Factoring, Supply Chain Finance and Global Treasuries

This article discusses business finance and topics to be introduced for discussion include management of accounts receivable and payable, supply chain finance, and the move toward globally integrated treasury functions. Companies, both buyers and suppliers, require access to quick and inexpensive capital to remain solvent and competitive in the marketplace. The practice of factoring, which is when a company sells its accounts receivables, is discussed as an option for many companies to increase cash flow. Supply chain financing integrates a company's finance functions with its physical supply chain and promotes transparency in interactions between buyers and suppliers along the supply chain continuum. Globalization of markets has led to rise in global corporations that are finding the need to centralize treasury and finance functions across all operation entities. Best practices and trends in implementing global treasuries are discussed.

Keywords Corporate Finance; Centralization; Factoring; Global Treasury; Supply Chain Financing

Finance > Corporate Financial Practice: Factoring, Supply Chain Finance & Global Treasuries

Overview

Business finance or corporate finance is a broad term that describes all aspects related to the allocation of an enterprise's financial resources. The allocation of a company's financial resources should be done in such a way as to support the initiatives, value creation and growth of an organization. Finance departments are tasked with many different responsibilities that include budget creation, and resource mobilization (which includes managing a company's debt, equity, savings and investments). Finance departments are responsible for preparing, maintaining and auditing a company's financial statements.

Business finance departments and personnel are responsible for managing the cash flow, accounts receivable and payable and investments for their organization. Working capital, whether it be from sales, loans or returns on investment, enables companies to pay employees, invest in supplies and equipment and grow the company in terms of sales or market share. A company's finance department plays a pivotal role in managing the flow of capital in and out of a company, as well as in helping to plan for and finance company strategies. Finance departments have long compiled and maintained comprehensive metrics as part of a company's financial statements. For many public and private companies, financial data often accounts for the most detailed and comprehensive metrics that a company has. Financial data has been sought after by company owners, investors and more recently has been required to meet compliance and regulatory requirements such as Sarbanes-Oxley. Today's company finance departments are increasingly responsible for tying financial metrics to business operations through the strategic planning process. Today's organizations (both public and private) are much more likely to have global subsidiaries and international partners within their supply chain than in the past. This essay discusses a number of current topics related to business finance; the implications related to business finance in both public and private companies is also discussed along with some of the methods that companies are employing to better manage their accounts payable (AP) and accounts receivable (AR). Receivables are the "outcome of doing business" by receiving payments from satisfied customers in return for goods or services (Salek, 2007). By definition, every company must manage receivables if the company is selling either goods or services. Unless goods are paid for at the time of purchase with cash, a company must manage outstanding payments from its buyers. This essay discusses how some innovative companies are managing not only their receivables and payables, but also integrating these functions into existing supply chains. The integration of supply chains and finance is known as supply chain financing (SCF). Stakeholders in supply chains include buyers and suppliers; the needs of these two groups of constituents are examined in terms of their need to access low cost and readily available capital.

Receivables are among the three largest assets of 75% of Fortune 500 companies. Companies manage receivables through credit control and the collection and payment process (Salek, 2007). Treasury functions surrounding the management of AP and AR are increasingly important to global organizations. Cash flow forecasting is critical to organizations, because access to working capital (cash on hand, equity, or credit) is essential to maintain business solvency. The emerging role of the Global Treasury is explored in this article and a number of best practice trends are outlined. As companies expand their global reach and operate global subsidiaries, the need to centralize treasury functions becomes more pressing.

Applications

Factoring

Factoring is the process by which companies sell some or all of their accounts receivable to a third party as a means to generate ready cash. Instead of waiting for customers to pay up, companies can secure a third party to give them a cash advance on their outstanding AR. Factoring can be an expensive undertaking for companies that choose this option to generate cash; borrowing rates typically exceed those that a bank would charge. Some companies and industries have difficulty securing bank financing and for these companies, factoring is a viable option.

