5 Things Procurement Needs to Know about Buyer-Led Supply Chain Finance

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While Procurement does not usually drive the decisions around adopting a supply chain finance program, they most certainly play a huge role in supplier adoption. While Treasury will drive discussions with funders, vendors and other third parties, it is important for Procurement to understand these programs more holistically

  1. To implement SCF, companies need to set up a credit line with their funding provider(s).

There is no free lunch. It’s important to realize that bank-led supply chain finance or what we sometimes call reverse factoring involves your credit.  Any bank setting up a program must set up an unsecured facility.  In traditional factoring, the underlying assets are the seller’s accounts receivable, which are purchased by the factor at a discount. The remaining balance is paid to the seller when the receivables are received, less interest and service fees.  In supply chain finance programs, the credit risk is equal to the default risk of the high-quality customer, and not the seller.  In this arrangement, credit is set up to “buy” the receivables on a without recourse basis to the seller and the risk is the buyer does not pay the amount on due date.

Companies need credit lines for all kinds of purposes, including FX trades, pcards, revolvers, letter of credits, etc. Think about how the price of oil is set as an example. Its not the average cost but the marginal cost of the highest producing method (ie, Alberta Oil Sands, Deep sea wells, Fracking in North Dakota, etc.) which determines barrel cost. While a company’s credit rating is used to price debt, too much leverage can become a problem. So when setting up a 500M or $1bn program, there is a marginal cost to establishing that credit. In this case, SCF is unsecured credit, meaning it can be pulled with short term notice.

2. There are alternatives when structuring a program.

There are many legal structures to do SCF, from promissory note structures to receivable purchase agreements to paying agents. More disclosure and transparency is a good thing. Multinational companies should be more upfront on their financial statements, especially if these programs are sizeable enough (note, many are not, and have underachieved based on expectations).

3. The need to get Legal and Accounting involved in the process early is critical.

 

Moody’s published a note on Abengoa’s supply chain finance structure, and the banking world is up in arms about supply chain finance as an accounting trick to disguise leverage. You dont want to be that company in the limelight. Understand the trade payable versus trade debt issue and why its important at your firm. Ask your internal auditors what your external auditors say about such a program. What criteria do they use?

4. Your organization probably doesn’t want to be a bank to your large suppliers, so the need for third party capital is important. 

Remember, it is a myth that multinational banks can fund all currencies and jurisdictions, not in this day and age of capital constraints, especially for trade finance - see Are Banks Gaming Capital Rules? – Basel IV & Trade Finance

What is the most appropriate funding model to fit your needs? Here are a few guiding questions that you can have your Treasury folks explain:

  • Do you want to self-fund some or all of your suppliers’ receivables?
  • Do you want to work with a single relationship bank? Or do you want to have a few relationship banks involved?
  • Do you want an agnostic Funding Model or one managed by a platform provider (who can work with your relationship banks) or other banks?
  • Are you willing to work with Non Banks?
  • Do you need to feed your Relationship Bank’s your business? 

5. Regardless of media hyping supplier risk as a reason for implementing SCF, these programs are done to extend payables.

Supply chain finance allows buyers to extend days payable outstanding (“DPO”) longer than standard payment terms.  SCF programs are part of the carrot after a term extension program is put in place. There are many examples, most recently Boeing putting the squeeze on suppliers.

 If you would like to discuss any of the above issues in more detail, please email me at dgustin@tradefinancingmatters.com

First Voice

  1. George Papanikolopoulos:

    Spot on with this commentary. Having been on both the sell and buy side of SCF programs I would probably add a 6 essential fact. Organizations need to treat the whole SCF program as an IT Finance project. Requiring a procurement led project manager involving IT, Finance, AP, the SCF Vendor (IT and Funding) and the various business units that will need to introduce the SCF program to the suppliers. Strive for a fully integrated IT solution to avoid messy reconciliations between the ERP system and the vendor platform.

    Organizations don’t typically have the SCF skill set in house to implement these programs without some unintended consequences (e.g. Disgruntled suppliers or extra AP resources), so consider a subject matter expert to facilitate the program and educate the organization.

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