Introduction to Supply Chain Finance

Supply Chain Finance
IAPP Maryland DC Chapter Meeting

Steve Keifer
Vice President
Industry & Product Marketing
May 9, 2008

Supply Chain Finance (SCF)

• What is Supply Chain Finance?

• Market Drivers for SCF

• Why is it Important?

• Comparison to Invoice Discounting

• Should you start an SCF Program?

• Services available from Banks

• Questions and Answers

Slide 2
Introduction to Supply Chain Finance May 9, 2008


Working Capital Tensions

Slide 3

Buyer-Supplier Payment Dynamics

Manufacturing Warehouse
Purchase Inspection Ocean Import & Ground Invoice Invoice Payment
& Assembly Receiving
Order & Export In-Transit Customs Transit Delivered Approval Released

0 15 45 50 80 85 90 95 100 150

Suppliers need cash to Buyers prefer to extend
pay for raw materials, payment terms and
manufacturing labor and hold cash to optimize
operating expenses. working capital.

Supply Chain Finance attempts to relieve buyer-
supplier payment tension, by enabling both parties to
set the terms they prefer.

Slide 4

Extending Payment Terms

Late Payment

Net 60

Net 45
Term

Cost
Risk
Net 30

Payment on Delivery

What are the hidden risks and costs to the buyer
of extending payment terms with suppliers?

Slide 5


International Trade

Slide 6

International Trade Challenges

Supplier of Goods or Buyer of Goods or
Services In China Services In US

Buyer’s
Supplier’s Location
Plant

Supplier’s Challenge Buyer’s Challenges
– Purchase raw materials – large – Risk of delay from inaccurate
upfront expense documentation or risk
– Fund labor for production – Working capital tied up in long
– Very long cash-to-cash cycles - 90 lead time and buffer inventory
days from shipment to payment – Risk of supplier not delivering
– Risk of buyer not paying against terms and conditions

Slide 7

Letter of Credit
International Trade Instrument

Supplier’s Buyer’s
Financial Institution Financial Institution • Letter of Credit – Means for
a shipper to collect payment
for his goods from the
customer.
Exchange of Funds
• Useful in international
shipments where US law
cannot help with
Sends all nonpayment
Upon Receipt
Documents Customer notifies
For Payment to • Letter of Credit specifies in
Bank to Pay
Bank
explicit terms what the
customer wants and when.
• Customer sets aside funds
for payment with bank
• Documents are sent to
Physical Flow of Goods
financial institutions to
mediate payment and terms
Supplier Buyer

Slide 8

Challenges with Letters of Credit

Use of Letters of Credit are in
decline in North America & Europe

– LOCs are time-consuming. Manual
matching of trade documents is required to
satisfy payment criteria.
Bank To satisfy
– LOCs are expensive ($1000-$1500)
personnel LOC
compared to open account transactions
match all requirements
($50-$200 plus variable expense).
trade for payment
documents to supplier
– LOCs require the use of a financial
institution. Open Account transactions don’t.
– Trade relationships between buyers and
suppliers have become more established
over longer periods of time. Supply chain
dependencies provide an effective deterrent
against non-payment.

Slide 9

Migration to Open Account

Open Account
Declining Use of Bank Instruments – Supplier offers credit to buyer with no
for International Settlement bank guarantee of payment
– Less formal structure for disputes or
missed payments
– Risk shifts from buyer to supplier in a
transaction

Market Drivers for Open Account
– International trade transactions
between are becoming more common
as global export/imports boom
– Suppliers have established long-
standing relationships with
2005 2006 2007 2008 2009 2010
international buyers
Letter of Credit Open Account – Less expensive, complex and time
consuming than letter of credit

Slide 10

Trade Settlement Risks
Primary International Trade Instruments

Risk of Non
Open Account
Payment

Buyer’s Risk
Documentary Collection
Supplier Risk

Letters of Credit

Risk of Non
Cash in Advance Delivery

Slide 11

Letter of Credit Finance Program


0 15 45 50 80 85 90 95 100 120

Supplier Buyer
Risk for Supplier’s Bank
is low with L/C
guaranteeing Payment
from Buyer’s Bank