Factoring AR may be more cost effective than some traditional financing options because a bank calculates interest on a company's entire line of credit (even if a company is only using only part of it). Factoring is essentially an advance against accounts receivable, with interest paid only on the money being used. Other aspects of a factoring agreement include (Kroll, 2007):

• Increased flexibility in maintaining cash flow.
• Ease in outsourcing AR functions: A company doesn't need to maintain international AR software or pay a staff.
• Factors advance some portion of the value of receivables to the client (AR = collateral).
• Factoring is asset-based financing (on time or revolving purchase of a company's AR).
• A factor collects and pays clients the portion that was held back minus any fees.
• Factoring companies can provide credit, collection, and accounting services as well.

Factoring is very accepted in Europe but not as much in the U.S. where factors are sometimes seen as last resort lenders. Factoring has gained more widespread popularity in some sectors of the U.S. economy, such as retail and manufacturing, but is also becoming popular in other industries. In fact, the use of factoring services grew 12% between 2005 and 2006.

Good Candidates for Factoring

In essence, any company that has good receivables could use factoring as a way to keep cash on hand. There are many companies that have not been in business long enough to establish a credit history or haven't gotten a warm reception from banks, these companies may want to use factoring for a few years. Many in the field of finance warn that factoring can lead to a slippery slope that can put a company at risk. While some companies have successfully used factoring as a long term strategy, many suggest that factoring is best used as a temporary solution for generating cash.

Cash constraints present real obstacles that can limit a company's growth. For companies that don't have ready access to traditional sources of financing, factors have proven to be valuable as a way for companies to access quick capital. Factors are generally willing to make a 60-90% advance on face value of AR and charge 2-6% on invoices every 30 days. There are two different types of factoring agreements that a company may enter into — each assigns risk to a different party. Some estimates have put the annual cost to companies that factor at 20% (Kroll, 2007).

In a non-recourse agreement, the factoring agency assumes all risk and the customer has no legal claim. In cases where the factoring agency assumes risk, the factors closely scrutinize a client's customers to assess the risk of their not paying on their invoices.

In a recourse agreement, outstanding receivables are deducted from a company's reserve payments to insure that the factoring agency will get paid (Kroll, 2007).

Third Party Financers

There are a number of 3rd party entities such as banks and institutions that are interested in buying into (or financing) the transactions that occur between buyers and sellers. Factoring agencies are one option for companies seeking capital, but the costs are very high. An emerging alternative for many companies are third party financers known as supply chain finance vendors. These third party entities specialize in providing access to capital as needed to finance supply chain activities. Supply chain finance vendors often provide access to lower cost capital than might otherwise be available and in a timelier manner (Enslow, 2007).

Supply Chain Finance

"'The transformation of the physical supply chain has been fairly dramatic over the past 20 years as companies have moved to sourcing overseas, but finance solutions haven't changed at all,' asserts PrimeRevenue CEO Joe Juliano. In contrast to 'all of the work that companies have put into low-cost-country sourcing and optimizing manufacturing and putting in all the technology to forecast demand,' most supply chains still rely on time-consuming and costly financing methods that can add up to 4 percent of the cost of goods, he says. For a supplier in China, the time between receiving an order and receiving payment for a finished product can be as long as five months, notes Juliano" (O'Sullivan, 2007).

Supply chain finance (SCF), which merges a company's physical supply chain with key financial data, is becoming a very strategic tool for many organizations to gain leverage over their competitors. SCF is being adopted by retailers and manufactures as a way to improve days payable outstanding (DPO) while decreasing the cost of capital and cost of goods sold. By merging physical supply-chain information with financial supply-chain data and flexible funding methods, companies are able to not only automate payables and receivables but also to inject much-needed liquidity at various stages of the supply chain (Enslow, 2007).

Benefits of SCF

Implementation of SCF benefits a company, its buyers and its suppliers. The company can benefit greatly by better managing its working capital through better inventory management (inventory reductions), and also by improving balances of A/P and A/R. Customer's reap benefits of SCF when companies are able to reduce the cost of producing goods (e.g., offering suppliers access to third-party capital at a lower rate in return for a lower cost of goods sold or by offering early payment discounts using a company's own cash).

