Pioneering a New Era of Financial Supply Chain Management
by Anil Walia, Executive Director, Head of Trade & Supply Chain Advisory UK & EMEA, RBS
Over recent years, the focus of financial supply chain management (FSCM) has been directed towards supply chain finance (SCF). It would almost appear that SCF and FSCM have become synonymous, but this is a misnomer. FSCM refers to a wider concept, of which SCF is just one part. By reverting to the original meaning of FSCM, and applying new techniques and solutions, treasurers have a powerful new opportunity for optimising working capital and process efficiency.
The origins of financial supply chain management
The term FSCM first became popular in around 2000, when innovative banks started looking at the financing and risk mitigation opportunities within the physical supply chain.
By that time, the manufacturing industry in particular had made substantial progress in automating the physical supply chain, with highly sophisticated sourcing, production and distribution.
The financial supply chain is a parallel, but reverse process to the physical supply chain. As a company purchases goods and services, cash passes from the company to its suppliers. Similarly, as the company sells goods to its customers, cash passes from the customer to the company. The financial supply chain encompasses the full spectrum of financial processes within and between companies. FSCM aims to optimise these processes by improving working capital management, reducing processing costs or mitigating risk. It therefore aims to deliver a comparable degree of automation and transparency in financial processes and flows as companies had achieved in their physical supply chains. While traditional banking had focused on the bilateral relationship between the bank and a customer, FSCM extends this focus across the different parties that comprise the supply chain, from suppliers through to customers. This includes the distribution of cash in the supply chain, passing demand of liquidity from the supplier down to the customer, thus providing liquidity when and where it is required during the supply cycle.
One early initiative by banks to achieve these objectives was to increase transparency and control over data and flows by connecting to shipping or logistics companies more closely, in order to accelerate the flow of information, enable consistent data to be shared across each party, and ultimately ensure more rapid payment. While this approach had some success, banks turned their attention to the direct financial participants in the supply chain i.e., buyers and suppliers. This resulted in a greater emphasis on purchasing and sales activities, from a balance sheet, financing and working capital perspective, with particular focus on the timing of cash flows between buyers and suppliers.
The importance of financial supply chain management
The financial crises of the last decade have underlined the importance of a robust balance sheet; this is accentuated further by regulatory requirements such as Basel II, and going forward, Basel III. With constrained market liquidity, smaller companies in particular have become more vulnerable, which in turn jeopardises their customers’ supply chains. Buyers and sellers are therefore increasingly recognising the symbiosis of their relationship, as opposed to pursuing a more combative approach that has characterised the vendor-buyer relationships in the past. Smaller companies or those with a lower credit rating find it more difficult, and more expensive, to source credit, the cost of which is then passed on to customers through the cost of their products and services. Consequently, it makes sense for their financially stronger counterparties to support them, as they have a lower cost of funding and are able to increase resilience in their supply chain by reducing supplier risk.
The growth of SCF programmes
This change of perception, and the growing recognition of the interdependency between buyers and sellers, has led to rapid growth in the popularity of SCF programmes. Buyers have the assurance that their supply chain is more robust, whilst also benefitting from extended payment terms. Relationships with suppliers are also enhanced, with the potential for better price negotiation. Sellers can receive payment promptly and are able to reduce the uncertainty in their cash flows. This leads to improvement in their working capital positions, since the uncertainty of predicting cash flows is the reason that companies need wasteful cash reserves in the first place. In a well-structured programme, this liquidity is made available without impacting on other credit facilities. Credit risk to customers is reduced considerably, and by freeing up limits to customers more quickly, they are able to do more business, which is attractive to both highly rated as well as smaller sellers.