Supplier’s Bank Supplier obtains Buyer’s Bank
Issues Export financing based Issues Import
Letter of Credit upon L/C Letter of Credit

Upon Matching of
Documents,
Payment Occurs
Bank Bank

Slide 12

Open Account Supplier Finance


0 15 45 50 80 85 90 95 100 120

Supplier Buyer

Risk for Supplier’s Bank
is high with just a
Buyer pays upon
Supplier seeks Purchase Order and no maturity of invoice
financing based Guarantee of Payment and resolution of
upon PO from Buyer or Buyer’s disputes
Bank

Funds transfer
occurs at
settlement
Bank Bank

Slide 13

Open Account & Extended Terms
Hidden Costs and Risks in the Supply Chain

Small Supplier Large Buyer
Longer Days Sales Outstanding Realizes higher overall costs as
and greater cash flow supplier’s pass on financing
challenges costs in pricing
Must seek alternative terms of Extended payment terms may
financing based upon supplier’s increase tensions in
credit worthiness and ratings relationships with suppliers
Inability to seek appropriate Risk of supply chain disruption if
financing may result in supplier insolvency or work
insolvency or work stoppage stoppage occurs

What impact do Open Account and Extended
Payment Terms have on Small Suppliers?

Slide 14

Unbalanced Trade Terms

Buyer Supplier
(Importer) (Exporter)

Buyers introduce Cash Flow
Higher Risk and Pressures burden
Cost Small Suppliers

Slide 15


Introduction to SCF

Slide 16

Supply Chain Finance Example

1 – Buyer issues purchase order

Supplier’s
Buyer’s
2 – Supplier delivers goods Accounts
Accounts
Receivable
Payable
3 – Supplier invoices buyer

5 – Supplier
4 – Buyer approves 6 – Supplier accepts
offered early
invoice for payment and early payment
payment
sends confirmation to discount
bank
7 – Bank funds early
payment to supplier
8 – Buyer makes
payment on
original due date

Or extends Supply Chain Processes
payment terms
Opportunity Identified
Financing Supplier Payment Process
Source Buyer Settlement Process

Slide 17

Supply Chain Finance Benefits
A Win-Win-Win Scenario for All Participants

Supplier Buyer
– Immediate access to cash – Lower cost of goods sold
– Reduced DSOs – Lower supply chain risk
– Improved cash flow visibility – Longer DPOs
– Lower financing costs – Use financial strength as
– No debt on balance sheet competitive advantage

Bank
– Re-intermediation into supply
Working
Costs and chains even open account
Capital
Risks are – Income from financing
– New customers – suppliers
optimized for
lowered in the who gain financing
all parties
supply chain – Cross-sell opportunities

Slide 18

Multiple Funding Options

Supplier’s
Buyer’s
Financed Accounts
Accounts
Transaction Receivable
Payable

Third Party
Buyer’s Buyer’s Supplier’s
Financier
Bank Treasury Bank

Slide 19

Supplier Segmentation by Credit Rating

Cost of Working Capital = Small to Medium
13.5%
Suppliers have the greatest interest rate
expense
8.5%

Cost of Funds
Prime Plus
5.0%
Cost of Funds Premium
Prime Plus 13.50%
8.50% (6.0%+750bp)
Cost of Funds
(6.0%+250bp)
Libor Plus
5.0%
(4.0%+100bp)

Small
Large Corporate Medium
Suppliers
Buyers & Suppliers Suppliers

Slide 20

Supplier Segmentation by Credit Rating

Post-Shipment Finance Scenario
13.5%
– Buyer has received goods and
confirmed intention to pay
invoice
Opportunity for
Cost Reduction – Invoice is date-certain, dollar-
certain from bank’s perspective
Cost of Funds
Prime Plus – Risk is with buyer non-payment,
5.0%
Premium independent of supplier credit
13.50%
– Financing can be offered to
(6.0%+750bp)
Cost of Funds
supplier based upon buyer’s
Libor Plus
credit rating and limits
5.0%
(4.0%+100bp) – Bank can obtain a margin for
accepting the risk and utilizing its
working capital
Small
Large – Supplier benefits from
Suppliers
Buyer significantly improved rates

Slide 21

Supply Chain Finance Defined

A category of solutions designed to provide working capital financing and
accelerated cash inflow to suppliers on the basis of the value of physical
or financial supply chain events such as issuance of a purchase order or
approval of an invoice.

