For manufacturers like AGCO and Michelin, adopting supply chain finance best practices is a matter of dollars and sense.
Manufacturing is having a moment. Optimism on Wall Street and rising levels of consumer and business confidence have put manufacturing squarely back into growth territory. One index that tracks global manufacturing performance, the JPMorgan Global Manufacturing PMI, is the highest it’s been since 2011. Production growth rates are at a three-year high. So is the rate of expansion in new orders. And factory payrolls are growing faster than they have in over five years.
By all indications, 2017 is shaping up to be a growth year for manufacturing. But a few concerns lie underneath the good news. Average input prices are rising and supplier delivery times are longer. While this is typical of growth pressures on the supply chain, it also underscores the challenges.
Growth, it turns out, can be messy. No matter how “optimized” the manufacturing environment may be, accommodating growth across the supply chain is a risky burden to bear. Rising production costs, new infrastructure projects, competitive R&D initiatives, acquisitions—these byproducts of growth require large sums of capital and flawless cash flow management.
AGCO, a global manufacturer of agricultural equipment, understands this well. Acquisition has been a highly successful part of the company’s global growth strategy for the last 25 years, but the implications on cash flow haven’t always been positive. As the company has increasingly consolidated its supply base, varying accounts payable practices and multiple ERP systems have made it difficult to manage cash flow. At one point, the company had more than 70 different supplier payment terms in North America alone.
Today, AGCO uses supply chain finance to standardize its accounts payable practices, improve cash flow and increase R&D investment—and they’re not alone. In a recent study conducted by Global Business Intelligence, one out of five companies surveyed uses supply chain finance. That number is expected to grow as companies seek new ways to access liquidity to fund growth initiatives.
Supply Chain Finance: What It Is, What It’s Not
Despite supply chain finance’s rise in popularity, there are many misperceptions. This is due in part to a growing marketplace of solution providers that are bending the definition to fit their offerings. It’s also due to the fact that it’s highly nuanced and the line that separates it from other financing alternatives is thin.
At its core, supply chain finance improves cash flow by extending a manufacturer’s supplier payment terms, while at the same time giving suppliers the option to receive early payment for invoices. All of this occurs without negatively impacting the manufacturer or supplier’s balance sheet.
Let’s focus on the first part of the supply chain finance for a moment—longer supplier payment terms. In the case of AGCO (and many other manufacturers), payment terms are often inconsistent across the supply base. Furthermore, they’re not always in line with the industry standard. For example, the standard for days payable outstanding (DPO) in the heavy equipment manufacturing industry is 80 days. A manufacturer that pays suppliers based on a 45-day term is paying too quickly and reducing the company’s access to working capital. By increasing supplier payment terms from 45 days to 80, the manufacturer frees up cash that would otherwise be trapped in the supply chain—cash that could be used to fund R&D, a new plant or another growth-centered initiative.
One of the reasons why many companies don’t extend supplier payment terms is because of the negative impact it can have on suppliers. Supply chain finance tackles this concern head-on.
That takes us to the second part of supply chain finance. To negate the impact of longer payment terms, suppliers that participate in a supply chain finance program have the option to get paid early—typically as soon as the invoice has been approved by the manufacturer. The supplier simply chooses which approved invoice(s) to submit for early payment, then “sells” their invoice to a funder (usually a large financial institution like a multinational bank). For those receivables that are paid early, the supplier will pay a small finance charge or discount. The manufacturer then repays the bank for the amount of the invoice traded.
Accounting treatment for supply chain finance, when done properly, doesn’t count as additional debt for the manufacturer or supplier. It’s a win-win for both parties. Both the manufacturer and supplier improve cash flow without affecting their balance sheets. This is a key benefit of supply chain finance and what separates it from other financing alternatives. In fact, in order to understand supply chain finances it’s important to understand what it’s not:
It is not a loan. There is no lending on either side of the manufacturer/supplier equation, which means there is no impact to balance sheets. It’s a non-recourse, true sale of receivables for the supplier and an extension of the manufacturer’s accounts payable function.
It is not dynamic discounting or an early payment discount program. Early payment programs, such as dynamic discounting, offer suppliers earlier payments in return for discounts. This tactic is expensive for both suppliers (who are getting paid less) and manufacturers who tie up their own cash to fund the programs.
It is not factoring. In factoring, a supplier sells its invoices to a factoring agent (in most cases, a financial institution) in return for earlier but partial payment. Suppliers trade “all or nothing,” meaning they can’t pick and choose which invoices to sell based on cash flow needs. Additionally, most factoring programs are recourse loans. If the supplier has received payment against invoices that the manufacturer subsequently does not pay, the lender has recourse to claw back the funds.
For AGCO, the decision to use supply chain finance was easy. It enabled them to standardize and streamline its account payable operations and improve cash flow, while reducing cost of capital.
A Growth Enabler and Defensive Line
AGCO’s supply chain finance program has been highly successful. In the first few months, the company on-boarded many of its largest suppliers which accounted for a meaningful percent of the company’s spend. This is due in part to the program’s multi-funder strategy. With operations and suppliers across the globe, it was important for AGCO to give suppliers access to multiple funding sources to ensure all currencies and jurisdictions were covered.
In the first year, AGCO’s supply chain finance program processed more than $100 million in direct material spend and freed up almost $30 million in working capital. Today, investment in R&D as a percent of sales is increasing. The company’s suppliers have also benefited from improved cash flow to prepare their own operations for growth.
AGCO’s story is just one example of how supply chain finance is helping manufacturers head off the challenges of growth. Michelin, the tire manufacturing giant, also uses a multi-funder supply chain finance program that covers seven countries and almost 100 suppliers. The program has freed up more than $200 million in cash flow, which is being used to fund an aggressive corporate growth and innovation strategy.
A German filtration systems manufacturer for automotive applications is also a proponent. The company uses supply chain finance as a lower-cost alternative to commercial-based lending to expand market share. With the help of cash flow generated through supply chain finance, the manufacturer has made four major acquisitions in recent years (including the purchase of a leading after-market oil filter brand) and opened new corporate campuses and an innovation center.
Suppliers are also getting in on the action. In one example, a leading appliance manufacturer used supply chain finance to improve its financial outlook following a major acquisition. By participating as a supplier in one of its customers’ programs, they were able to access $1 billion in working capital to invest in new manufacturing facilities and plant upgrades. The company was so impressed it eventually launched its own supply chain finance program with its suppliers.
Growth is an interesting thing. Businesses, especially manufacturers, take extraordinary measures to achieve it. But the optimism it creates often overshadows the liquidity demands that accompany it. Economic expansion, like recession, comes with risks. And, while current reports suggest manufacturing growth will continue for the foreseeable future, global manufacturers don’t have the luxury of being overconfident in this data. How long will growth sustain? How will the nascent economic policies of the current administration impact the business? What about the economic slowdown in China, the banking crises in Europe or Brexit?
Being able to optimize cash flow and reduce the cost of liquidity in any economic environment is the end goal. Manufacturers that focus on this cash flow mission will be able to realize growth more quickly and easily—as well as weather whatever changes lie ahead in 2017.
Tom Roberts is senior vice president, global marketing, with PrimeRevenue, a provider of supply chain finance services, where he and his team are engaged in building digital demand generation capabilities. Prior to PrimeRevenue, he held both sales and marketing executive leadership positions at other financial technology companies such as Fiserv, CashEdge and E*TRADE Financial.