Suppliers benefit from SCF by having better access to information (visibility and predictability) about when a company will pay them. The overall goal of SCF is allow for visibility into the supply chain; particularly the buyer-supplier interactions. Analysis of supply chain interactions allows companies to view interactions along the supply chain as a continuum. Along the supply chain, there are numerous interactions that affect buyers and suppliers and each may offer an opportunity for potentially injecting capital or other strategic financing options. By looking at a supply chain and it components, it is possible to "help unlock [the] trapped value of goods throughout their lifecycle" (Enslow, 2007).

According to Jeff Poff, Treasurer of Big Lots (a discount retailer with 1400 stores in the U.S.), Big Lots had supply chain management down to a science; but when it came to integrating the supply chain with financing, weak links started to break. Poff acknowledged that many small and mid-size suppliers were struggling to access capital to run their businesses. In many cases, suppliers were "factoring their receivables" and paying dearly to do so. The cost demanded by factoring agencies is high; sometimes as high as 18% of the total receivable (O'Sullivan, 2007).

Requirements for Managing & Financing Supply Chains

A 2006 Aberdeen survey polled buyers and suppliers about their greatest needs in managing and financing their supply chains. Buyers and suppliers share some needs in common, namely: Development of better technology to automate supply chain functions; streamlining transactions processing, and; access to financing. Suppliers want to track buyer interactions and performance, while buyers want to track supplier performance. Access to low cost capital is critical for all parties in the supply chain, but suppliers are by far and away more concerned with having access to low cost capital. The overall goals that buyers and suppliers are seeking as a means to improve supply chain efficiency are (Enslow, 2007):

• Gaining improved access to working capital.
• Implementing better cash flow forecasting.
• Lowering the cost of capital.

Complications to the Buyer/Supplier Relationship

While both buyers and suppliers have a vested interest in optimizing their particular channel of the supply chain, actions that benefit one party may have an adverse effect on another party. For example, a buyer wants to negotiate extended payment terms with a supplier in effort to hold onto working capital as long as possible. While this action may be of great benefit to the buyer, it is likely to translate into negative implications for a supplier whose greatest challenge is access to capital-as stated by the Aberdeen study.

If a supplier extends payment terms to a buyer, then the supplier may be forced to borrow capital at a higher rate from a third party. A supplier may need to delay ordering raw materials, neglect plant maintenance, and skimp on quality processes, all as a result of reduced access to capital. On the flip side, the buyer-who is enjoying the benefits of extended payment terms may have to contend with product delays, product quality issues, and late orders for critical customers. In short, perceived benefits to a buyer (in this case better payment terms) may negatively impact the buyer by breaking the continuity of the supply chain, adding to the unit cost of goods and possibly giving a strategic advantage to competitors.

Supply Chain Incentives

Companies that have successfully implemented SCF share a number of common factors as incentives are created along the supply chain. One innovative company, a clothing retailer from Great Britain, is experimenting with new payment options to its suppliers. Fast fashion retailer, ATJ, works with many foreign suppliers. In an effort to reward supplier responsiveness and work as a strategic partner with it suppliers, AJT uses a method of advancing payments to its suppliers. For example, AJT pays its suppliers up to 70% of the total invoice when an order is shipped and the remaining balance when the order is received at AJT's warehouse. It is not difficult to see the benefits that this type of arrangement can provide to the supplier by injecting much needed capital back into the supply chain. It is not just the supplier that benefits from this scenario according to Richard Clark, finance director for AJT. Clark estimates that AJT and its suppliers save between 5-10% off unit cost as a result of flexible payment options implemented as part of SCF. SCF provides a means for both buyers and suppliers to benefit, not just one party, as it is reiterated by Richard Clark: "We want our vendors to have an improvement in their bottom lines — we are not looking to have all the savings passed on to us" (Enslow, 2007).

