Supply Chain

FINANCE

 

INVERTO Customer Magazine

Win-Win-Win

Everyone is a winner with supply chain finance

These uncertain times in the global market call for flexibility. But to be able to respond flexibly, it is essential to have large cash reserves available. Companies and their suppliers are coming to a head as they both seek to optimize their working capital. So, what’s the answer? Reverse factoring.

The German car industry was once the shining beacon of the stock market, and served as a role model for many other sectors. Thanks to superior engineering skills, the big corporations enjoyed fantastic growth, high profit margins, and expansion into more and more countries. Suppliers benefitted from the knowledge of experts in their field and gained loyal partners. One company’s ideas would fuel another’s, and vice versa. There was a time when an economic crisis in the sector was unfathomable.

But just a few years later, top managers at automotive manufacturers and suppliers started to become agitated. Companies have been rocked by the diesel crisis, the trade war is stepping up in the Asian and US export industries, Brexit is creating uncertainty in the European Union, and billions of dollars are needed to invest in innovations such as electro mobility.

Now, it is all about savings, leaner processes, and liquidity. Even in sectors with well developed supply chains and firm interdependencies between manufacturers and suppliers, nothing is possible without close cooperation based on mutual trust. This is true, not least for the automotive industry at the moment, but also for practically every sector – from the chemical and consumer goods industries to mechanical engineering.

Ultimately, it is about creating high cash reserves and low stock supplies. Investing smartly can work for companies and generate returns, despite the low interest rates. Liquid reserves are also needed for procuring at the right times, such as when the price of a raw material drops in the short term, therefore reducing risk and making procurement much more flexible.

Suppliers are also striving to create the highest possible cash reserves and optimize their working capital. Since the financial crisis, it has become increasingly difficult for SMEs to obtain a loan at an interest rate they can afford, as a result of new regulations for financial institutions, such as Basel III or the upcoming Basel IV, this makes issuing capital considerably more difficult.

 

 

Ultimately, it is about creating high cash reserves and low stock supplies. Investing smartly can work for companies and generate returns, despite the low interest rates.

Payment terms often pushed back to 90 days

Customers seeking to extend payment terms are causing more problems for suppliers. When payment is delayed, this negatively affects working capital, creating bottlenecks in liquidity and, in the worst case, bankruptcy. One of the most feared risks for customers
is non-delivery.

But financing solutions are available to help suppliers, companies, and investors alike: supply chain finance, or more precisely reverse factoring. It is intended to secure a company’s own liquidity as well as the strategic supplier’s. As the financial crisis came to an end, the new way of optimizing financial structures gained popularity for the first time . Supply chain finance has since become a firm favorite for many firms.

With reverse factoring, a company outsources its supplier’s receivables to an investor, which then assumes the interim financing for a fee that is lower than the refinancing rate.

For example, a supplier charges its customer, a mechanical engineering company called Techlife, €100,000 for 100 tons of steel. In order to work with the €100,000 for as long as possible, the customer seeks to secure a payment term of 90 days. Yet, the supplier needs the money as quickly as possible to replenish its stock of raw materials.

 

Refinancing is significantly cheaper

Instead of using its position of power and making the supplier wait for the money, the customer can arrange reverse factoring with the supplier. A fintech or a bank uses a platform that brings investors, suppliers, and customers together. The supplier now issues an invoice to its customer, which uploads it to the platform, functioning like a virtual marketplace. This has the advantage that several investors, mostly banks, are available for refinancing. They are now vying to pay the money to the supplier as quickly as possible for a fee, and in doing so they accept that the end customer will only pay the invoice to them much later. Using the platform
means companies operate independently from a single bank, which reduces the fee to be paid. It also massively reduces red tape for suppliers and customers.

In our example, the supplier Techlife submits the invoice, and asks an investor to pay it. Several investors bid to finance it on the marketplace, most for an interest rate just above the base rate, e.g. 1% per annum. The key factor is that Techlife is responsible for the entire transaction, as its creditworthiness is at stake, which suits the supplier very well; otherwise, it would have to pay 3% to 4% interest for the refinancing.

The 1% fee covers both bank and fintech platform fee, in this case €250. Either Techlife pays this fee by transferring only €99,750 to the supplier, or the supplier pays it directly to the investor. The investor pays the supplier the invoice amount after just a few days. The customer Techlife, on the other hand, does not pay the investor’s invoice until 90 days later.

In most cases, the fee is paid by the supplier. However, this is a negligible amount in the grand scheme of things, since the advantages of a higher working capital outweigh the fee. In the end, it’s a win-win for all parties involved. 

 

What to bear in mind when considering a fintech platform

A more diverse portfolio means more competition, which could mean better conditions.

It must be able to work with all your strategic suppliers.

The platform must connect to your own IT infrastructure as well as your strategically important suppliers’.

Implementation and ongoing processes should be supported by the fintech, including support for suppliers.

 

Close coordination needed

With reverse factoring, the supplier does not need to worry about an inability to pay or delayed payments. And thanks to the buyer’s solvency, it can benefit from a better interest rate. All in all, the financing costs can be reduced significantly. It also involves the supplier forging a close, mutually dependent relationship with the customer, which can offer a competitive advantage over other suppliers.