These solutions frequently include features that are beneficial to the
buyer, but this is not a requirement.

SCF solutions are equally applicable to domestic and cross-border trade
activity.

Source: Tower Group

Slide 22


What’s New in SCF?

Slide 23

Invoice Discounting
Buyer Initiated and Funded Early Payment Program

Normal Accounts Accounts Payable
Payable Process with Discounting

Buyer Buyer

Purchase Purchase Supplier
Order Order Invoice
Payment
Term
Physical Physical
Shipment Shipment
Supplier
Invoice

Buyer Discounted
Payment Payment

Supplier Supplier

Slide 24

Payment Discounting
Buyer Initiated Early Payment Program

Discounting Explained
Accounts Payable
– Buyer manages program
with Discounting
– Upon invoice approval propose discount
to supplier
– Full payment minus discount released
Buyer upon acceptance of proposal
– Buyer funds with cash on balance sheet
(or through 3rd party)
Purchase Supplier
– Buyer compares opportunity cost of
Order Invoice
using cash for discounting versus others
Physical
Shipment
Pros & Cons of Discounting
– Accelerates cash flow to supplier
reducing DSOs and freeing up working
Discounted
capital
Payment
– Provides cost savings to buyer with
strong cash position
– Only available post-shipment
Supplier
– Relatively high financing rates

Slide 25

Factoring Receivables
Supplier Initiated Early Payment Program

Normal Accounts Accounts Receivable
Receivable Process with Factoring

Buyer Buyer

Purchase Purchase Supplier
Order Order Invoice
Payment
Term
Physical Physical
Shipment Shipment
Financial Institution
Supplier
Invoice

Buyer Upfront Final
Payment Payment Payment

Supplier Supplier

Slide 26

Factoring Receivables
Supplier Initiated Early Payment Program

Factoring Explained
Accounts Receivable
– Supplier initiates process with Factor.
with Factoring
– Sells book of receivables to Factor.
– Cash for as much as 90% of invoice
– Receive remaining 10% minus a
Buyer factoring service fee once the company
receives payment
– Factoring fees depend upon credit
Purchase Supplier
worthiness of customers
Order Invoice
– Factor assumes responsibility for
Physical
accounts receivable and collections
Shipment
Financial Institution
Pros & Cons Factoring
– Free up cash-flow to solve short-term
Upfront Final
financial crunches
Payment Payment
– Smoother, more consistent cash flow.
– Relatively expensive financing cost
– Must factor book of receivables to
Supplier
balance risk for 3rd party factor

Slide 27

Supply Chain Finance Versus Traditional

Invoice Receivables Supply Chain
Discounting Factoring Finance

3rd Party Buyer, Supplier
Cash Rich
Funding Financial Buyer or Supplier’s Bank
Buyers
Sources 3rd Party Financier
Institutions

Can be based
Financing 15-25% Effective 15-25% Effective
upon buyer’s
APR is typical
Rates APR is typical
credit rating

On Demand
Payment PO Acknowledgement
Upon Buyer’s Typically upon
Export, Import or
Invoice Approval Invoice Submission
Timing
Invoice Approval

Entire invoice or
Financing Individual Bundle of
Specific line items
Amount Invoice Receivables
on purchase order

Slide 28


Other Financing Types

Slide 29

Three Types of Financing


0 15 45 50 80 85 90 95 100 130

Pre-Export Financing Inventory Financing Post-Export Financing
Inventory owners (which may Most banks will only offer
Suppliers need a working
be buyer or supplier) want to financing once the invoice is
capital loan to finance
finance the inventory while it approved by the buyer. The
purchases of raw
is in transit. Banks offer window for financing is only
materials and to fund
financing for goods as they the last 30-60 days of a 130-
operating expenses for
flow through the supply chain. 180 day transaction
manufacturing and labor.