Supply Chain Finance Systems

As with most today's business systems, SCF systems leverage computing technology and access to large data repositories. SCF systems are also user-friendly, intuitive and web-based which makes them ultimately accessible to a diverse set of users; in the case of SCF, buyer, sellers and even third party lenders have access to supply chain finance data. Supply chains within companies are internally facing, but SCF systems are externally facing toward all supply chain stakeholders. As an example, Big Lots utilizes a third party SCF application called PrimeRevenue that has significantly improved the SCF process and has gone a long way in reducing friction between buyers and suppliers. PrimeRevenue allows for the following steps:

• Approved invoices are posted on a web-accessible system.
• Supplier can see all approved invoices and can either wait for full payment from buyer (Big Lots) or sell the invoice to a bank or other third party to get their cash the next day.

When a supplier sells their receivable to a third party in a case such as the one above, the transaction is different than a factoring situation. In the case above, the supplier receives a discount on the receivable that is based on Big Lots credit rating, resulting in much more favorable terms than what factors charge for their cash advance-type transactions. If a supplier decided to sell their receivable to a third party, the third party financer looks to the buyer to assume the risk for re-payment of the invoice. In this example, Big Lots simply pays the third party lender, rather than the supplier. An SCF system removes a lot of uncertainly for suppliers who were often left in the dark about the status of outstanding invoices (O'Sullivan, 2007).

Aberdeen's 2007 survey on supply-chain financing estimates that only about 13% of companies are actively using SCF techniques in their daily operations. While supply chain financing has been a topic of discussion for the past decade or so, the discussions have mostly been about how buyers could benefit. Buyers typically saw SCF as a means to extend payment terms to suppliers. As was previously discussed, this approach is great for the buyer, but often puts a supplier's finances at serious risk (O'Sullivan, 2007).

"We thought, 'There's got to be a way for us to let vendors compete on their ability to make the product and not on their ability to access financing,' says Poff" (O'Sullivan, 2007).

Issues

Global Treasuries

A company's treasury is the name given to the center of financial operations within a company. Global treasuries are a growing presence in companies that have subsidiaries in multiple geographic locations, especially internationally. Companies are striving to centralize finance functions across the globe in an effort to promote collaboration, standardized finance practices and increase transparency of treasury functions.

Globally integrated and controlled treasuries are sought after for all the benefits that can be gained from such a system. A global treasury allows stakeholders access to:

• Visible global cash balances.
• Centralization, which helps to control high risk activities such as investments and cash flow management.
• Global banking partners that will help to streamline access to capital and ease of maintaining banking relationships.

A global finance function will allow for an effective three pronged approach to global finance: investments, risk management and cash forecasting (Baird, 2007). Strategies that address these goals through integrated processes and technology will reap large cost benefits.

Treasury Consolidation

The wave of treasury consolidation is being driven by four pressures (Gamble, 2003):

• Companies need to manage liquidity tightly. Doing so maximizes cash from operations and reduces their reliance on external borrowing.
• Businesses want to automate operations and introduce straight-through processing to reduce time spent manually handling transactions.
• Global consolidation can lower banking fees.
• Organizations can reorganize staff when they no longer employ dozens of cash managers around the globe.

For today's U.S. multinational organization, the rule pertaining to finance functions is "domestically centralized and international decentralized" (Baird, 2007). U.S. Treasury functions for most large U.S. based corporations are still primarily based in the U.S. with few treasury personnel placed in operations oversees. The lack of presence of U.S. treasury personnel in foreign subsidiaries leads to local practices and local control of finance functions. International subsidiaries often display reluctance to give up control and want to manage their own banking relationships.

Creating a Global Treasury

Trends in creating a truly global treasury function include four key areas that demand integration, data sharing and a commitment to collaboration (Baird, 2007).