As the customer, Techlife can also use its working capital sensibly over a long period, and does not need to worry about the supplier failing to deliver, thereby increasing stability in its supply chain and reducing delivery bottlenecks.

Banks and investors receive a fee for the financing on top of the base interest rate; the profit is the corresponding difference. This is a particularly attractive option in these times of low interest rates, as the interest can be passed on to other buyers.

Reverse factoring is not suitable for everyone, though. If customers and suppliers have access to very high cash reserves, then refinancing invoices just does not make sense. Although reverse factoring is perhaps the most crucial method in an uncertain environment for procurement at the moment, it is very rarely used, comparatively speaking. In most cases, this is because of the high amount of coordination required, and due to a lack of specialist expertise, not least the cooperation needed with external experts who support the team for months during the long process restructuring.

With reverse factoring, the supplier does not need to worry about an inability to pay or delayed payments. And thanks to the buyer’s solvency, it can benefit from a better interest rate.

Five steps to score a triple-win in procurement

1. Get your departments on board

The department primarily responsible for supply chain finance is, naturally, the finance department. But to ensure the process is successful, this requires cooperation with other departments, such as accounting and legal. This is what makes supply chain finance so complex within a company. The procurement department’s close involvement early on and a clear division of roles, with the support of management, are especially crucial for success. The procurement department coordinates with suppliers, while the finance department takes care of the conditions and the financial benefits. Procurement is accustomed to working in cross-departmental teams, and as a networker within the company, is able to move the subject forward. Since it is this department that has the closest relationship with suppliers, it is this department that plays a key role in the process. Reverse factoring can only work if the suppliers are closely involved too.

2. Choose the platform

The next step is to decide which platform should be used to broker the reverse factoring. In theory, the financing could go through a single bank, but the conditions offered would not be as good as on a platform where several investors are competing against each other. When choosing the platform, it is essential to determine whether the IT system is compatible with the customer’s. Is there a seamless connection via SAP, for example? In addition, the project team should check out the platform’s references to see which banks it has as partners, what experience others have had with it, and how global the platform is. Whether the platform also works with suppliers from the USA or China is something that could be particularly relevant to global companies. Platform costs are usually negligible, and do not vary much, so this should have little bearing on the decision. 

3. Select your suppliers

Procurement now needs to start getting in touch with suppliers. Before turning all the tried-and-tested processes on their head, it is worth first selecting a small group of suppliers to take part in a pilot. Ideally, these will be strategically important partners that have been supplying the company for a while, with whom there is already a suitable relationship of trust. Procurement must approach these suppliers systematically, and provide them with as much information as possible. A test phase is then agreed, during which both parties can familiarize themselves with the methodology and the platform, without being directly bound by an agreement. Each one of these tests initially runs as a single project, tailored to each individual supplier, and is only later summarized in an all-encompassing process. If these initial tests with suppliers are successful, additional suppliers can be contacted and incorporated. As more and more experience is gained, processes can be optimized on both sides.

4. Clear the legal hurdles

To prevent legal or even accounting difficulties, involving the legal and financial departments is a must. The agreement needs to be based on trade accounts payable and not become a financial service, because then there is a reclassification risk. This means that the contracts have to be rewritten early on to include an extended payment term. Refinancing is then independent of the actual contract. The supplier joins the fintech platform, and is paid through that platform, but has no written guarantee that it will actually be paid any earlier. The deal and the many advantages that come with it are based on trust instead. So, it is important to involve your company’s own departments and suppliers in the planning as closely as possible.

5. Monitor the process

To make reverse factoring successful, it is important to clearly define the responsibilities and KPIs. Once all framework conditions have been agreed, the process is then managed by the finance department, but there must be rules on which issues involve procurement. After all, it is always the procurement department’s job to communicate with suppliers. If the first pilot projects are successful, it is up to procurement to build trust with new suppliers and convince them of the benefits of supply chain finance. Finally, feedback is routinely required from each supplier to help identify any potential for improvement in processing.

 

 

CONCLUSION

Everyone is a winner

A supply chain is only as strong as its weakest link. If there is a weak link in the chain, this can harm business and, in turn, the company. These risks are difficult to predict and counteract, especially in these uncertain times. The key here is flexibility, especially in financial terms. A high working capital can be achieved through reverse factoring and subsequently boosted with other supply chain finance methods, such as dynamic discounting.

But supply chain finance done right can do much more for procurement. The intensive discussions and personal coordination needed help take the relationship with your suppliers to the next level – toward close cooperation that benefits both sides and can be extended to other areas in the future.

Authors

André Thuvesson

is Managing Director of INVERTO in Stockholm. He primarily supports Scandinavian customers and a wide range of industries with supply chain optimization and working capital enhancement.

contact@inverto.com

Gökhan Yüzgülec

is a Principal at INVERTO in Munich. With a doctorate in mechanical engineering, he is an expert in supply chain risk management, and deals with the optimization and design of folder-to-delivery processes.

goekhan.yuezguelec@inverto.com

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