Supply Chain Finance for Working Capital Advantage
by Adeline de Metz, Head of Supply Chain Finance Solutions, Global Transaction Banking, UniCredit
Working capital optimisation is a priority for companies of all sizes, but the motivation of these companies can differ quite significantly. For smaller companies that lack ready access to liquidity, techniques such as factoring and receivables financing provide valuable sources of liquidity; however, in addition, supply chain financing solutions on both sides of the balance sheet are becoming an increasingly important part of larger corporations’ working capital strategy.
A customer-centred strategy
We work with a wide spectrum of clients, across geographies, industries and sizes of company, to understand their working capital needs and design solutions to meet their specific needs. Although smaller and lower-rated companies are often motivated by liquidity considerations, these are rarely as significant for larger corporations, given the high level of market liquidity. Amongst larger businesses, therefore, we see three broad drivers:
i) Working capital metrics
In many cases, achieving financial key performance indicators (KPIs) such as return on capital employed (ROCE) is a motivating factor, and receivables financing techniques are especially attractive during periods of low interest rates as the costs are low while the value can be significant; however, we may see a change in strategy when interest rates rise in the future.
Many companies measure days payable outstanding (DPO) and days receivable outstanding (DRO) and benchmark these indicators against peers and competitors. Often, treasurers and finance managers identify opportunities for improvement as a result of this process, but it is neither feasible nor desirable simply to extend DPO, given the negative impact that this can have on suppliers, and therefore the resilience of the supply chain.
This is where supplier financing programmes come into play by enabling a company to achieve its DPO objectives without compromising the interests of suppliers: indeed, suppliers may benefit by gaining access to more cost-effective financing.
All these programmes also present the opportunity to review existing contracts and understand the risks and cash flows. In many cases, there are unexpected outcomes, particularly in relation to the ultimate debtor (for receivables finance), so it can be a very useful exercise in improving contract discipline and managing risk, as well as optimising working capital.
ii) Aligning objectives
A second driver is to align priorities across the business more effectively. For example, procurement departments have traditionally been incentivised to structure contracts to reduce costs, but without necessarily considering the working capital implications; conversely, treasury’s motivation is often contradictory, with a greater focus on working capital. Implementing tools such as supplier financing aligns these two sets of objectives, enabling procurement departments to negotiate competitive rates for products and services with suppliers whilst also reinforcing the company’s working capital position.
iii) Supporting free cash flow generation
Supply chain financing can also be useful when free cash flow is under stress. For instance, some clients have large capital expenditure projects which will not generate a return for several months or years. Putting in place a working capital optimisation plan at the same time as investing in capex projects can help to offset the one-off negative free cash flow impact of those projects, and therefore be a key element in mitigating their financial impacts.