Slide 30

Multi-Stage Supply Chain Finance Example
Part 1 – Export Triggered Finance Opportunity


0 15 45 50 80 85 90 95 100 130

Quality Inspection Electronic Event
Certificate from Confirmation of Notification
Buyer’s Local Export from Port
Agent in Region. of Origin.

Supply Chain Finance Platform

Bank presents
early payment
option to supplier

Supplier accepts
option for partial
early payment
Financier Buyer
Supplier

Slide 31

Part 2 – Export Triggered Finance Opportunity


0 15 45 50 80 85 90 95 100 130

Quality Inspection Electronic Event
Certificate from Confirmation of Notification
Buyer’s Local Export from Port
Agent in Region. of Origin.


70% of Purchase
Order Value
Transferred to
Supplier
Financier Buyer
Supplier

Slide 32

Part 3 – Buyer Receipt Triggered Payment


0 15 45 50 80 85 90 95 100 130

Quality Inspection Electronic Electronic Proof
Event Event
Certificate from Confirmation of of Delivery from
Notification Notification
Buyer’s Local Export from Port Buyer’s
Agent in Region. of Origin. Warehouse

Phase 1
Phase 2

30% of Purchase
Order Value
Transferred to
Supplier

Financier Buyer
Supplier

Slide 33

Multi-Stage Example –Part 4 - Buyer Payment at Term


0 15 45 50 80 85 90 95 100 130

Quality Inspection Electronic Electronic Proof
Event Event Payment
Certificate from Confirmation of of Delivery from
Notification Notification Approved and
Buyer’s Local Export from Port Buyer’s
Release by Buyer
Agent in Region. of Origin. Warehouse

Phase 1
Phase 2

Remaining 30% of Funds
Released to Supplier
100% of Funds
Release to
Financial
70% of Funds Institution
Released to Supplier
Financier Buyer
Supplier

Slide 34


Starting a Program

Slide 35

Benefits Achieved from SCF
Aberdeen Research – State of the Market 2008

Level of Activity in SCF Benefits Achieved

26% - No 15% - Actively Lower unit costs of 57%
Action Taken using SCF procured goods

Lower risk in 48%
supplier base

Extended payment 33%
terms (DPOs)

Lower production
52%
costs

Lower days sales
43%
outstanding

Improved business 38%
continuity
18% - Plans
40% -
Trade financing at
in Place for 43%
Investigating
lower rate
SCF
SCF

Slide 36

Should you Create an SCF Program?

Considerations for You
– Accounting Treatment – A/P
versus Short Term Debt
– Credit Rating as compared to
Supplier Community
– Funding Sources – Internal
versus Banks & Specialists
– Opportunity Cost of Credit Lines
and Cash versus Others

Vendor Considerations
– Global Footprint in Locations
Suppliers are based
– Legally authorized to Factor in
Supplier’s Country
– Understands Taxes owed on
Factored Invoices
– Financial Resources to Fund
Your Program

Slide 37


Bank Services

Slide 38

Banks focus on Supply Chain Finance

Declining Use of Bank Instruments Declining Trade Revenues Need to
for International Settlement Be Offset with New Services

2005 2006 2007 2008 2009 2010 2005 2006 2007 2008 2009 2010

Traditional New Working
Letter of Credit New Mechanisms
Trade Finance Capital Services

Slide 39

Landscape of Banking Services

Slide 40


Post-Shipment Scenario
– Financing based upon the credit
rating of the buyer.
– Buyer using good credit to provide
low cost financing to suppliers.
– Can be a competitive differentiator
in battle of supply chains.

Reverse Factoring
– Financing buyer’s A/P versus
supplier’s A/R
– True sale of supplier’s receivable
– Recourse solely back to buyer
– Required date and dollar certainty
from buyer on invoices

Slide 41

Thank You

Slide 42

Introduction to Supply Chain Finance

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