Assisting our clients in optimising their working capital is, in essence, a co-development exercise. It is not just a matter of designing and offering a financing product, but rather a matter of embedding a solution within the company supply chain processes, to ultimately generate available cash, without the client showing additional debt on its balance sheet. Improvement of working capital metrics can be achieved using one or a mix of paths. Each of them will result in an improvement of the company's cash conversion cycle:
How working capital metrics can be improved through a collaborative business approach.
- Extending the payment terms granted by suppliers
- Accelerating the conversion of inventory into cash
- Accelerating the conversion of receivables into cash
Each of those levers is embedded in the core operation of a company, its suppliers, its client, its purchasing or commercial strategies. The efficiency of each lever is therefore substantially different from a sector to another and even among peers in the same industry. The commercial balance of power between the client and its suppliers or clients, their granularity, the weight and nature of inventory, are just a sample of parameters that can change the equation drastically. This lack of homogeneity generally prevents standardised or pre-defined solutions being appropriate for the client and instead tailor-made solutions are required.
The need for tailor-made advice and deep due diligence process with clients may not be enough to qualify a co-development process. After all, most corporate financing solutions with some level of structuring would have such ingredients. Here, however, the processes relevant to working capital optimisation, as described above, involve many more stakeholders within a corporation than the average financing deal, ranging from Procurement to Operations to Sales or Accounting. Each of those internal stakeholders, are following their relevant agenda and KPIs, which are not always naturally converging. This is where co-development is needed. Now let's get into a couple of purely fictitious business cases to illustrate this statement; one following the Inventory path and a second the extension of payment term path.
How to decrease purchase price while supporting your critical suppliersThis promise is not one that is commonly attached to a financing deal, nor one that can be delivered in a face to face development with Treasury and Finance. Imagine a large, multi-national corporation in the food industry, manufacturing and marketing large volumes of products based on tomato paste. Tomato paste supply, its quality, price and reliability are critical to the production process which is linear over the year, as the end product consumption is only moderately seasonal. The harvesting of tomato crop and its transformation into paste, however, is concentrated over a single month each year. This leads to long presence of inventory in the supply chain, to feed the constant production flow.
In our case, the production of tomato and tomato paste, comes from relatively small sized agricultural cooperatives located, say, in southern Spain. Those suppliers have to keep substantial amount of inventory for an average period of six month, before it is released and bought by their main client to feed its production needs. Given their relatively low credit rating and cost of credit on the local market, the financial cost of holding large amount of inventory for such a long period is very substantial, and has to be reflected in their selling price.
"The processes relevant to working capital optimisation involve many more stakeholders within a corporation than the average financing deal"
How to obtain extended payment terms from happily consenting suppliersPayment terms are driven by many parameters, which include regulation (not negotiable), and industry or regional practice. Commercial leverage, or the lack of it, remains the most powerful driver. If a company is in the business of buying smartphones that everybody wants to buy, but only one (or two) companies can sell, or needs to buy this rare metal that is produced in only two mines around the globe, then payment term extension (happily or otherwise), is going to be an uphill battle. At the other end of the commercial leverage scale, efficient pressure can be made for favourable payment terms, but abusing such leverage can become a Pyrrhic victory if supplier base suffers too much.
Setting up a payable programme - whereby suppliers can discount their invoice at favourable terms, get paid earlier and negotiate an extension of the payment terms as part of the deal - is the solution that a financial partner can provide to achieve this objective. There is a long way, however, between this concept and its successful implementation. Parameters such as the commercial leverage described above, the granularity of the supplier base, the respective credit rating and average cost of financing of the suppliers and of the buyer, and how the cost of the programme will be shared will require substantially different solutions and strategies: again a real case of co-development.
Imagine a large, multinational, transportation equipment manufacturer, with ten factories and operational divisions spread over three continents. Their targeted supplier base is constituted of sixty companies, also geographically spread, of various sizes, credit standings and invoicing currencies. The objective of this client is to obtain a substantial extension of payment terms from the largest possible proportion of this supplier base in a short period of time. The programme needs to achieve true sale treatment for the suppliers, in all the jurisdictions regardless of their accounting conventions (IFRS, USGAAP...). The client requires "trade payable" accounting treatment. Ultimately, the success or failure of the programme will be dictated by the suppliers. If the client and the bank manage to demonstrate to suppliers that the programmes brings value to them and, or at least, is non-disruptive, they'll "happily" join. If the design of the programme and, of equal importance, the direct involvement of the client with its supplier, is not well executed, they'll just listen politely and the expected working capital improvement will never happen.
In this case the first ingredient of success is the setting-up of dedicated client project team. The second ingredient is the design and execution of a "marketing" strategy towards suppliers, which was based on targeting first the largest and more likely to consent to generate momentum, investing lots of resources and dedicated presentations on those initial steps. Those supplier on-boarding actions, again, were in design and execution a joint work with our client.
The BNP Paribas Supply Chain Management set-up includes a wholly-owned trading company called Utexam Logistics Limited, set up for the specific purpose of buying, holding and selling inventory to achieve working capital optimisation for our clients, a process that includes: a thorough co-development process with the client, its procurement department, its suppliers, its accounting, a review of the supply contracts, the storage facilities and insurance arrangement. After this review, Utexam buys the portion of the product needed by our client on day one. This flow allows its supplier to achieve a massive improvement of working capital and very substantial savings in the financing cost attached to the inventory. Suppliers, logically, are successfully invited to decrease their selling price accordingly.
From our multinational client perspective, the structures allow for the strengthening of the financial position of critical but fragile suppliers, and improve their procurement cost substantially in excess of the financing cost attached to the Utexam structure.