• Global Payments and Distributions Systems are not well integrated in most multinational corporations. More typically, each local division within a country is likely to be operating a unique clearing system to manage both its accounts receivable and accounts payable. Because of the nature of local currencies and exchange rates, local subsidiaries have been responsible for this finance function which is probably the least centralized of all finance functions.
• Global Treasury databases are important repositories for maintaining key financial metrics such as foreign bank balances, cash forecasts, and foreign currency exposures. Treasury databases allow financial metrics to be linked to key metrics from other business units. Access to global data and worldwide accessibility require centralized tracking of all treasury management practices for an organization. Without a comprehensive treasury database, each local operation will be operating in an information silo and decentralization will remain the operating procedure.
• Technology and web-based applications enable organizations to centralize operations despite differing geographies. Web-based applications allow access to anyone with an Internet connection and appropriate permissions to access data. Older, technology management systems resided on local computers and sequestered data from other users. Web-based applications have obviated the need for each local division of an organization to compile its own forecast spreadsheets. Data can now be input into a central database that allows all company stakeholders access to real time reporting, distributed data and even a company's global cash position.
• Global Banking allows corporations with international offices the ability to access capital regardless of geographic location. For the most part, corporate finance has remained a local function and remains supported by local (home-grown) banks. Domestically, U.S. companies have streamlined banking relationships while in foreign companies, there are many individual banking relationships being maintained. The cost of dispersed banking relationships is high, but global banks are emerging. In Europe, the trend is well established as banks are beginning to consolidate into large global banks; the trend is also happening in developing nations.

Terms & Concepts

Accounts Receivable: Money owed by customers (individuals or corporations) to another entity in exchange for goods or services that have been delivered or used, but not yet paid for.

Accounts Payable: An accounting entry that represents an entity's obligation to pay off a short-term debt to its creditors.

Cash Flow Forecasting: (or Cash Flow Analysis) The study of the cycle of your business' cash inflows and outflows, with the purpose of maintaining an adequate cash flow for your business, and to provide the basis for cash flow management.

Days Payable Outstanding (DPO): The time in days that a company takes to pay its creditors.

Days Sales Outstanding (DPO): The number of days during which customers have not paid for purchases.

Factoring: The process by which companies sell some or all of their accounts receivable to a third party to generate ready cash.

Supply Chain Finance (SCF): The integration of financial data such as accounts receivable and accounts payable with more traditional supply chain management systems. SCF allows participants in the supply chain better access to the financial information related to the supply chain.

Treasury: The name for the center of financial operations within a company. The treasury is responsible for such things as issuing new securities.

Bibliography

Baird, S. (2007). Five trends transforming global treasury. Business Finance, 13(5), 19-22. Retrieved December 26, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=25139041&site=ehost-live

Enslow, B. (2007). How to create a more competitive end-to-end supply chain. Business Finance, 13(4), 48-54. Retrieved December 26, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=24846015&site=ehost-live

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Kroll, K. (2007). Factoring comes into fashion. Business Finance, 13(9), 18-21. Retrieved December 26, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26775068&site=ehost-live

Laura, G. (2010). International factoring — A viable financing solution for firms. Young Economists Journal / Revista Tinerilor Economisti, 8(14), 27-34. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=51707324&site=ehost-live

Muldowney, P. & Speirs, D. (2007, May). Managed growth: How to establish and achieve optimum financial targets. BusinessFinance. Retrieved December 26, 2007, from http://www.businessfinancemag.com/magazine/archives/article.html?articleID=14806&pg=1

O'Sullivan, K (2007) Financing the chain. CFO.com. Retrieved December 27, 2007, from http://www.cfo.com/article.cfm/8581992/c%5f8613584

Polak, P. (2011). Global challenges in corporate finance and treasury management - centralisation and internationalisation. Journal of Corporate Treasury Management, 4(3), 242-250. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=65144279&site=ehost-live

Salek, J. (2007). 7 steps to optimize A/R management. Business Finance, 13(4), 42-46. Retrieved December 26, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=24846014&site=ehost-live

Wuttke, D.A., Blome, C., Foerstl, K., & Henke, M. (2013). Managing the innovation adoption of supply chain finance-empirical evidence from six European case studies. Journal of Business Logistics, 34(2), 148-166.Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=88106788&site=ehost-live

Suggested Reading

Blansfield, D. (2007). Simply the best (practices). Business Finance, 13(4), 4. Retrieved December 26, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=24846004&site=ehost-live

Kroll, K. (2005). Treasury controls tighten. Business Finance, 11(2), 39-41. Retrieved December 26, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=15954813&site=ehost-live

O'Brien, C. (2007). How to close the door on bad payers. Cabinet Maker, (5563), 13-14. Retrieved January 3, 2008, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=27737388&site=ehost-live