their supplier community.
Sebastian di Paola, PwC
Martin, I know that Caterpillar has introduced supply chain finance. What was the main driver for you?
Martin Bina, Caterpillar
All three, in some respects. We had a working capital focus, but we also wanted to help sustain our suppliers during difficult times. By offering them alternative financing solutions, we were hoping to see a pickup in the business and give our suppliers the opportunity to accompany us as we grew, without capital constraints, the effect of which would ultimately need to be passed on to us in the form of increased costs.