Supply Chain Financing in the Face of COVID-19

Supply Chain Financing in the Face of COVID-19
Automotive Banking and Finance Chemicals Construction Consumer Goods Industrial Manufacturing Mining and Cement Oil and Gas Public sector Services Transport Utilities COVID-19 poses a challenge to the supply chain of many industries. The spread of COVID-19 across the world has put a strain on global trade, which has brought about temporary...

Automotive
Banking and Finance
Chemicals
Construction
Consumer Goods
Industrial Manufacturing
Mining and Cement
Oil and Gas
Public sector
Services
Transport
Utilities

COVID-19 poses a challenge to the supply chain of many industries.

The spread of COVID-19 across the world has put a strain on global trade, which has brought about temporary paralysis of operations in many industries. No sector across the global economy has been spared some level of disruption, with some of the most prominent sectors being hospitality, transportation and construction. Governments have mandated near-total shutdowns for many businesses, while many others are operating at greatly reduced capacity after a collapse in demand and/or supply.

Elaborate supply chains critical to most industries, and the COVID-19 outbreak has dramatically illustrated the difficulties of securing critical goods such as PPE when links come under pressure.

For supply chains to operate it is not only the physical logistics that need to be in place, but also the requisite financial flows. The latter will be a major challenge for some supply-chain players, and they will need all the financial help they can get to stabilise their operations and ensure their survival. This article looks at approaches to securing supply-chain finance in order to ensure business continuity for many companies during these hugely challenging times.

Symbiotic/Mutualistic Relationships

One of the organisation types within supply chains that is most exposed to risk, and is struggling to stabilise operations, and in some cases stay afloat, is small-scale suppliers, especially those who supply only a handful of products. Their lack of diversification prevents them from switching efforts to products with greater demand, and in some cases, they have limited exposure to different supplier financing solutions, which could help increase their chances of survival.

These suppliers are very important to the supply chain ecosystem and their survival may require buyers to step in proactively and change the nature of their relationship. As an approach to mitigating risk, they can identify and explore the causes of their established suppliers’ risks, which will often be inadequate working capital. Whereas in normal times, driving prices down and fostering competition among suppliers might be good business, such tactics could rob buyers of their supply altogether during this crisis.

There are helpful analogies with the natural world when discussing buyer-supplier relationships. Parasitic relationships (where one organism benefits at the expense of another) are common in the natural and business worlds but will exacerbate supply-chain disruption when links are already in distress. Neither does commensalism (where one benefits and the other is neither helped nor harmed) strengthen strained supply chains.

In contrast, if organisations can foster relationships based on mutualism (where both sides benefit) the chain stands greatest chance of surviving and recovering when the crisis is diminished.

Several supply chain finance options offer a path for this synergistic relationship that can be formed between buyers and suppliers in order to minimise the impact of the current cash flow strains.

Supply Chain Finance Options

Dynamic Discounting

This form of financing mainly involves a Supplier offering a discount to a Buyer, if the Buyer takes up an offer to pay the Supplier early. Through this arrangement a supplier will be able to raise a request for an early payment to be made at any time, upon the approval of an invoice.

This supplier financing solution typically features different discount amounts that can apply based on how early the invoice payment to the supplier is, thereby boosting supplier finance operations. This could be an attractive proposition to Buyers who may be in a relatively strong cash position, and provided the discount requested is fair, their collaboration will be symptomatic of a mutualistic relationship that is well suited to the current business climate.

If both parties can negotiate this type of arrangement, it can be the difference between the supplier staying in business—thereby being able to pay their running costs, overheads and maintaining cashflow, whilst also reducing any disruptions to the buyers supply chain, and the supplier going out of business, thereby leading to loss of jobs and expertise. Costco Wholesale is one of the companies that have successfully used dynamic discounting.

