Managing the flow

One of the greatest challenges facing finance directors today is delivering a
sound return to shareholders. But an increasingly competitive environment,
customer demands, increasing operating costs and greater volatility is driving
down return on capital. These pressures are present at a time when private
equity, or at least the threat of private equity, stalks every boardroom.

One of the positive ways that FDs can respond to this threat is to improve
the financial flows in the company’s supply chains. It seems finance can follow
where logistics has led. Whereas the physical supply chain between customer and
suppliers has changed out of all recognition in the past two decades, financial
flows in the supply chain have remained largely unmoved.

Improving the supply chain could improve the three key drivers of financial
performance – growth, profitability and capital utilisation. Improved technology
and a willingness by banks to up their game on payments means that corporates
should be able to reduce delays in processing and reconciling both sales and
purchase invoices, enhance visibility and reduce uncertainty of accounts
receivable and accounts payable and so achieve a significant reduction in
working capital needs.

Safety net
Most companies still use a safety net in terms of excess working capital to deal
with variable and highly unpredictable financial inflows and outflows. The key
financial flow management challenges are slow and unreliable processing, poor
cashflow forecasting and poor debtor management.

Of course, improving this is easier said than done. For large corporates, the
financial flows in a typical supply chain includes thousands of invoices and
payments in a year. Corporates need to streamline their processes without
sacrificing accuracy. For instance, many companies still have problems with how
to set up and manage accounts payable systems – many companies still use a
three-way match of purchase order, shipping receipt and invoice.

Traditionally, information and financial flows have been treated separately.
However, payment solutions can now include detailed transaction information.
Having financial and logistical information together should reduce human error
and reconciliation time. Systems can even post automatically to the general
ledger.

All these improvements are aimed towards one goal – improving cashflow. Do
that and you can reduce the need to borrow and the financial supply chain can
itself become a driver for growth and improved liquidity. A white paper
published in 2005 by Visa International,
Financial
Flows & Supply Chain Efficiency, estimated that improving the
financial supply chain could save a $1bn (£508m) revenue company $10m a year in
working capital costs.

Inevitably, it is possible to see some self-interest motives in the
heightened focus on supply chain finance. Banks, technology companies and
consultants all have something to say on the subject. They want to talk to
finance directors about products, which the financial service industry claims
will benefit both customers and suppliers. Aimed at western-based companies that
are sourcing products from developing markets such as India and China, banks are
formulating programmes which leverage the buyer’s balance sheet and credit
standing to provide accelerated payment to suppliers at a discount, in return
for a better deal – usually in terms of price – for the buyer. For the supplier,
the finance will be cheaper as it is priced around the buyer’s credit standing
rather than theirs. The reason for the promotion of this type of deal is the
growth of cross-border trade on open account terms.

Beware the risks
This type of deal would only work between established trading partners, and
buyers may be uncomfortable about, in effect, lending their balance sheet to
suppliers.

But, of course, that is what a supplier does every time credit is extended.
It seems the financial supply chain will mean a greater focus on terms and
conditions between suppliers and buyers. Then the big fear is that this is just
a cloak or a fancy term around which companies can delay the day when they
actually pay for the goods and services that they use.

But at its best it can be more than that. Working capital management,
operating costs, processing speed and proactive risk management are all parts of
the financial supply chain which could be improved. The question for FDs is how
they can link all these parts effectively to gain competitive advantage.