Supplier Benefits: Quick access to very much needed cash, sustainability of their business in a challenging environment

Buyer Benefits: Discount derived from paying suppliers early, higher margins and growth Opportunities

A quick definition of this type of financing as laid out by the Global Supply Chain Finance Forum, is that payables finance is a “buyer-led programme within which sellers in the buyer’s supply chain can access finance by means of receivables purchase”. The finance provider in this type of scheme is a financial institution, such as a bank. The financial institution provides funding for this scheme based on the creditworthiness of the buyer, therefore, there is less emphasis on the financial status of the supplier.

The financing works in a fashion whereby a buyer approves an account payable, with a guarantee to pay, and the supplier can then sell the product(s) required, with the benefit of being able to receive payment early from the participating financial institution (typically a bank). It is worth noting that this payment will be a reduced/discounted amount than the supplier would have otherwise received.

Payables Finance: A Guide to working capital optimisation by Deutsche Bank, provides further details how working capital of organisations can be enhanced by using this financing option.

Supplier Benefits: Certainty of payment, Payment visibility, Availability of working capital.

Buyer Benefits: Reduced supply chain risks, Improved supply relationships, liquidity optimisation, alternative source of funding.

According to Trade Finance Global “A Special Purpose Vehicle (SPV) or Special Purpose Entity (SPE) is a separate legal entity created by a parent company”.

This can be further described as a situation where a Buyer uses a special purpose vehicle (separate entity to the Buyer organisation or parent company) to create a financial instrument, which can be purchased by financial institutions such as banks, hedge funds, pension funds, or by the Buyer themselves, depending on the dictates of the law within the jurisdiction or country they operate in. By adopting this approach, the buyer can increase their revenue and their working capital.

SPVs are a way for a parent company to isolate financial risk away from them and to securitise assets. The ability of the Buyer to increase their revenue through the use of this type of financing offers a mutualistic and collaborative avenue of engagement between the parties involved, as the supplier will also be able to gain access to much needed funds to maintain their business operations. Although this supplier financing solution offers tangible benefits, they have been misused in the past and contributed to the last financial crisis as documented by KPMG: Creating an understanding of Special Purpose Vehicles .

Supplier Benefits: Payment certainty, visibility of payment.

Buyer Benefits: Improving supplier relationships, Reduced supply chain risks, increased working capital.

According to the Professional Association for the Commercial Card and payment industry “A Purchasing Card (P-Card) is a type of Commercial Card that allows organisations to take advantage of the existing credit card infrastructure to make electronic payments for a variety of business expenses (e.g., goods and services). In the simplest terms, a P-Card is a charge card, like a consumer credit card. However, the card-using organisation must pay the card issuer in full each month, at a minimum”.

With this facility a supplier can be offered early payment terms for them to receive their payments early. This could be a viable supplier financing solution for small payments to small scale suppliers within a buyers network of suppliers, if a Buyer chooses to use this option. Thereby there is a potential for a mutually beneficial relationship to be established from the benefits that both parties stand to derive.

Supplier Benefits: Early payment, enhanced cash flow.

Buyer Benefits: Reduced admin costs, Reduced supply chain risks.

Most of the supply chain financing options highlighted in previous sections provide a win-win solution for the parties involved, if they work together to choose the option that best suits their business situation.

Moreover, building mutualistic relationships should pay dividends for a stable supply-chain that mitigates risks and provides opportunities that can be explored well beyond the COVID-19 crisis.

Admittedly these are challenging times in business and in society, however, in the words of Michael Jordan, “Talent wins games, but teamwork and intelligence win championships.” If buyers and suppliers work together as a team to explore different options in forging ahead, there will be light at the end of the tunnel.

Disclaimer

Readers understand that Achilles provides information relating to financial options for general information purposes only and does not provide legal or professional financial advice. Achilles is not responsible for any damages resulting from any decisions of the reader that are made in reliance on the information provided through the blog post, including legal, compliance and/or risk management decisions.

Written by Akinola Fakeye, Product Manager, Achilles

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Source: www.achilles.com